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The Perils of a Discredited Appraisal: Critical Insights on Kollsman v. Commissioner

We welcome guest blogger Cindy Charleston-Rosenberg, ISA CAPP. Cindy is a past President and Certified Member of the International Society of Appraisers (ISA), the largest professional organization of qualified appraisers in the United States and Canada.   She is an experienced expert witness and writes and presents widely on advanced appraisal methodology issues. Cindy is active in industry activities to raise awareness of the critical importance of meaningful appraiser qualification standards. She provides insight on things we should consider in hiring an expert witness in order to avoid problems of qualification or bias. Keith 

A US Tax Court ruling has brought the perils of a discredited art appraisal into sharp focus. In the Estate of Kollsman v. Commissioner, the court rejected a premiere auction house appraisal for bias and absence of objective support. Relying almost exclusively on the IRS expert, the court concluded a $2,400,000 value for the disputed artwork. (The estate had valued the artwork at $600,000, the IRS at $2,600,000). Kollsman illustrates that preeminence in the auction business, or in another art-related profession, is not adequate assurance of appraisal expertise or competency. As Keith Fogg thoughtfully covered in a previous Procedurally Taxing blog post, an expert who has or is seeking any involvement in the sale or purchase of the subject of an appraisal can signal an obvious and avoidable conflict of interest.

Beyond bias, this post explores exposure in failing to select a relevantly credentialed expert, who will submit fully supported, impartial testimony and reports, allowing their opinions to be confidently embraced by the IRS and the courts. Those who practice tax law where the value of art is at issue may be held liable for failing to secure a qualified expert who can competently support contested value. Therefore, lawyers offering estate planning services should be familiar with established, meaningful, credible and defined appraiser qualification criteria when vetting personal property appraisal experts.

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In contrast to the disregarded expert witness offered by the estate in Kollsman, the IRS expert whose opinion prevailed and was found qualified, was a properly credentialed appraiser. Credentialed appraisers are trained and tested in appraisal standards, ethics and methodology, have had sample reports vetted through peer review, and are more likely to submit a full and impartial expert analysis.

In rejecting the appraisal offered by the estate in Kollsman as “unreliable and unpersuasive”, the court found profound deficiencies in competency as well as independence:

  • Absence of comparable market data: The court found it “remarkable” that the opinion was not supported by the comparable sales price data consistently found to be significant in prior cases, or that “any objective support” was offered to support the valuation figures. “He effectively urges the Court to accept them on the basis of his experience and expertise. We have no basis for doing so”.
  • Exaggerated discount for condition. In rejecting the wholly unsupported opinion of diminution of value based on condition, the court believed any reasonable investigation of condition impacts on value would, at a minimum, include an opinion from a qualified conservator.
  • Direct conflict of interest: The expert provided his fair market value estimates simultaneously with a solicitation for exclusive rights to auction the paintings if they were to be sold. The court found this to be a “significant conflict of interest that could cause a reasonable person to question his objectivity”.
  • Direct financial incentive: The court believed the expert was acting with incentive to undervalue estate tax liability in exchange for an agreement to benefit from selling the property. Judge Gale’s language was strong on this point, finding: “a direct financial incentive to curry favor” by providing “lowball estimates that would lessen the Federal estate tax burden borne by the estate”.

The Appraisal Foundation’s 2018 Personal Property Appraiser Qualification Criteria

The appraisal of art is a recognized professional discipline, distinct from other types of art market expertise, with clearly defined credentialing standards. When engaging an art appraisal expert it’s critical to assert the same diligence employed in engaging any other expert witness, which includes understanding the professional criteria specific to the discipline of appraising.

In the United the States, The Appraisal Foundation (TAF) is the foremost authority on the valuation profession. Under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), Congress authorized The Appraisal Foundation as the source of appraisal standards and qualifications.  TAF’s Appraiser Qualifications Board (AQB) is responsible for developing appraiser qualification standards for the real estate and personal property professions. TAF’s Appraisal Standards Board (ASB) issues and updates The Professional Standards of Professional Appraisal Practice (USPAP). Together these standards help ensure a trustworthy level of professional competency. After five years of research and analysis, including input from the credentialing sponsoring organizations, TAF issued an updated and more stringent Personal Property Appraiser Qualification Criteria, which is in effect as of January 1, 2018.

TAF sponsoring professional personal property organizations are required to adhere to these criteria when credentialing members. The International Society of Appraisers, The Appraisers Association of America, and The American Society of Appraisers maintain public online registries where the expert’s specialization, level of credentialing and current USPAP compliance may be accessed and confirmed.

Suggested Standards of Professional Responsibility in Vetting Appraisers and Expert Reports

  1. Require a current credential issued by one of the three TAF sponsoring personal property appraisal organizations. Members of the qualifying organizations earn their credentials through a rigorous admissions, training and testing process. They are required to comply with IRS and AQB guidelines, adhere to a code of ethics, are subject to oversight, and continuing education requirements. Before attaining Accredited or Certified status, members must submit appraisal reports to a stringent peer review process. These qualifications support competency, accountability and a commitment to professionalism. Consult the public registries of the qualifying organizations to ensure current credentialing. The International Society of Appraisers, the Appraisers Association of America, and The American Society of Appraisers.

 

  1. Appraisal reports should be well-supported. Every appraisal submitted to assist in determining tax liability has the potential to become the subject of litigation. The IRS Art Appraisal Services (AAS) is staffed by experienced appraisers, tasked with protecting the public from abuse in valuation resulting from inadequately supported appraisal reports. The IRS Art Appraisal Services is part of the IRS Office of Appeals. All AAS reviewers have been trained in appraisal methodology by one of the three TAF Sponsoring organizations and comply with USPAP continuing education requirements. The AAS is distinct from the IRS Art Advisory Panel. The members of the Art Advisory Panel are renown art experts, scholars and gallerists who serve without compensation.

Reports for objects of significant value should be supported by comparable sales data, relevant expert opinions, and a well-reasoned objective justification for each value conclusion. In response to IRS guidance, this is a required reporting component of all three TAF qualifying organizations for any object valued above $50,000. At a minimum, all appraisal reports should also disclose the approach to valuation and methodology employed, intended use, definition of value, markets explored, any conditions limiting assignment results, extraordinary assumptions, and scope of work.

  1. Appraisal reports should be comprehensive. IRS Publication 561, Determining the Value of Donated Property, outlines a Preferred Object Identification Format for Art Valued over $50,000. The suggested appraisal format includes a complete physical description of the object, including size, materials or medium, subject matter, name, nationality and life dates of the artist, signatures or other identifying inscriptions or markings, date of creation, provenance (history of ownership), condition, literature references and exhibition history. The IRS also recommends the appraiser exercise due diligence in confirming authenticity. The appraisal must include professional quality photographs of the subject properties. The IRS Preferred Object Identification Format for Art Valued over $50,00 defines “Art” as including paintings, sculptures, watercolors, prints, drawings, ceramics, antiques, decorative arts, textiles, carpets, silver, rare manuscripts, historical memorabilia, and other similar objects. This format essentially applies to all personal property.
  1. Appraisals submitted to the IRS should address how the appraiser meets the IRS Appraiser Qualification Criteria, and acknowledge civil liabilities associated with a grossly inaccurate valuation. The Pension Protection Act of 2006 ((PPA), P.L. 109-280, at §170(f)(11)(E)), codified the definition of a qualified appraiser and qualified appraisal report. The PPA strengthened the professional requirements a qualified appraiser must meet, specifically identifying organizational credentials, experience, and professional-level coursework. All IRS appraisals are required to include a statement of how the appraiser meets the IRS qualification criteria.
  1. Appraisals should include a signed and dated certificate of compliance with the Uniform Standards of Professional Appraisal Practice (USPAP). This certification must confirm that the assignment was not predicated on a pre-determined result. The certification should include a statement that the appraiser is compliant with the current version of USPAP (2018-19)
  1. The Uniform Standards of Professional Appraisal Practice (USPAP) is not a credential. USPAP sets critical ethics and reporting standards, but it is not a credential. An individual who promotes as “USPAP Certified” displays a superficial understanding of the standards of their own profession, because USPAP does not certify. The qualifying personal property organizations issue credentials. USPAP training and compliance is a 15-hour foundational course with a 7-hour bi-annual continuing education requirement. It is a required, but rudimentary component in achieving and maintaining an AQB compliant credential.
  1. Experts should be objective and disinterested. The PPA specifically disqualifies individuals who would have a conflict of interest in the outcome of the appraisal. An expert should do nothing that would cast doubt on the impartiality of their opinion.
  2. Contingent fees are prohibited by USPAP. The Ethics Rule of USPAP prohibits contingent fees without exception. An appraiser must not accept an assignment, or have a compensation arrangement for an assignment, that is contingent on a predetermined value result, based on a percentage of value, or attainment of any advantage (e.g., the appraiser will broker or sell the subject property).

In summary, preeminence in art sales or other art-related professions is not assurance of appraisal expertise or competency. In fact, an expert’s involvement in the sale and purchase of the subject artwork can undermine the perception of objectivity. Further, to manage the risk of a disqualified expert, appraisers should meet recognized professional standards for qualification and competency, including active credentialed membership in one of the three TAF qualifying organizations. In Kollsman, the appraisal credential of the IRS expert was referenced in the opinion.

Professional Qualification Criteria for Personal Property Appraisers are developed by The Appraiser Qualifications Board of The Appraisal Foundation. The standard is rigorous, meaningful, easily accessible to opposing parties, and is clearly defined. Qualification to AQB standards is the accepted minimum professional standard.

The three major appraisal organizations (TAF Sponsors) have united in a collaborative effort to inform the public of meaningful qualification standards. The Appraisal Foundation is in the process of developing a public campaign to promote these standards. Increasingly, it will be difficult for allied professionals to credibly overlook the qualifying standard of experts they customarily engage.

In the wake of Kollsman, it is critical for tax attorneys and tax and estate advisors who rely on expert appraisals to be familiar with appraiser qualification and reporting standards. Assertively vetting experts illustrates an advanced level of diligence, providing a critical, and often overlooked layer of protection for the clients we mutually serve.

 

 

 

 

 

IRS Art Advisory Panel

I saw a notice that “the IRS Art Advisory Panel plans to hold a closed meeting September 14 in Washington to review and evaluate the fair market value appraisals of works of art involved in federal income, estate, and gift tax returns.” While my low income clients have not in nine years raised any issues that cause me to have any concern about the Art Advisory Panel, I did have cases in which the panel was involved when I work for Chief Counsel. The panel is a rather unique part of the IRS. I thought I would write a post on it for those who have never had a case in which the panel is involved and may not know what it does.

Art is also just a fun topic to discuss. Les alerted me to a tax case involving art. The tax problem in that case is mostly a sales tax case related to state sales taxes and not valuation of art, but I think that art and taxes creates a combination that makes people sit up and listen a little closer. In the tax case in which I encountered the art advisory panel, there were a number of shenanigans going on related to the piece of art but not by the taxpayer. Art is so portable, so difficult to value, and so closely related to rich and famous that it creates its own interest.

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The panel consists of up to 25 experts from America’s art world who serve on the panel for no compensation. Based on my observation, the IRS is very fortunate to attract to this panel some of the top experts from the art world. A list of the current panelist is at the back of the current annual report from the Art Advisory Panel. I do not know exactly how the IRS goes about recruiting the experts and convincing them to provide service by participating in this panel and I do not know who came up with the original idea of creating the panel. The goal of the panel is to provide assistance to the IRS in valuing works of art without requiring the IRS to hire experts for all of the cases it works where valuing art becomes important.

The report contains a good description of the way the panel operates and provides figures on the amount of art work the panel appraised last year and the differences between the values it determined and the values provided by taxpayers. While the panel found higher values, the percentage of cases with higher values and the amount of the higher values was lower than I expected. The existence of the panel may discourage taxpayers from low-balling and keep art values submitted to the IRS generally in line with market value. The report did not discuss the types of cases in which the panel provided an opinion. My guess is that estate tax, and perhaps the gift tax, returns brought in most of the work of the panel.

The art advisory panel, or rather its members, does not generally serve as an expert witness for the IRS if it goes to trial but rather it serves as an expert for revenue agents and Estate Tax Attorneys who encounter the artwork during the examination process. The last case I tried when I worked for the Office of Chief Counsel, IRS involved the valuation of a painting. There were many interesting aspects to the discovery of the painting and what happened to the painting after discovery, but the trial essentially involved just the valuation of the painting on the date of death in an estate tax case. During the examination, the art advisory panel had been asked to opine on the value of the painting. The opinions of the experts at trial diverged wildly; however, the value placed on the painting by the Art Advisory Panel seemed quite logical and supportable to me. I was impressed with their work and I felt the panel served as somewhat of a neutral arbiter of value. The panel has no charge but to provide its best opinion of the value of a painting. The report does not provide data on how influential the panel’s valuations are in causing a resolution of the valuation issue. I suspect the panel’s opinions play a large role in reaching resolution in valuation cases involving art.

The values it provides may not always hit the mark but that is true of most experts. I am sure that sometimes artwork does not fit within the scope of expertise of any panel members and then the value provided by the panel loses some of its authority. Generally, a panel member exists in many fields of art in order to provide coverage for all of the types of art it may appraise. The Internal Revenue Manual at 4.48.2 and 8.18.1.3 requires that all cases selected for examination that include an art item with a claimed value of $50,000 or more must be referred to IRS office of Art Appraisal Services for possible review by the panel.

Rev. Proc. 96-15 provides a process for taxpayers to request a review of art valuations. Taxpayers can obtain a Statement of Value from the IRS for an advance review of art valuation claims before filing the return, which may then be used to complete the taxpayer’s return. The taxpayer can request this when the value of the art is $50,000 or more. Art is defined in Section 4.01 of the Rev. Proc. as:

.01 The term “art” includes paintings, sculpture, watercolors, prints, drawings, ceramics, antique furniture, decorative arts, textiles, carpets, silver, rare manuscripts, historical memorabilia, and other similar objects.

The Rev. Proc. details the method for making a request for an art appraisal prior to filing a return. The cost is $2,500.  If you get such an appraisal, you must attach a copy of the appraisal to the return even if you, the taxpayer, disagree with the appraisal.  I do not know how many people use this service.  As a litigator, I do not remember ever having a case in which someone used this service.  I do not know whether that is because almost no one uses it, those who use it do not have problems with valuation or a combination of both.

Bill Branch was the Chief of the Estate and Gift Branch when I was the District Counsel in Richmond. Bill is now retired and he works for McGuire Woods, a law firm in Richmond. I spoke with Bill about this post because I felt that Bill would have had a lot more experience than me dealing with the panel. He forwarded to me a fax and document he recently received from an E&G attorney listing out the items Bill needed to provide for the art advisory panel.   Bill also forwarded to me a short bio of Karen Carolan. Karen headed up the panel for the IRS for many years and was the person who assisted me in the case I had with the panel. Like many people I know from the IRS, she is also retired, but she would be the expert to contact if you had questions about the panel.

PBS must get decent viewer ratings for its antique roadshow program since it has lasted a long time. If they could produce a show based on the meetings of the art advisory panel, I suspect the ratings would be equally as good or better. The panel sees a lot of interesting stuff, it has top experts and mostly it operates under the radar.

 

Reasonable Litigation Costs and Motions to Exclude: Designated Orders 10/28/19 to 11/1/19

This week of coverage for the end of October and beginning of November brought two designated orders. The first was a short order regarding IRS motions to exclude expert testimony and reports. The second details how petitioners argued they should be awarded reasonable litigation costs for litigating against the IRS.

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Motions to Exclude Expert Testimony
Docket No. 23444-14, Palmolive Building Investors, LLC, DK Palmolive Building Investors Participants, LLC, Tax Matters Partner v. C.I.R., Order available here.

This first order deals with two IRS motions in limine to exclude from evidence at trial the expert testimony and reports of two experts for petitioner. The Court denies both motions with prejudice.

For the first expert, the IRS argues the report fails to provide sufficient reasoning to support its conclusions and that the report should either be excluded in its entirety or that the expert’s direct testimony be limited “so he cannot use that testimony to expand on his report’s limited explanations to cure its obvious deficiencies”. The Court does not conclude that the expert ‘disregarded relevant facts or exaggerated values to incredible levels’ to reject the report. Instead, the IRS has the ability at trial to cross-examine the expert’s testimony and present contrary evidence.

For the second expert, the IRS argues that the report provides legal conclusions and analysis and should be excluded in its entirety (or redact such conclusions or analysis). Also, Part II should be characterized not as rebuttal but an opening report because it addresses new matters rather than rebutting specific items raised in the IRS’s expert reports, making it untimely for submitting such a report. As a cure, the Court gives the IRS opportunity to submit surrebuttal to address arguably new matters raised no later than December 2.

Takeaway: This case involves advanced litigation, but illustrates tactics involved regarding expert testimony and reports at trial. Certainly, there are guidelines for what may be included in expert reports and the adverse party at trial will do what they can to keep the reports within those guidelines.

For further details from Procedurally Taxing, there are blog posts on the same case here and here regarding the downsides of having a bad appraisal report.

If you would like to do further research on appraisal reports, here are several sources:
Estate of Elkins v. Comm’r, 140 T.C. 86 (2013), aff’d & rev’d in part, 767 F.3d 443 (5th Cir. 2014) (discounting the valuation of artworks due to the fractional interests held in them by decedent’s children)

Crimi v. Comm’r, T.C. Memo 2013-51 (excusing petitioner’s failure to comply with the qualified appraisal regulations for charitable contributions due to reasonable reliance on his CPA)

Estate of Mitchell v. Comm’r, 2011 Tax Ct. Memo LEXIS 93 at *34-41 (analyzing the comparable artworks used by expert witnesses and agreeing with the estate’s valuation of two paintings instead of the IRS’s “unreasonably high” valuations)

Estate of Noble v. Comm’r, 89 T.C.M. 649 (2005) (finding that a sale of stock of a closely-held corporation occurring subsequent to an appraisal was the appropriate method of valuation)

Bond v. Comm’r, 100 T.C. 32 (1993) (holding that taxpayers “substantially complied” with the appraisal regulations and thus were entitled to a charitable contribution deduction)

Neely v. Comm’r, 85 T.C. 934 (1985) (finding that an ordinarily prudent taxpayer should have known that an appraisal of contributed art was a substantial overvaluation).

• Glenn Dixon, The Secretive Panel of Art Experts That Tells the IRS How Much Art Is Worth, Washington Post (Dec. 7, 2017)

• Anne-Marie Rhodes, Valuing Art in an Estate: A New Perspective, 31 Cardozo Arts & Ent. L.J. 45 (2012).

Keith is on a panel presentation in February on appraisals so we are reaping the benefits of his research.

Motion for Award of Reasonable Litigation Costs
Docket No. 14429-18, Paul Edwin Johnson & Susan H. Johnson v. C.I.R., Order and Order and Decision available here.

On their 2015 tax return, the Johnsons did not report information from a Form 1099-R from Equity Trust Company (ETC) that stated Mr. Johnson received a gross distribution of $20,000 and taxable income of $20,000. In addition, ETC reported on Form 5498, IRA Contribution Information, that Mr. Johnson made a rollover contribution of $141,233 to an IRA during tax year 2015. The forms described did not identify the dates the distributions were made or the date Mr. Johnson made the rollover contribution. Although the Johnsons attached other Forms 1099-R to their tax return, the ETC forms were not attached to their 2015 tax return.

The IRS sent a Notice CP2501 requesting additional information related to the discrepancies. The Johnsons sent their own letter requesting documents, but did not provide any documents of their own related to the ETC transactions.

The IRS later issued a Notice CP2000, proposing changes to the 2015 tax liability including an additional tax of $40,429, an accuracy-related penalty of $8,086, and interest of $2,818. The IRS proposed to increase the Johnsons’ taxable income to include a $20,000 taxable distribution from ETC and a $141,793 IRA distribution from Riversource (one of the Forms 1099-R attached to their 2015 tax return).

The Johnsons responded with a letter alleging that Mr. Johnson received a retirement distribution of $141,000 in 2015 and deposited that amount into another retirement account. They did not provide any documentation for the rollover contribution or ETC distribution.

The IRS issued a notice of deficiency determining the same adjustments originally proposed in the Notice CP2000. The Johnsons again responded with a letter claiming the IRA distribution was not taxable because of the rollover without providing documentation.

The Johnsons filed a timely petition with the Tax Court for redetermination and represented themselves.

IRS counsel referred the case to the IRS Office of Appeals, who recommended that the IRS settle the case with no adjustments to the Johnsons’ tax liability. The parties filed with the Court an agreed decision (which the Court treated as a joint stipulation of settled issues) that resolved all issues in the Johnsons’ favor.

Two weeks later, Mr. Johnson filed a motion for reasonable litigation costs seeking an award of $13,486 that includes $71 for out of pocket expenses (postage and the $60 Tax Court filing fee), $3 for mileage expenses, $3,709 for preparation and filing expenses, and $9,703 for disputing the purported accuracy-related penalty. The IRS opposed that motion by the Johnsons.

In a footnote, the Court explains that the majority of the expenses do not constitute “reasonable litigation costs” as defined by Congress in IRC 7430(c)(1)(A) and (B). As a result, the Court limited its consideration to the claim for an award of $71 (the postage expenses and filing fee).

In order to be awarded a judgment for reasonable litigation costs in connection with a court proceeding under IRC section 7430, a taxpayer must (1) be the prevailing party, (2) have exhausted administrative remedies with the IRS, and (3) not have unreasonably protracted the proceedings.

The IRS conceded that the Johnsons did not unreasonably protract the proceedings. The parties have at issue whether the Johnsons exhausted their administrative remedies, but it does not reach that point.

In order to be a prevailing party, the taxpayer must (1) substantially prevail with respect to either the amount in controversy or the most significant issue or set of issues presented and (2) satisfy applicable net worth requirements. The taxpayer will ultimately fail to qualify as the prevailing party if the IRS position is shown to have been substantially justified.

The IRS concedes the two elements for the Johnsons to be the prevailing party, but contend their position in this case was substantially justified.

To establish their position as substantially justified, the IRS must show their position was “justified to a degree that could satisfy a reasonable person” or that the position has a “reasonable basis both in law and fact.” The relevant question is “whether [the IRS] knew or should have known that the position was invalid at the offset.” Generally, the position of the United States in a judicial proceeding is established in the answer to the petition.

The Court’s analysis starts with the IRS receiving the third-party information regarding Mr. Johnson’s retirement transactions and being justified in seeking clarification. The Johnsons should have records of those transactions to provide to the IRS. Their failure to provide that documentation led to the issuance of the notice of deficiency. Because the Johnsons did not provide evidence regarding a timely and proper rollover contribution in 2015, the Court finds that the IRS position in the case was substantially justified and denies Mr. Johnson’s motion for reasonable litigation costs.

Takeaway: Even though their request was reduced from $13,486, they did not even get an award of $71 from the Tax Court! This case certainly illustrates the difficulties for a petitioner to take an unstructured approach to receive reasonable litigation costs in a Tax Court case and failing in the attempt to overcome the high burden of proof regarding IRS knowledge.

The Knudson case discussed in this Procedurally Taxing post provides the path to success on fees. To overcome the substantial justification hurdle, a taxpayer must almost always make a qualified offer. The Knudson case holds that a concession by the IRS does not keep the taxpayer from obtaining fees in the situation of a qualified offer. Further PT posts on qualified offers are here and here. Christine also provided me an example of a rare case here where the court found that the IRS position was not substantially justified.

9th Circuit Affirms Tax Court’s Ruling in Kollsman Disregarding the Report of Taxpayer’s Appraiser

We welcome back guest blogger Cindy Charleston-Rosenberg. Cindy is a past president and a certified member of the International Society of Appraisers. She and I both posted on the Tax Court’s earlier decision in the Kollsman case. Now, the 9th Circuit, in an unpublished opinion, has affirmed the Tax Court’s opinion. I am somewhat surprised that the taxpayer appealed this case because the burden to overturn the Tax Court’s decision was high. The 9th Circuit seemed to have little trouble finding that the Tax Court correctly relied on the appraiser used by the IRS and dismissing the taxpayer’s appraiser who came burdened with conflict problems and a desire not to use comparables in setting a value. The 9th Circuit stated “The Tax Court did not err in rejecting Wachter’s (the petitioner’s appraiser) opinion in part because he did not support his valuations with comparable sales data.” The 9th Circuit did not directly address the conflict of the taxpayer’s appraiser that greatly influenced the Tax Court to ignore or deeply discount his opinion but instead continued to focus on the deficiencies of his opinion stating “the Tax Court did not err in finding that Wachter failed to explain the nearly fivefold increase in value between his valuation and the sale price.” As Cindy explains and as we discussed in the prior posts, getting the right appraiser makes a huge difference in getting the “right” outcome. Trying to fix a problem with an appraisal through an appeal will generally not end well. Keith

On July 26, 2019, The Appraisal Foundation released a press statement urging legal advisors and wealth managers, in light of the recent affirmation of Kollsman v Commissioner, (T.C. Memo. 2017-40) to recognize the primacy of the personal property appraisal profession. The Appraisal Foundation is the nation’s foremost authority on valuation services, authorized by Congress as the source of appraisal standards and appraiser qualification criteria.

The 9th Circuit affirmation of Kollsman establishes that attorneys and other allied professionals should, as a minimum standard of care, recognize appraising as a professional discipline distinct from other types of art market expertise. From the Foundation’s release: 

with this ruling, the competency and professionalism of personal property appraisers has been confirmed for the second time by the judicial system in the United States … wealth managers and estate attorneys now have a greater fiduciary duty to their clients to fully understand appraiser qualification criteria and appraisal standards when vetting personal property appraisal experts.

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The Tax Court decision in Kollsman essentially disregarded an appraisal submitted by a high ranking executive of a premiere auction house as lacking basic qualification, credibility, support and objectivity. The decision relied almost exclusively on the opinion of the IRS expert, who was a relevantly credentialed, professional appraiser. The 9th Circuit opinion found the Tax Court did not err in rejecting the auction house expert’s opinion, in part because it was not supported by comparable sales data and failed to consider relevant past sales. In disregard to established caselaw and standard professional appraisal practice, the auctioneer testified that when he arrived at his valuations, he was “not interested” in comparables, and had only reviewed comparables after the IRS challenged his methodology. In finding the auction house appraisal to be “unreliable and unpersuasive” the Tax Court opinion deemed the omission of comparables supporting the valuations to be “remarkable”, stating; “we have repeatedly found sale prices for comparable works quite important to determining the value of art”. In contrast, the court found the credentialed appraiser engaged by the IRS explained his methodology, relied on comparables, and conducted research as to the impact of the subject property’s condition to an expected level of professional performance and objectivity. 

To help ensure a trustworthy level of professional competency, The Appraisal Foundation’s sponsoring professional personal property organizations, the International Society of Appraisers, the Appraisers Association of America, and the American Society of Appraisers, have embraced and are bound to implement the Personal Property Appraiser Minimum Qualification Criteria in issuing credentials to members. Each organization maintains a public registry where the appraiser’s level of credentialing, areas of specialization, education and experience may be accessed and confirmed. Members of these associations earn their credentials through a stringent admissions, training and testing process. They are required to comply with IRS guidelines and the Appraisal Foundation’s Uniform Standards of Professional Appraisal Practice (USPAP), are bound to continuing education requirements and to submit to the oversight of their professional organization’s ethics committee. 

As a member of the Appraisal Foundation’s Board of Trustees, I welcome the opportunity to collaborate with the legal and wealth management professions on best practices in identifying and engaging qualified appraisers, particularly for IRS use appraisals. As we see here, every appraisal report submitted to the IRS has the potential to become the subject of litigation. Procedurally Taxing readers are invited to review my earlier post for an in-depth analysis of the implications of the original ruling, and Keith Fogg’s earlier coverage of this case highlighting the avoidable perception of bias when engaging an expert seeking any involvement in the sale of purchase of the subject of an appraisal. 

Last September the American College of Trust and Estate Counsel (ACTEC) Regional Meeting in Baltimore hosted a panel addressing this issue. The feedback from the considerable post-presentation engagement from attendees was that the qualification criteria for real property appraisers are well understood by the legal profession. However, qualification criteria and practice standards for personal property and business valuation experts, sourced by the same authority, are clearly less so, often with devastating outcomes for consumers.

In the wake of the Kollsman affirmation,particularly as the ruling applies to the benefits of engaging relevantly credentialed experts for IRS valuations, and critically, the Appraisal Foundation’s now public stance on this issue, it will be increasingly difficult for tax and legal advisors to defend engagement of less than fully qualified valuation experts. 

Finding the Right Appraiser and Writing the Report Correctly

The recent case of Estate of Kollsman v. Commissioner, T.C. Memo 2017-40 shows the perils to a taxpayer of a disregarded expert.  Judge Gale found petitioner’s expert unreliable for several reasons, not including his basic qualifications as an expert, and relied, essentially exclusively, on the expert testimony offered by the IRS.  Naturally, the estate did not benefit from this outcome.  Why did the Court reject the testimony of petitioner’s expert and how can you make sure that your expert will not suffer the same fate?  This post will focus on answering those questions.

I wrote a post recently on the IRS Art Advisory Panel.  That post focuses on some of the work the IRS does to determine value.  Today, the focus is on the taxpayer side although the same rules and concepts apply to respondent when hiring experts.

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The estate owned two paintings by “Old Masters” that became the subject of a valuation case in Tax Court.  The estate hired a very qualified expert who was a “vice president of Sotheby’s North America and South America and cochairman of Sotheby’s Old Master Paintings Worldwide.”  In addition, petitioner’s expert had known the decedent for many years and had periodically seen the paintings in decedent’s home for almost 25 years before her death.  On the date Ms. Kollsman died, the expert wrote a letter to the executor providing preliminary estimates of the paintings if they were sold that winter by his auction house.  The estate’s expert wrote two additional letters to the executor about four weeks after Ms. Kollsman died providing values for the paintings which the estate attached to its returns and providing an agreement for sale through his auction house.

The Court found the valuation letter and the agreement to use the auction house providing the appraisal too cozy.  After walking through the basis for his opinion in the report, the Court states:

“We find Mr. Wachter’s valuations unreliable and unpersuasive for several reasons.  First, he had a significant conflict of interest that could cause a reasonable person to questions his objectivity.  Mr. Wachter first gave his fair market value estimates for the paintings at the time of decedent’s death (in amounts that remained unchanged in his expert report prepared for trial).  His correspondence with Mr. Hyland [the executor] during that period demonstrates that the two had previously discussed the disposition of Maypole and Orpheus upon decedent’s death and that Mr. Hyland was considering selling the paintings.  Mr. Wachter provided his fair market value estimates at the same time he was soliciting Mr. Hyland for the exclusive rights for five years to auction the paintings in the event they were sold….  Thus, Mr. Wachter, on behalf of his firm, had a direct financial incentive to curry favor with Mr. Hyland by providing fair market value estimates that benefited his interests as the estate’s residual beneficiary – that is to say, ‘lowball’ estimates that would lessen the Federal estate tax burden borne by the estate…. The fact that Mr. Wachter simultaneously presented Mr. Hyland with these fair market value estimates and his pitch for exclusive auction rights for Sotheby’s gives rise to an inference that the latter affected the former.”

Strong stuff, and Judge Gale did not stop there.  He then pointed out problems with the valuation itself including an overstatement of the dirtiness of the paintings and the problems cleaning them might cause plus his failure to provide comparable sales supporting his valuations.  Judge Gale points out that “we have repeatedly found sale prices for comparable works quite important to determining the value of art.”

With respect to the simultaneous valuation and business solicitation, the lesson from the Kollsman case is easy to draw.  Do not use as your valuation expert someone who seeks to benefit from the relationship in ways that extend beyond compensation for services as an expert witness.  The opponent in a valuation case always looks for ways to show that the expert is biased.  Here, petitioners served up that basis on a silver platter.  It is fine to use someone like Mr. Wachter to get an idea of the value of the paintings and fine to use him to assist in finding an expert.  It might even be fine to use someone like Mr. Wachter to value the property on the return though I would not recommend it, but it was not fine not to use him as the expert at trial.  For trial, the estate needed an expert whose testimony could not be impeached on the basis of a simultaneous business transaction.

Judge Gale’s concern that Mr. Wachter’s overstated the devaluation of the paintings based on their dirtiness is no doubt real but it serves, for me at least, to provide more support for the Court’s conclusion and not enough of a basis from which to draw general conclusions about experts.  On the other hand, the judge’s observation about the absence of comparable sales in the expert report deserves attention.

Tax Court Rule 143 sets out the way expert testimony comes into evidence in Tax Court cases.  The rule provides that the report of the expert serves as the expert’s direct testimony.  For this reason, it is imperative that the expert write a comprehensive report that sets out the basis for the appraisal included comparable sales.  While the attorney hiring the expert must be careful not to dictate the report, the attorney must also be careful to impress upon the expert the need for a full and complete report that documents the basis for the findings in the report.  The Tax Court came to this approach after tiring of experts who played hide the ball with their reports and then came to Court and testified about many things on direct including the underlying basis for their conclusions.

I have not seen the report submitted by the estate in this case but the description by Judge Gale makes me believe that the report was short and conclusory.  A person like Mr. Wachter with clear expertise concerning the subject matter but who may not serve often as an expert may have expected his clear expertise to carry the day in convincing the Court.  While the depth of his expertise clearly matters, so does his report.  Here, the description makes it sound as though the report lacked a major element and the Tax Court rules would prevent Mr. Wachter from fixing this mistake with his testimony.

After dismissing petitioner’s expert, the Court essentially embraces the report of the expert hired by the IRS.  This result does not necessarily follow.  There are times when the Court dismisses or heavily discounts the experts of both sides, but here the IRS expert proved persuasive.  The Court discounts his opinions based on certain factors but uses the IRS expert report as the basis from which to build its determination.

It is worth noting that the IRS valuation report exceeded the amount determined as the value of the paintings in the notice of deficiency.  This happens regularly because the IRS will rely on the Art Advisory Panel or other in house experts during the examination phase and not hire an expert until the case goes to court.  The hired expert determined higher values that the IRS determined in the notice which would have caused the IRS to amend it answer to the petition in order to assert a higher deficiency and to take on the burden of proof with respect to the additional amounts.  Of course, the additional burden does not mean much in a valuation case of this type.   Here, the IRS made its motion on March 11, 2011, about two months before the trial.

Notice that it took the Court about five and one-half years after the trial in order to render the opinion in this case.  While I do not think that is a record, it is certainly a long time to wait for an opinion.  I have written before about the language in IRC 7459 which talks about the Tax Court deciding cases as quickly as practicable.

Conclusion

Practitioners headed into litigation need to vet the expert to make sure that nothing prevents the expert from rendering an impartial opinion.  The petitioner is already paying for the opinion and an expert worth hiring will know what outcome the petitioner would like.  No further incentive for the expert to reach a beneficial result for the petitioner should exist.  Additionally, petitioners need to impress upon the expert what the report must contain and how the report will serve as the direct testimony of the expert in a Tax Court trial.  Here, an individual with great qualifications as an expert in the field of art relating to the specific paintings at issue got disqualified for avoidable reasons.

The Solicitor General Would Have the SCOTUS Overrule Freytag v. Commissioner

Our Villanova colleague, Tuan Samahon, who serves as co-counsel in the Kuretski case and who argued the case for the taxpayers before the D.C. Circuit, provides an assessment of the Solicitor General’s brief opposing cert. in the case. Those of you not familiar with this case will find links in his comments to earlier posts on this case. You can also look to SCOTUSblog, which featured the case as its “petition of the day” earlier this week. The case concerns the ability of the President to remove Tax Court judges and whether the removal power granted to the President in IRC 7443(f) providing that “Judges of the Tax Court may be removed by the President, after notice and opportunity for public hearing, for inefficiency, neglect of duty, or malfeasance in office, but for no other cause” violates the constitutional separation of powers because Tax Court judges exercise judicial, not executive, power. Keith

On April 2, the Solicitor General filed his brief opposing cert. in Kuretski v. Commissioner, a separation-of-powers case which challenges the Tax Collector in Chief’s superintendence over the U.S. Tax Court through his removal power of its judges at section 7443(f).  For the original cert. petition, see the Procedurally Taxing blog post from Dec. 2, 2014.  This means that the decision on whether to grant cert. will be made by the Supreme Court in mid-May. The case’s merits turn on the nature of the power the Tax Court exercises — whether it merely exercises executive power but in a mode of decision making most common to courts, that is, case-by-case adjudication, or whether it exercises a portion of the judicial power of the United States, as the taxpayers argue and the Freytag majority said.

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In Kuretski, the D.C. Circuit had noted an inconvenient “wrinkle” in reaching its conclusion for the Commissioner that the Tax Court exercises only executive power. The panel needed to interpret the Supreme Court’s 1991 precedent Freytag v. Commissioner to not really say what the majority seemed plainly to say: the Tax Court “exercises a portion of the judicial power of the United States” and “exercises judicial, rather than executive, legislative, or administrative power.” The Freytag majority explained its constitutional conclusion was not clause bound — and indeed, could not be because the broad separation-of-powers principle is “embedded in the Appointments Clause.” It examined cognate provisions in a whole Constitution “analytic method” that resulted in its view that the Tax Court exercises judicial power, albeit wielded by judges without Article III tenure.

Nonetheless, the D.C. Circuit glossed the Freytag majority as meaning only that the Tax Court was, for the limited purposes of interpreting the excepting provision of the Appointments Clause, a part of “the Courts of Law.” Armed with that narrowed view of Freytag, the D.C. Circuit concluded Freytag didn’t really control the characterization of power and that any separation-of-powers problem with the President’s removal authority over Tax Court judges simply vanished if the judges really exercised only executive power, as the panel believed. In doing so, the D.C. Circuit’s Kuretski panel seemed to adopt the separate Freytag concurrence, penned by Justice Scalia, not the majority’s controlling opinion. DOJ hadn’t asked the D.C. Circuit to ignore or revisit the Freytag majority — and the D.C. Circuit would have been powerless to overrule it — but its argument drew heavily from Scalia’s characterization of the Tax Court’s power as executive, not judicial. A fair appraisal of Freytag might have required DOJ to argue candidly for the majority opinion’s overruling or at least an argument for its overruling sub silentio — both weak positions, particularly in an inferior court of appeals. Several commentators acknowledged the D.C. Circuit’s apparent fudge in preferencing the concurrence over the majority rationale.

Unsurprisingly, then, the SG asks the SCOTUS to overrule the Freytag majority’s reasoning with Justice Scalia’s separate Freytag concurrence, should the SCOTUS take the case. The SG discreetly tucked away that invitation to overrule Freytag in a footnote (note 3). There it preserves the argument without calling too much attention to the tension between the SG’s simultaneous positions that (1) Kuretski does not deserve review and (2) the Commissioner may well lose if Freytag‘s majority controls.

Several tax proceduralists have noted the confusion over the Tax Court’s status. A cert. grant would allow the SCOTUS to clarify that Freytag‘s majority approach remains the law of the land and that the opinion meant what it said: the Tax Court exercises judicial, not executive, power.