Judge upholds IRS penalties against estate over art donation tax scheme

A federal judge in Texas has upheld more than $1.3 million in IRS penalties against the estate of a deceased art consultant who promoted an art donation scheme that allowed his clients to claim charitable deductions far larger than the amounts they paid for the art.

U.S. District Judge David Alan Ezra ruled February 4 that the IRS had provided enough evidence to support the penalties against the estate of David Ehrlich, according to court documents obtained by Urgent Matter.

Ezra found that Ehrlich, through his company Abbey Art Consultants, promoted an art donation tax scheme by falsely telling clients they owned artworks earlier than they did.

While the IRS also alleged false statements regarding appraisals, the court found it unnecessary to rule on those claims because the evidence of ownership timing alone was sufficient to establish liability.

“Beginning in the 1990s, Abbey Art was in the business of buying, storing, and donating art for the purpose of facilitating tax deductions for its clients,” Ezra wrote. “The art donation operation was Abbey Art’s sole business.”

The judge wrote that Abbey Art “took advantage” of IRS rules that allow taxpayers to claim an income tax deduction for non-cash property donated to charity at the property’s appraised fair market value instead of the price at which they purchased it.

However, to be able to claim the fair market value for deduction purposes, Ezra noted that “certain conditions must be met,” which include that “the property must be owned by the taxpayer for at least one year.”

Under the scheme, Ehrlich bought art, often overseas, and stored it in New York facilities. His clients paid a small deposit, were told the art had been “set aside” for them, and were led to believe they had already acquired ownership.

The court found that Ehrlich sent letters confirming ownership as of the date the art was "set aside," often before the deposits were made.

About a year later, the artworks were donated, and clients claimed deductions based on appraisals that were several times the original purchase price.

The IRS assessed penalties under Section 6700 of the Internal Revenue Code, which targets promoters of tax shelters. Ehrlich initially paid $35,000 and sued the IRS for a refund, seeking to overturn the penalties.

He died while the case was pending, and his estate was substituted as the plaintiff. The government later assessed an additional penalty of more than $1 million.

At the heart of the case were statements Ehrlich made to clients about when they acquired ownership of artworks used for charitable tax deductions.

The court found that clients did not actually own the art when Ehrlich said they did because they had no binding obligation to pay the full purchase price and did not know which specific artworks were supposedly theirs.

The judge cited earlier Tax Court rulings involving Abbey Art clients, in which the arrangement was described as “too good to be true.” He found that Ehrlich continued making similar claims even after those rulings were issued.

“Ehrlich himself admitted he knew of the Williams decision,” Ezra wrote, referring to a prior case involving Abbey Art. As a result, the judge concluded that Ehrlich “knew or should have known” that his statements were false.

The estate argued that clients believed they owned the art and intended to pay for it in full. The judge rejected that defense, saying belief was not enough where no enforceable obligation existed.

“Testimony that the clients subjectively believed they had to pay the remaining balance is insufficient,” Ezra wrote.

The ruling also addressed how the IRS calculated penalties, which were based on 50% of Abbey Art’s gross income over several years. The estate argued the government should have to prove misconduct for each individual transaction, but Ezra disagreed.

“It would go against the text and common sense to limit liability only to the false statements when Congress’s goal was to punish abusive tax shelters,” the judge wrote, quoting appellate precedent.

The court directed both sides to submit additional filings to calculate interest owed before a final judgment is entered.

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