Kozlowski and the Art of Taxation

Taxes are always how they get them, in the end. Remember Al Capone and the bookkeeper? It was tax evasion that brought Chicago's mobster down. And now the same snare seems to be encircling Dennis Kozlowski, Tyco's beleaguered former chief executive.

Tyco's taxes are at issue here, but Mr Kozlowski's personal tax problems are as well. The tax he personally may have evaded is not a federal one but a lesser-known challenge: the states' "sales and use" tax. It seems Mr Kozlowski may have pretended to ship some art intended for enjoyment at a New York residence out of state. That is a no-no, as are many other steps involving collectibles. Indeed, some of the rules on collectibles are worth reviewing for anyone who likes nice things and wants to avoid a Kozlowski-style interaction with authorities.

First, about the "sales and use" tax. The rule in New York is a simple one. If you buy your objet d'art within the Empire State's borders for enjoyment there, you pay sales tax on it. If you buy it in New York and send it to your home in New Hampshire, you do not have to. That's legal tax avoidance. New York's reach simply does not extend out of state, as much as the state's tax authorities wish that they did.

But if you buy it, and then send it back - one of the things that Mr Kozlowski may have done - you do owe tax. Indeed, anything of value that New York residents bring into New York is subject to "use" tax. If you use it in New York, the theory goes, you must pay the same rates that you would have paid in sales tax had you made your acquisition there.

Most people do not know this, or pretend not to. That is because, while they have identical rates, the sales and use taxes have one critical difference. The sales tax is collected by the seller at purchase. The use tax, though, is collected by no one: it must be self-reported. And very many people, of course, "forget".

But the authorities have a way of finding things out. Say, for example, you buy a wonderful piece of ceramic work in Hong Kong. You declare it on your return at Kennedy airport. Sooner or later, you may get a letter demanding that you send a "use" tax to Albany, New York's capital. Your bowl was more expensive than you thought. Other states have similar laws. And by the way, this same rule applies to that suit you had made by your favourite Hong Kong tailor as well. A $1,000 suit? You owe $82.50 in tax.

But state and use taxes are not the only problem challenging collectors. Another is the capital gains tax. Back in the late 1990s, Congress brought the capital gains rate down to 20 per cent for long term holdings, from 28 per cent. But they wrote an exception for collectibles. For collectibles, the rate stayed at 28 percent. If you bought a painting for $50,000, and its value subsequently rose to $500,000, you will owe tax on that $450,00 increase come time to sell.

There is a way - at least for art dealers - to get around this. It is to trade your $500,000 precious artwork for another dealer's $500,000 item. But the rule often does not apply for personal collectors - sorry, guys. You have to be able to prove you originally bought the art for investment purposes.

Then there is the issue of trading art. Artists like to trade their work for things so that they can avoid paying taxes (a painting for a week at a summer house, for example). But whatever thing the artist gets for the painting is, legally, income. So he must declare it and pay income tax on it. Pop artist Peter Max received a jail sentence back in 1998 for income tax evasion; at the time he acknowledged he had bartered when he should have declared.

The rule is a clear one. American residents who buy art are not merely giving themselves a present. They are, likely as not, also going to give something to the taxman.

© Copyright 2002 Financial Times

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