• Complex decision values intangible assets in Michael Jackson’s estate—In Estate of Michael Jackson v. Commissioner, T.C. Memo. 2021-48 (May 3, 2021), the Tax Court issued a voluminous but fascinating valuation analysis of certain intangible assets of Michael Jackson’s estate.
The analysis of the date-of-death value of these assets was particularly difficult not only because of the nature of the assets but also because of the particularly unique circumstances of Jackson’s personal and commercial status at his death. He was one of the most famous people in the world, but his reputation was destroyed by allegations regarding his personal life and his floundering businesses. However, after his death, the estate managed the business and intangible assets very successfully, which resulted in lucrative deals and contracts for the estate. That turnaround wasn’t necessarily foreseeable at the time of his death.
In this case, the Internal Revenue Service disputed the value of three assets: (1) Jackson’s image and likeness; (2) Sony/ATV, a music publishing catalog; and (3) Mijac Music, a music publishing catalog that owned copyrights to compositions written or co-written by Jackson, as well as other songwriters, administered by Warner Brothers. Both of Jackson’s interests in Sony/ATV and Mijac were held through trusts and had significant liabilities and debts.
The estate retained Moss Adams, a large accounting and consulting firm, as its appraiser. On the estate tax return, it valued Jackson’s image and likeness at just over $2,000, his partial interest in Sony/ATV at $0 and his interest in Mijac at $2,207,351. The IRS disagreed with these values and revalued the assets as follows: image and likeness at over $434 million, Sony/ATV interest at almost $470 million and Mijac interest at $58 million. The estate and the IRS opinions of value in the case were so divergent as to cause a notice of deficiency of over $500 million in estate tax and $200 million in penalties.
The IRS relied on one appraiser whose credibility was called into question. But the court acknowledged the very particular difficulty of valuing these assets at the moment of death given Jackson’s volatile career, commercially unsuccessful status at death and valuable deals achieved by the estate after death.
After assessing valuation methods, the effects of synergy, discounts, income streams, tax-affecting and reputational value and carefully trying not to permit the effects of hindsight, the court ultimately determined the following values for the three assets: image and likeness–$4,153,912; Sony/ATV–$0 (due to liabilities and debt); and Mijac–$107,313,561. The court found that the estate reasonably relied on its expert appraiser, and therefore, penalties weren’t warranted.
• State court properly reformed grandfathered generation-skipping transfer (GST) trusts without adverse tax consequences—In a series of private letter rulings (PLRs 202116002, 202116003 and 202116004 (April 23, 2021)), the IRS confirmed that a state court’s reformation of a trust instrument to clarify ambiguities and correct scrivener’s errors wouldn’t interfere with the grandfathered GST tax status of three trusts established by the trust instrument.
The original trust instrument created three trusts, one for each of the grantor’s three children’s respective family lines. Later, the grantor signed a second amendment that changed the disposition of the trust property on the death of a child. However, the language of the second amendment was ambiguous and unclear and could have caused the property held in one child’s trust to be paid to the other children’s trusts, even while there were descendants of that child still living.
The trustees petitioned the local probate court for a judicial construction of the trust and to reform its terms to conform to the grantor’s intent. The reformation was contingent on a favorable ruling from the IRS. The local court construed the trust to reform its language and approved clarifying language that resolved the ambiguities, which included keeping the trust property within a family line as long as descendants in that line were living.
The IRS agreed that there were no adverse GST, gift or estate tax consequences to the reformation. The PLRs confirmed that the judicial action involved a bona fide issue, and the construction was consistent with applicable state law that would be applied by the highest court of the state. Because it met the requirements of the GST tax regulations, there was no change to the grandfathered GST tax status of the trust.
In addition, because the construction clarified the terms of the trust to conform with the donor’s intent, no beneficiary was treated as making a taxable gift. Because no beneficiary transferred any property to the trust, and no beneficiary was granted any power or right over the trust, no portion of the trust (prior to termination) would be included in a beneficiary’s taxable estate.
Further, because the construction was a clarification and correction of the terms of the trust to effectuate the original intent of the donor, there was no exchange or material difference in the beneficiaries’ interests in the trust before and after the correction of the errors. As a result, it wasn’t an income taxable event that caused recognition of gains to any beneficiary.