Many of our readers have asked me about the likely controversy that will ensue following the death of Prince. In fact, two readers feel, since I have been reporting about some of the controversy surrounding the Estate of Michael Jackson, that I must write about Prince’s estate and the expected controversy surrounding it. So, here we go!
Prince Rogers Nelson, known to his fans as “Prince,” passed away on April 21, 2016 in Carver County, Minnesota at his estate, Paisley Park. He was 57 years old. The media reports that he left no spouse or children, but he is survived by a sister and five half siblings. In addition, the initial accounts are that he died without a Last Will and Testament. What is likely to follow is best summed up by the title to Prince’s 1981 hit song “Controversy.”
Controversy involving the pop star’s estate could arise on many fronts. Potential instigators of controversy include the taxing authorities and persons claiming to be legal heirs of Prince.
Probate and Estate Tax Laws in Minnesota
In Minnesota, like most states, if a person dies without a valid Last Will and Testament, his or her probate estate passes by the laws of intestate succession. Under the Minnesota Uniform Probate Code, if a decedent has no surviving spouse and no surviving descendants: (1) the estate passes to his or her parents or the survivor of the parents; (2) if there are no surviving parents, the estate passes to the descendants of the parents (i.e., the decedent’s siblings, half or whole, nieces and nephews etc.); and (3) if there are no surviving descendants of the parents, then a detailed statutory scheme kicks in, which includes paternal and maternal grandparents and their respective descendants. Ultimately, if there are no family survivors, the “no-taker” provision of the statute comes into play – the estate passes to the state.
A probate has been filed in Carver County, Minnesota. I suspect there will be controversy arising about who are the deceased pop singer’s lawful heirs and who is entitled to inherit his suspected massive estate under the Minnesota laws of intestate succession. Perhaps a Last Will and Testament will be presented to the probate court? Time will tell. In any event, it should be interesting.
A Controversy Coming to Pass?
The controversy that is of most interest to me and likely to you is the estate tax controversy that will likely occur. Some background is needed to set the stage.
This year, the federal estate tax exemption is $5.45 million. The federal estate tax rates are graduated, starting at 18% and quickly rising to 40% on taxable estates over $1 million. For a taxable estate over $1 million, the federal estate tax is $345,000, plus 40% of the amount exceeding $1 million. So, for an estate of $505,450,000 (after taking the $5,450,000 exemption), the federal estate tax is $199,945,000 ($499,000,000 X 40% plus $345,000 = $199,945,000).
The Minnesota estate tax exemption in 2016 is $1.6 million. Like the federal estate tax rates, the Minnesota estate tax rates are graduated, starting at 10%, but quickly rising to 16%. For taxable estates over $10,100,000, the estate tax is $1,082,000, plus 16% of the amount exceeding $10,100,000. So, in our example above, the Minnesota estate tax would be $80,082,000 ($505,450,000 - $1,600,000 = $503,850,000 – $10,100,000 x 16% = $79,000,000 + $1,082,000 = $80,082,000).
So, for purposes of illustration, if Prince’s estate was valued at $505,450,000, it could end up being exposed to more than $250 million in state and federal estate taxes. That amount is enough to set the stage for controversy. The issue is likely twofold: (i) what assets are included in the estate; and (ii) what is the value of those assets (on the date of Prince’s death or the alternative valuation date). I suspect the latter will be the most significant issue facing the estate.
The Artist’s Teeming Trove
Prince’s estate likely is comprised of real estate, financial assets (e.g., stocks and bonds), art, collectibles and other personal property. The “other personal property” may be where most of the valuation debate rests. This category of property consists of:
- Song royalties;
- Film rights;
- Intellectual rights to Prince’s likeness; and
- Unreleased song recordings.
Prince reportedly left over one thousand unreleased song recordings in what has been referred to as “the Vault.” What is the value of a musical artist’s unrecorded songs? This is an especially difficult question to answer, given the songs had not debuted prior to the artist’s death. Nobody knows how well the songs will be received by the public.
What is the value of a deceased musical artist’s likeness? It is hard to debate (or at least I think it is hard to debate) that Prince’s likeness is an asset of the deceased artist’s estate. Placing a value on it, however, will likely be the subject of a heated fight among the estate and the government.
Keep in mind, many artists, including Elvis Presley and Michael Jackson, arguably earn more money from their lifetime work after their deaths than they earned during their lifetimes. For example, it was recently reported that Elvis Presley’s heirs earned more than $55 million in 2012 alone from licensing and royalties relating to the late singer’s songs, theatrical works, likeness and sales of personal assets. This is clearly more than “The King” ever earned in any year during his life. So, the valuation of Prince’s future income stream should be a challenging debate. The focus should be the value of assets on the decedent’s death (or the alternate valuation date) rather than some other post-death date.
“Life” After Death
While Prince’s tangible personal property may appear to be less of a challenge from a valuation perspective than the intangible personal property, it certainly will not be left out of any valuation fight. When a star passes away, the value of his or her personal property can skyrocket. For example, just one of Prince’s many guitars sold at auction a few days ago. Indianapolis Colts owner Jim Irsay purchased the late artist’s guitar known as the “Yellow Cloud” for $137,500. It was reported that the auction house originally pegged the guitar’s value at $30,000, but the bidding frenzy concluded with a sales price of almost five times that amount. The guitar was custom made for Prince by Knut-Koupee in 1989. It is described as being in good condition, despite the fact that Prince broke its neck while performing in 1994 (it was professionally repaired). Arguably, the guitar’s value significantly increased on or after the artist’s death (as exemplified by the auction house’s original valuation). This assuredly makes valuation for estate tax purposes challenging as the focus should be on the value of the guitar at the date of death (or the alternate valuation date).
Prince understood and recognized that paying taxes is required. In fact, the following lyrics from his hit song “Paisley Park” support that hypothesis:
“See the man cry as the city
Condemns where he lives
Memories die but taxes
He’ll still have to give”
It will be fascinating to learn what is reported on the state and federal estate tax returns as the value of Prince’s estate. The value will presumably be huge, and the number of assets will likely be many. It should be an interesting battle of the valuation experts.
In March 2014, I reported on the all-out battle that was ensuing in the U.S. Tax Court between the IRS and the Estate of Michael Jackson over the value of the late pop singer’s estate. It began in 2013, when the estate petitioned the court, alleging that the Service’s assessment, based upon the assertion that the estate underreported its estate tax obligation by more than $500 million, was incorrect. In addition, the estate challenged the IRS’s additional assessment of almost $200 million in penalties. Keep in mind that although these numbers are staggering, they do not include the estate’s potential state of California estate tax obligations.
If Michael Jackson could instruct his estate lawyers about case strategy, I am sure he would be recounting the lyrics from his 1982 smash hit Beat It:
Just beat it, beat it, beat it, beat it
No one wants to be defeated
Showin’ how funky and strong is your fight
It doesn’t matter who’s wrong or right
Just beat it, beat it
Unfortunately, the case is not going the way Michael Jackson would have wanted it to go. Rather, victory appears to be nowhere in sight for either the taxpayer or the government.
It is now well over two years after the battle started. It continues to rage. Neither the IRS nor the estate is taking the tack from the title of the late pop singer’s 1991 hit song, Give In to Me.
In July 2014, the IRS added a little more pain to the estate’s already existing misery. It took a deeper look at the value of the estate’s ownership rights to the Jackson Five master recordings and the accrued royalties. As a result, the IRS increased the assessment by almost $29 million. Ouch! I am confident Michael Jackson would have responded to the IRS, quoting from his smash hit Leave Me Alone that appeared on the 1987 album Bad:
Leave me alone, stop it!
The IRS either isn’t hip enough to remember the late pop singer’s hit, Leave Me Alone, or it simply isn’t listening! Last week, it asked the court to add another $53 million in value to the estate.
The battle continues roaring strong. The IRS, in its quest to collect more taxes and penalties, appears to be leaving no stone unturned. I apologize in advance to my readers, but I have to quote Michael Jackson one more time; this time from his hit song Scream that appears on the 1995 album HIStory: Past, Present and Future, Book I:
Tired of injustice
Tired of the schemes
The lies are disgusting
So what does it mean
Kicking me down
I got to get up
As jacked as it sounds
The whole system sucks
Trial in this case is currently scheduled for February 2017. It continues to be interesting. Stay tuned! I will follow up if the case resolves or takes another interesting turn.
On November 2, 2015, the Bipartisan Budget Act (“Act”) was signed into law by President Barack Obama. One of the many provisions of the Act significantly impacts: (i) the manner in which entities taxed as partnerships will be audited by the Internal Revenue Service (“IRS”); and (ii) who is required to pay the tax resulting from any corresponding audit adjustments. These new rules generally are effective for tax years beginning after December 31, 2017. As discussed below, because of the nature of these rules, partnerships need to consider taking action now in anticipation of the new rules.
The Current Landscape
Entities taxed as partnerships generally do not pay income tax. Rather, they compute and report their taxable income and losses on IRS Form 1065. The partnership provides each of its partners with a Schedule K-1, which allows the partners to report to the IRS their share of the partnership’s income or loss on their own tax returns and pay the corresponding tax. Upon audit, pursuant to uniform audit procedures enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”), examinations of partnerships are conducted generally under one of the following scenarios:
- For partnerships with ten (10) or fewer eligible partners, examinations are conducted by a separate audit of the partnership and then an audit of each of the partners;
- For partnerships with greater than ten (10) partners and/or partnerships with ineligible partners, examinations are conducted under uniform TEFRA audit procedures, whereby the examination, conducted at the partnership level, is binding on the taxpayers who were partners of the partnership during the year under examination; and
- For partnerships with 100 or more partners, at the election of the partnership, examinations may be conducted under uniform “Electing Large Partnership” audit procedures, whereby the examination, conducted at the partnership level, is binding on the partners of the partnership existing at the conclusion of the audit.
Lawmakers believed a change in TEFRA audit framework was necessary for the efficient administration of Subchapter K of the Code. If a C corporation is audited, the IRS can assess an additional tax owing against a single taxpayer—the very taxpayer under examination—the C corporation. In the partnership space, however, despite the possible application of the uniform audit procedures, the IRS is required to examine the partnership and then assess and collect tax from multiple taxpayers (i.e., the partners of the partnership). In fact, the Government Accountability Office (the “GAO”) reported in 2014 that, for tax year 2012, less than one percent (1%) of partnerships with more than $100 million in assets were audited. Whereas, for the same tax year, more than twenty-seven percent (27%) of similarly-sized corporations were audited. The GAO concluded the vast disparity is directly related to the increased administrative burden placed on the IRS under the existing partnership examination rules.
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Evaluating the Built-in Gains Tax for C to S Conversions After TCJA," New York University Tax Conferences in July – Advanced Conference on Subchapter SNew York, NY, 7.26.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationNew York, NY, 10.21.18-10.26.18
- Portland, OR, 11.5.18
- "The Tax Cuts and Jobs Act – What It May Mean to Your Clients," Estate Planning Council of Portland Mini-SeminarPortland, OR, 11.7.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationSan Diego, CA, 11.11.18-11.16.18