On February 21, 2014, then House Ways and Means Committee Chairman Dave Camp (R-Michigan) issued a discussion draft of the “Tax Reform Act of 2014.” The proposed legislation spanned almost 1,000 pages and contained some interesting provisions, including repealing IRC § 1031, thereby prohibiting tax deferral from like-kind exchanges. Not only would taxpayers have been impacted by this proposal, but it would have turned the real estate industry upside down. Qualified intermediaries would have been put out of business. Likewise, title and escrow companies, as well as real estate advisors specializing in exchanges, would have been adversely affected by the proposal.
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.
As reported in my November 2014 blog post, President Obama’s administration wants to limit taxpayers’ ability to defer income under IRC § 1031. In response to former House Ways and Means Committee Chairman David Camp’s proposed Tax Reform Act of 2014, which would have eliminated IRC § 1031 altogether, the Obama administration proposed to retain the code section, but limit deferral with regard to real property exchanges to $1 million per taxpayer each tax year. Personal property exchanges, under the President’s proposal, would go unscathed.
In 2015, President Obama expanded his proposal relative to IRC § 1031 to limit personal property exchanges by excluding certain types of property from the definition of “like kind.” The excluded personal property included items such as collectibles and art. The President’s proposed $1 million real property exchange limitation was left intact.
Fast forward to today. No tax reform legislation has gained enough traction to even come close to being enacted into law. Nevertheless, President Obama’s attack on IRC § 1031 continues. In the administration’s 2017 budget proposal (released a few months ago), the White House expands its quest to limit the application of IRC § 1031. This proposal is identical to President Obama’s original response to former Chairman Camp’s 2014 tax reform proposal, but it goes further. Now, the President is proposing that the $1 million limitation apply to both personal and real property exchanges. In addition, like his 2015 proposal, President Obama wants to exclude certain personal property, collectibles and art, from the definition of “like kind.”
I am not sure any real logic or significant tax policy supports the White House’s latest proposal to limit the application of IRC § 1031. Rather, the proposal appears to be solely aimed at tax revenue generation. According to the Treasury, the proposal, if enacted into law, would increase tax revenues by $47.3 billion over 10 years.
IRC § 1031 is clearly on lawmakers’ radar screens as a means to increase tax revenues. Time will tell whether IRC § 1031 will be repealed or significantly curtailed in its application. Nevertheless, one thing is for sure: IRC § 1031 remains a potential target. Stay tuned!
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
- "Planning Using IRC Section 1031 Exchanges," Oregon Society of Certified Public Accountants (OSCPA) Forest Products ConferenceEugene, OR, 6.22.18
- "Evaluating the Built-in Gains Tax for C to S Conversions After TCJA," New York University Summer Institute in Taxation – Advanced Conference on Subchapter SNew York, NY, 7.26.18-7.27.18
- "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, 11.7.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationSan Diego, CA, 11.11.18-11.16.18