On June 25, 2009, a saddened world bade an untimely farewell to legendary recording artist Michael Jackson. Known affectionately to many of his fans as the “King of Pop,” Jackson is remembered by many as one of the most talented and influential performers of all time.
The end of Jackson’s life has triggered a debate over the value of his legacy. In addition to his musical talents, Jackson was a savvy businessman who owned a unique collection of assets at the time of his death. Jackson’s executors are now in battle with the Internal Revenue Service (the “IRS”) regarding the manner in which these assets were valued on Jackson’s federal estate tax return.
On Jackson’s federal estate tax return, his executors claimed the estate had a taxable value of approximately $7 million. Upon review, the IRS has concluded that the taxable estate is worth in the neighborhood of $1.125 billion, approximately 160 times higher than the reported value. In addition to a deficiency notice for $505.1 million in unpaid taxes, the estate was assessed $196.9 million in accuracy-related penalties. The vast discrepancy between the reported asset values and the values as determined by government auditors most likely resulted from the fact that a substantial portion of Jackson’s estate consists of unique and intangible assets for which market values cannot readily be ascertained. A major component of the disagreement is the value placed on Jackson’s image and likeness.
Following the death of a popular entertainer, the public often experiences a surge of nostalgia that feeds an uptick in sales of the decedent’s works and memorabilia. If the estate owns the rights to these future revenue streams, they must be valued and reported on the celebrity’s federal estate tax return. Jackson’s executors valued his likeness at just $2,105, while the IRS valued it at over $434 million. Other reported asset values, including the value of Jackson’s interest in a trust containing the rights to some of the most popular Beatles’ songs, have also been challenged.
As Jackson’s executors have learned, the IRS does not take kindly to the perceived understatement of asset values on an estate tax return. Under applicable rules, if the value of any property claimed on an estate or gift tax return is 65% or less of the amount that the IRS determines to be correct, a “substantial understatement” has occurred, and a penalty is imposed in the amount of 20% of the portion of the underpayment that is attributable to the understatement. In the event the value claimed on the return is 40% or less of the final amount, it is deemed a “gross understatement,” and the underpayment penalty increases to 40%.
Return preparers also face potential inaccuracy penalties. A penalty in the amount of the greater of $1,000 or 50% of the preparer’s fee will be triggered if such preparer, either knowingly or under circumstances that he or she reasonably should have known, takes an “unreasonable position” that results in an understatement of tax. As a general rule, a position is unreasonable unless there exists substantial authority to support such position. No penalty will be imposed against a preparer if it can be shown that there is reasonable cause for the understatement and the preparer acted in good faith. However, the minimum penalty increases to $5,000 if the preparer acted willfully or recklessly with respect to the understatement. It is unknown at this time whether Jackson’s estate tax return preparers will be penalized.
Because the amount of federal estate tax is determined by the value of the assets as reported on the estate tax return, there exists a powerful incentive to report such assets at their lowest possible values. In doing so, preparers and fiduciaries must be cognizant of the potential penalties and loss of personal credibility that may result if such valuations are so aggressively low that they become indefensible.
IRC §6662(g) and (h).
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