Estate of Michael Jackson Wins Favorable Ruling in Valuation Dispute with IRS

(Parker Tax Publishing May 2021)

In a dispute between the IRS and the estate of Michael Jackson involving the value of Jackson's image and likeness, the Tax Court rejected the IRS's inflated valuation and held that it was more appropriate to value Jackson's image and likeness at the time of his death rather than years later after the estate had grown in value. The court also determined that no penalties applied because the estate's return and valuations were prepared by reputable accounting firms and the estate relied on them in good faith. Estate of Jackson v. Comm'r, T.C. Memo. 2021-48.

Background

From the time he was a child, Michael Jackson was famous and, at times in his life, he was the most famous person in the world. In some years, Jackson was the world's most well-known popular music star and, even after he died in 2009, there were years when he was the world's highest earning entertainer. However, there were also many years when his reputation suffered as a result of his unusual behavior. Jackson's reputation was also tarnished by allegations of child abuse.

At the time of his death, three of Jackson's most valuable intangible assets included: (1) his image and likeness; (2) New Horizon Trust II (NHT II), which held Jackson's 50 percent ownership of Sony/ATV Music Publishing, LLC (Sony/ATV), the principal asset of which was the rights to 175 songs by the Beatles; and (3) New Horizon Trust III (NHT III), which contained Mijac Music (Mijac), a music publishing company that owned the rights to Jackson's own compositions and those of other songwriters. All of these assets were distressed. Jackson's image and likeness was not producing any noticeable income at the time of his death. His interest in Sony/ATV secured $303 million in loans with maturity dates less than 18 months away, and his interest in Mijac secured over $72 million in debt.

Jackson's estate hired the accounting firm Crowe Horwath to prepare the estate tax return. The estate also retained Moss Adams, a large accounting and consulting firm, to value Jackson's image and likeness and his interest in Mijac. Moss Adams valued Jackson's image and likeness at $2,105 and his interest in Mijac at $70,860,000. To value Jackson's interest in Sony/ATV, the estate selected the Salter Group, an independent financial and strategic advisory firm that specializes in valuations. The Salter Group valued Jackson's ownership interest in Sony/ATV at $0, based on the debt exceeding the value of the assets. Using these valuations, the estate filed a 2009 Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, reporting the value of Jackson's image and likeness at $2,105, NHT II at $0, and NHT III at $2,207,351.

The IRS audited Jackson's estate tax return and, in May 2013, issued a notice of deficiency that adjusted the estate's reported values. The IRS valued Jackson's image and likeness at $434,261,895; NHT II at $469,005,086; and NHT III at $58,478,593. Based on these valuations, the IRS concluded that the estate had underpaid Jackson's estate tax by approximately $500 million. The IRS also determined that the estate's valuations were so far off that penalties of nearly $200 million applied. The estate took its case to the Tax Court.

Code Sec. 2001(a) imposes a tax on the transfer of a decedent's taxable estate. Code Sec. 2051 defines the taxable estate as the value of the gross estate less applicable deductions. The value of a decedent's gross estate is defined in Code Sec. 2031(a) as the value at the time of his or her death of all property, real or personal, tangible or intangible, wherever situated, to the extent provided in Code Sec. 2033 through Code Sec. 2045. Code Sec. 2033 includes in the gross estate the value of all property to the extent of the decedent's interest therein at the time of death. Reg. Sec. 20.2031-1(b) provides that the value of the decedent's property is its fair market value. One method of determining an asset's fair market value for estate tax purposes is the income approach, which values the asset by calculating how much revenue it will produce in the future and discounting that revenue back to its present value. Another approach is the market approach, which determines the value by reference to the prices at which similar assets have changed hands in arm's length transactions close in time to the date of death.

Analysis

The Tax Court calculated the value of Jackson's image and likeness at the time of his death at $4.1 million. The court rejected the estate's $2,105 valuation of Jackson's image and likeness, saying it was roughly equivalent to the price of "a heavily-used 20-year-old Honda Civic." However, the court found that the analysis of the estate's valuation expert was much closer to reality than the value determined by the IRS's expert. The estate's expert, the court observed, gave proper weight to the effect that the child abuse allegations had on Jackson's ability to market his image-and-likeness rights. The court also agreed with the estate's estimates of the future expenses of managing Jackson's image-and-likeness rights, noting that the estate would need to spend a significant amount of money to rehabilitate Jackson's image.

In rejecting the IRS's valuation analysis of Jackson's likeness and image, the court noted that the IRS expert had included assets other than Jackson's image and likeness in the valuation. According to the court, the IRS's expert should not have included trademarks, copyrights and licensing rights in the valuation because those are separate assets. In addition, the court found that the IRS's expert included revenue streams (e.g., themed attractions and branded merchandise) that were unforeseeable at the time of Jackson's death. The court further found that the IRS's expert failed to consider the fact that Jackson's reputation as a person was not in a good place when he died and that he had earned almost no revenue related to his image and likeness in the last 10 years of his life.

With respect to the value of NHT II, the Tax Court agreed with the estate that its value on the day Jackson died was $0. The court noted that Sony/ATV was more than just a music catalog, it was an operating music publishing business. The court opined that one way to value that business would be to apply the market approach using comparable sales. However, the court found that there were no sales of music publishing businesses in 2009, so it applied the income approach instead. After applying discounts for lack of marketability and for lack of control, the court valued Jackson's interest at approximately $212 million - around $88 million less than the debt secured by it. With a negative value, the court concluded that the value of Jackson's interest in NHT II was $0. Regarding the value of NHT III, the court said that Mijac was the most difficult of Jackson's assets to value because its income derived from different groups of songs, and each group produced income from different sources. The court rejected the values offered by both the IRS and the estate; the court questioned the credibility of the IRS's expert and said that the estate's expert's report contained many inconsistencies. In valuing Jackson's songs, the court explained that it had to take into account the foreseeable spike in sales that occurred after his death. After subtracting the $72 million of debt to which NHT III was subject, the court arrived at a value for NHT III of $107 million.

Turning to the issue of penalties, the court noted that the estate's valuation of Jackson's image and likeness at $2,105 was based on an appraisal by Moss Adams, an accounting firm that the court found to be reputable and credible. The court said that Moss Adams' low valuation was not farfetched given that Jackson made almost no money from his name and likeness for the last 10 years of his life. The court also noted that Moss Adams followed standard appraisal procedure in this area by focusing on the last 10 years of Jackson's life. The court disagreed with Moss Adams' appraisal, but said that it was reasonable and that the estate relied on it in good faith. The court determined much the same for the valuation of NHT III, noting how complicated it was to value Mijac and NHT III. Thus, the court concluded that no penalties should be applied.

For a discussion of estate tax valuation, see Parker Tax ¶224,700.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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