Two things are virtually certain in life: death and taxes. But, one more should be added to the list where the two converge—an IRS audit. Indeed, this scenario played out all too well for the “King of Pop,” Michael Jackson’s, estate as shown in the United States Tax Court’s recent 271-page memorandum opinion. See Estate of Jackson v. Comm’r, T.C. Memo. 2021-48.
Although the lengthy opinion boiled down to general valuation and estate tax principles, it was noteworthy for several reasons. First, the Tax Court explicitly found that the IRS’ expert had perjured himself during trial, resulting in a significant discounting of his offered opinions to the court. Second, the Tax Court was called upon to value significant intangible assets of Mr. Jackson at the time of his death, including his image and likeness. Third, the opinion offers additional insights into how estates, unlike individuals, bear the burden of showing non-compliance with Section 6751(b) of the Code. Each of these are discussed more fully below.
The Federal Estate Tax
Prior to diving into the relevant facts of this case, it is helpful to have an understanding of general principles of the federal estate tax. The Internal Revenue Code (the “Code”) requires the executor or administrator of an estate to file an IRS Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, in the event the estate’s valuation exceeds a certain reporting threshold. For 2009, the threshold was over $3.5 million—however, the threshold amount has steadily increased since then.
Compared to other taxes, the federal estate tax is fairly large. For example, in 2009, the federal estate tax was 45% of any estate valuation that exceeded $3.5 million (subject to some deductions and other adjustments). Currently, the federal estate tax sits at 40%.
As seen above, valuation is an extremely important component of the federal estate tax. These concepts of valuation are also found in the Code. For example, the “taxable estate” is defined as the “value of the gross estate,” less applicable deductions. Sec. 2051. In turn, the “value of the gross estate” of a decedent is “the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated,” to the extent provided in Sections 2033 through 2045. Sec. 2031(a). For these purposes, the “fair market value” of property is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” Treas. Reg. § 20.2031-1(b).
Battle of the Experts
Because valuation drives the federal estate tax, it is not hard to guess that valuation issues are front and center in IRS audits regarding estate tax returns. If the dispute goes to court, each side generally employs experts to assist the court in its determination of the proper valuation of property. Commonly, these disputes are referred to as “battles of the experts” because one side will value the property low whereas the other side will value the property high.
In the Estate of Jackson case, the parties disputed the valuation of three intangible assets of the late Michael Jackson on his date of death: (1) Jackson’s image and likeness; (2) his interest in New Horizon Trust II (“NHT II”), which held a 50% interest in another entity, Sony/ATV; and (3) his interest in New Horizon Trust III (“NHT III”), which held an interest in another entity, Mijac Music. Naturally, the Estate argued that these assets had a low (or relatively low) valuation on the date of his death. Conversely, the IRS argued that all three assets had a much higher value.
To support its valuation, the Estate retained four experts—two for Jackson’s image and likeness, one for Sony/ATV, and one for Mijac Music. However, the IRS opted to rely upon only one expert as to all four assets.
The problem with relying upon one expert in trial should be apparent—i.e., if that expert messes up, there are no other experts on that side to support the contested valuations. And in Estate of Jackson, the IRS’ sole expert suffered from a major problem: credibility. The Tax Court explained the IRS’ problem in its opinion as follows:
As the Commissioner’s only expert witness, Anson’s credibility was an especially important part of the case. And it suffered greatly at trial. His problems began when he was asked about the effect on himself and his firm if the Commissioner prevailed in the case. He responded: ‘I have no idea. I’ve never worked for the Internal Revenue Service before.’ Later when asked whether he or his firm had previously been retained by the Commissioner to write an intellectual-property valuation report in Whitney Houston’s estate-tax case, Anson replied: ‘No. Absolutely not.” That was a lie.
Approximately two years before he testified, the Commissioner had retained Anson to write a valuation report titled, ‘Analysis of the Fair Market Value of the Intangible Property Rights Held by the Estate of Whitney E. Houston as of February 11, 2012, for Estate Tax Purposes.’ It was only after a recess and advice from the Commissioner’s counsel that Anson admitted to this.
Anson also testified that neither he nor his firm ever advertised to promote business. This was also a lie. In the midst of trial, Anson’s firm touted his testimony in . . . [an] email blast . . . And in a lecture given before trial Anson referred to his valuation in this case, stating, ‘I’m sitting today . . . in a deposition in what’s known as the ‘Billion Dollar Tax Case.’ . . . [W]e’ve just spent the last year valuing the estate of Michael Jackson.’
Given the Tax Court’s findings that the IRS’ expert had perjured himself, the Tax Court could have chosen to strike all of his testimony. Indeed, the Estate’s attorneys filed a motion for just that. However, the Tax Court opted instead to discount the IRS expert’s credibility by providing the expert opinion with less weight than it otherwise would. Although this was a far less severe sanction than striking his testimony, the Tax Court noted that its finding “affects our factfinding throughout.”
Valuation of Michael Jackson’s Image and Likeness
The Tax Court went on to determine the value of the three intangibles at issue. However, for purposes of this Insight, I will focus only on Michael Jackson’s image and likeness. On the Estate’s Form 706, the Estate had reported his image and likeness as having a fair market value of $2,105 as of the date of his death. The IRS disagreed and issued a notice of deficiency contending that Jackson’s image and likeness should be valued at $434,264,000. At trial, the parties moved away from their original positions—the Estate argued on brief that the image and likeness intangibles had a value of $3,078,000 whereas the IRS contended on brief that their value was $161,307,045.
At the end of the day, the Tax Court sided more with the Estate and concluded that Jackson’s image and likeness should be valued at $4,153,912. In so concluding, the Tax Court relied upon the Estate’s experts, California law (where Jackson died), and the unlawful allegations against him while he was alive that would have severely damaged his image and likeness rights.[i]
I have written much on Section 6751(b), and a prior article of mine on this topic can be found here. However, put simply, Section 6751(b) provides that the IRS may not assess certain penalties against a taxpayer “unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.” In the Estate of Jackson case, penalties subject to Section 6751(b) had been asserted against the Estate in the notice of deficiency. Accordingly, that provision was in play for purposes of determining whether the penalties were appropriate.
In cases of individual taxpayers, the Tax Court has held that the IRS must come forward with evidence of compliance with Section 6751(b) as part of its burden of production. See my blog post on this topic here. However, that only applies to individuals and not estates. On this point, the Tax Court remarked on the Estate’s burden to show non-compliance with Section 6751(b):
This is a somewhat unusual burden—the burden of producing evidence that no evidence exists of the Commissioner’s compliance with his obligation to show supervisory approval of penalties. We described the problem at greater length in our order denying the Commissioner’s motion to reopen the record. SeeOrder dated December 20, 2017. But the Estate failed to enter any evidence that the Commissioner didn’t comply with Section 6751(b).
When the burden lies on the Commissioner, we have held that he must introduce evidence that he complied with section 6751 to meet his burden of production. See, e.g., Dynamo Holdings, Ltd. P’ship v. Comm’r, 150 T.C. 224, 227 (2018) (stating that when the burden of production lies with the Commissioner, he must enter evidence of supervisory approval); Higbee v. Comm’r, 116 T.C. 438, 446 (2001) (“[F]or the Commissioner to meet his burden of production, the Commissioner must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty.”). We see no reason the Estate shouldn’t be held to the same standard.
Although this would seem difficult for any estate to meet, particularly proving a negative, the Tax Court did offer help to future estates in this predicament in future cases. Specifically, the Tax Court reasoned that the Estate should have: (1) entered into the record its discovery request for any written supervisory approval or other evidence that it had raised this issue with the IRS; or (2) raised the issue in the list of assignment of errors in its petition. Because the Estate failed to do so here, the Tax Court held it had failed to meet its burden on the Section 6751(b) issue. However, the Tax Court did find that the penalties were not appropriate under reasonable cause.
The Estate of Jackson case, similar to its namesake, was an interesting one. The opinion provides additional guidance to tax practitioners on issues of valuation, expert testimony, and Section 6751(b). Although it is a long read, tax practitioners would be wise to read it in its entirety.[ii]
[i] As the Tax Court explained, Michael Jackson had earned “close to nothing from his image and likeness” in the years before he died. Moreover, the Tax Court concluded that “[t]his cannot be a surprise—allegations that a celebrity molested little boys might reasonably be thought to repel potential licensees in any society that has not become completely decadent. Those allegations had a dramatic effect on Jackson’s ability to win sponsorships and merchandising deals once they became public. The fact that he earned not a penny from his image and likeness in 2006, 2007, or 2008 shows the effect those allegations had, and continued to have, until his death.”
[ii] All told, the IRS asserted additional increased valuation adjustments totaling approximately $360 million for the three intangible assets at issue in the case. However, the Tax Court determined that the only major increased valuation adjustment should relate to NHT III with little to no valuation adjustments for Jackson’s image and likeness and NHT II.