In March of 2022, Brian Foltyn, CVA, REDW Principal and Valuation, Disputes, and Transaction Advisory Practice Leader, was featured in a special publication by Arizona Attorney Magazine, aimed at serving practicing law professionals. The Lawyer’s 2022 Expert Witness Guide is an annual resource publication purposed to help lawyers manage and maximize their relationships with experts. The article (with permission, shared below) by Mr. Foltyn, titled “What’s It Worth? Estate of Michael Jackson v. Commissioner,” exemplifies complications that can arise in the foundational valuations of a high-value estate, and the benefits that a team of experienced valuation and tax professionals can bring to estate owners.
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How much is something worth?
In early December 2021, the Prince estate settled its tax dispute with the IRS. The brilliant musician died on April 21, 2016, without a will, setting off several legal claims. However, in a matter separate from dying intestate, there was a dispute with the IRS regarding the overall taxable value of his estate. Prince’s estate reported a total taxable value of $82 million on its tax return, compared to the $163 million as determined by the IRS after audit. Prince’s total estate value contained significant investments in real property (i.e., real estate). Although valuation disputes can arise around the value of tangible assets, such as real estate, valuation disputes are typically more common around intangible assets. That was certainly true in the Michael Jackson estate (the “Estate”) case.
Michael Jackson died on June 25, 2009, and like the Prince estate, there was a massive difference between the valuations reported by the Estate and the value determined by the IRS—an extra $500 million in taxes and penalties. The Estate dispute was primarily over the fair market values of three intangible assets: Michael Jackson’s name and likeness, and two trusts that ultimately held interests in a music publishing company and music catalog, respectively.
The conclusion of the Tax Court’s opinion on the Estate of Michael J. Jackson v. Commissioner* sided more with the Estate on the name and likeness value as well as the value of the music publishing company, but it sided more with the IRS on the value of the music catalog. The Tax Court concluded that the fair market value of the Estate’s three assets in contention totaled $111.5 million, compared to the Estate’s tax return of $2.2 million and the IRS’s Notice of Deficiency of $964 million.
Reported Values (in Millions) Estate Tax Return I.R.S Notice Tax Court $2.2 $964.0 $111.5
It should be noted that at trial, the Estate’s valuation experts testified to a value of $5.3 million, and the IRS’s valuation expert testified to a value of $481.9 million—still massive differences. So, what was the Estate worth?
As is so often true in estate tax fights, divergent values are the result of differing valuation assumptions and methodologies, which was certainly true in this case and included the following issues:
- Tax affecting a pass-through entity’s earnings
- Discounting projected pre-tax cash flows using after-tax derived discount rates
- Attempting to identify hypothetical and most likely buyers
- Reliance on management prepared financial projections vs. actual historical financial results
- Use of hindsight
Revenue Ruling 59-60
The IRS issued Revenue Ruling 59-60 in 1959, which provides the fundamental rules for business valuations of closely held corporations. To this day, valuation professionals follow Revenue Ruling 59-60 in their work. The purpose of the ruling is to outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift purposes. It recommends consideration of these eight factors:
- The nature of a company’s business and its history since its inception
- The outlook for the economy in general and the company’s industry in particular
- The financial condition of the company and the value of its underlying net assets
- The past earnings and future earning capacity of the company
- Prior transactions of the company’s stock and the size of the block to be valued
- The ability of the company to distribute earnings
- Whether the company has goodwill or other intangible value
- The price of stock actively traded in a free and open market for comparable companies in the same or similar line of business
While most taxpayers and estates do not need to worry about the value of image and likeness, the Estate of Michael J. Jackson v. Commissioner is an important reminder that it is not uncommon for tax matters to arise because of fundamental and foundational valuation issues. A team of experienced valuation and tax professionals can add great benefit to an estate, including reducing the risk of tax surprises when an estate is transferred—even if your client is not The King of Pop.
* T.C. Memo 2021-48 (U.S. Tax Court May 3, 2021).
This article originally appeared in the Lawyer’s 2022 Expert Witness Guide by Arizona Attorney Magazine. Shared with permission.