Estate Tax

Michael Jackson’s tax bill: Off the Wall? Bad? Can they ‘Beat it’?

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Michael Jackson spent over forty years singing, dancing and "weird-ing" his way to owning the title "King of Pop". Michael was six years old when he debuted as part of the Jackson 5 in 1964 and was 24 when he dropped the album "Thriller" and the ground-breaking videos for "Beat It", "Billy Jean" and "Thriller". Michael recoded 13 number-one singles and won 13 Grammy Awards during his prolific career and "Thriller" remains the best-selling album of all time. Sadly, Michael died of acute propofol and benzodiazepine intoxication on June 25, 2009. He was 50 years old.

An estate tax return was due for the estate of Michael Jackson on March 29, 2010 (which was probably extended to September 29, 2010). This return listed the assets owned by Mr. Jackson at the time of his death and included valuations on each asset. As you can imagine, Mr. Jackson’s estate probably owned some things that many of us will own when we die: bank accounts, automobiles, real estate, etc. Mr. Jackson also owned some things that were unique to his celebrity status and his profession: recording rights, rights to his likeness and image, his endorsement deals with Pepsi and other corporate sponsors, etc.

The Internal Revenue Service has charged the Jackson estate with undervaluing the assets on the estate tax return, as the estate reported a taxable estate of $7 million. The IRS has sent the estate a tax deficiency notice for $702 million ($505.1 million in taxes and $196.9 million in penalties). The primary arguments surround the estate’s valuation of Mr. Jackson’s likeness and image (valued by the estate at $2,105 and by the IRS at $434 million) and the value of some of Mr. Jackson’s recording contracts owned by "MJ/ATV Publishing Trust Interest in New Horizon Trust II" (valued at $469 million by the IRS and not listed on the estate tax return.)

Most of the audits we come across on estate tax returns feature disagreements over the valuation of assets. When filing these returns, it is often wise to obtain a written appraisal of real property and business interests and then discuss the valuations of these assets (for return purposes) with a tax professional. The IRS has provided a good deal of guidance when it comes to properly valuing assets, following this guidance may save the taxpayer’s family from the headaches (and financial costs) of an IRS audit and appeal.

It is uncommon that the IRS disagrees with tax assessments by over $900 million, as is the case with Mr. Jackson’s estate. It will be interesting to see how the arguments over the value of Mr. Jackson’s assets plays out on TMZ and it will be equally interesting to see the justifications used by the estate and the IRS regarding the valuation of Michael’s likeness.

Two final notes about Michael Jackson: First, today would have been his 55th birthday, so happy birthday Michael. Second, it looks like he has got some new music on the way:

http://www.youtube.com/watch?v=76VC2Dsy1SU

James Gandolfini’s estate: Disaster or well-executed plan?

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I recently read an article about the “disasterous” estate tax planning done by the attorneys for late James Gandolfini. The article pointed out that the actor left the majority of his $70 million estate to his children, family and friends; while “only” leaving his wife 20%. The crux of the article was that, by allowing 80% of assets to pass to people other than his spouse, the estate will unnecessarily pay tax on about $50 million. (The $50 million that would have otherwise been passed tax-free if Mr. Gandolfini had left everything to his wife). The tax bill is reportedly going to be in the neighborhood of $30 million.

$30 million is a substantial check to write to the government; but to assess whether the estate plan is a “disaster”, we need to dig a little deeper. James Gandolfini was married twice and he had a child with each wife: Michael, born in 2000, and Liliana, born in 2012. He met his second wife in 2006 and they were married in 2008. Mr. Gandolfini’s mother was a lunch lady and his father a mason and custodian. He did not land his first acting job until he was 26 and his life changed forever when he landed the role of gangster Tony Soprano in 1999 then became a millionaire many times over at the age of 40.

James Gandolfini’s life was far from ordinary, but the issues that his attorneys had to deal with in preparing his estate plan were very common: multiple marriages, children with different spouses and the unique challenges presented by first-generation wealth. It is not uncommon or “disastrous” for people to pass assets to their loved ones knowing there will be an estate tax to pay as a result, due to the unique nature of the beneficiaries and the assets. What is important is that potential taxes are laid out ahead of time to allow the individual to make informed decisions. Sometimes it is worth the tax bill for someone to pass assets outside of the “traditional” family map of everything-to-the-surviving-spouse.

In Mr. Gandolfini’s case, he chose to establish trusts for the benefit of his children at his death so that he could provide for the children’s well-being immediately and so that he could have some control over how (and when) assets are distributed. He also chose to leave substantial amounts to his sisters and friends. These choices cost the estate tens of millions of dollars in taxes, but that may have been a choice Mr. Gandolfini made. Only he and his lawyers know if the result was “disastrous” or exactly as planned.

It is worth noting that Mr. Gandolfini could have left the assets in trust for his wife’s benefit, then provided for the distribution of these assets to his beneficiaries on upon her death. This strategy is fairly common. In this case, however, Mr. Gandolfini’s surviving spouse is only 45 years old and that hypothetical distribution to the kids may not take place for thirty or forty years. Mr. Gandolfini may also have been advised to transfer some of his assets during his lifetime, at this point it is not clear whether any sort of plan was in place.

Properly executed planning documents can help parents protect their children from themselves and from creditors and predators. Our firm will be hosting a seminar to discuss the planning challenges that families face when planning for minor children. We will talk about the red flags that parents should be looking out for and then discuss the legal and financial variables that emerge when we add a child to the mix. The seminar will be held from 7:30-9 AM on July 25, 2013. To register for this seminar, please contact us at events@samuelslaw.com or 503-226-2966. Space is limited, so be sure to contact us soon.

Times are a-changin’ … So should your documents.

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“The line it is drawn, the curse it is cast
The slow one now will later be fast
As the present now, will later be past
The order is rapidly fadin’
And the first one now will later be last,
For the times they are a-changin’.”

Bob Dylan wrote these lyrics to ‘the times they are a-changin’ in September of 1964, while probably examining the political and racial upheaval he saw around him. When I hear the song these days, however, I’m convinced that the last verse is actually about updating business and estate planning documents. Bear with me…

2013 has brought changes to the tax structure that impact all of us and our clients: higher income and capital gains rates, higher estate tax exemptions, expiration of the 2% payroll tax holiday, the extension of portability, and the long-term patch to the Alternative Minimum Tax, to name a few. In the tax world, the times they are almost always a’ changin’, so it makes sense to occasionally review your estate and business documents to make sure this important paperwork reflects these changes appropriately.

Many of our clients’ families are going through transitions. (“The present now will later be past, the order is rapidly fading”). The birth or death of a family member, marriage, divorce, graduation, retirement, changes in jobs, receipt of an inheritance, and similar events often prompt the question: Does this change need to be addressed in my estate planning documents or the organizational documents for my business? If you think the answer might be “yes”, you are probably right.

Many of our clients also come to us because their businesses are going through a transition where the order is changing, or is going to change in the near future. Drawing the proper lines around how the next generation will inherit and manage a business can be done in many different ways. Some arrangements provide a business owner’s heirs with equal shares in managing the business and splitting its profits (and risks), and some arrangements hire a property manager to take over the day-to-day operation while the constantly-fighting children inherit profit rights and nothing more. There are many agreements that fall in between these extremes. There is a lot of room to customize the plan to the business (and family) involved, depending on taxes, family dynamics, and other factors. Some of these transitions go really well and some go terribly wrong. The ones that go smoothly usually involve well thought out written plans, open lines of communication, and children that are on good terms.

I am often asked how often our clients should review their estate and business planning documents. The answer is: whenever the times are a-changin’.

I hope this post has not ruined Bob Dylan’s music for any of our readers.

You can watch Bob Dylan perform ‘The times they are a changin’ at the White House here:

http://www.youtube.com/watch?v=k2sYIIjS-cQ

Taxageddon -The Unpleasant Possibilities for Taxes in 2013

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On January 1, 2013, we may awake on New Year’s Day to find a Tax Code that looks very different from the day before. If Congress fails to act (imagine that!), the combination of various expiring provisions and new taxes scheduled to take effect as part of the Health Care and Education Affordability Act of 2010 (referred to by some as the “Health Care Act” or “Obamacare”), taxes will be going up significantly, especially for taxpayers with incomes in excess of $250,000. Here’s a summary of these tax changes:

Health Care Tax on “Net Investment Income.” As part of the Health Care Act, in 2013 there will be a new tax equal to 3.8% of “net investment income.” In general, this tax applies to married taxpayers with incomes in excess of $250,000 ($200,000 for single taxpayers). “Net investment income” generally refers to income from sources like interest, dividends, annuities, royalties, and capital gains. It’s worth noting that interest on tax-exempt bonds, and excluded gain from the sale of a principal residence that are excluded from gross income are not considered net investment income for purposes of the additional tax. Qualified retirement plan and IRA distributions are also not considered investment income.

Income Tax Rates. For 2013, the top income tax rate will be 39.6%. However, all tax brackets will change under the 2013 revision. For example, in 2012, the 28% tax bracket begins when the income of a couple filing jointly reaches $142,701. In 2013, for the same couple, the 28% bracket will begin when their income reaches approximately $58,000.

Capital Gains. In 2012, the top rate on long-term capital gains is 15%. In 2013, the top rate on capital gains will increase to 20%.

Dividends. Under current law, most dividends are taxed in a similar fashion to capital gains, with the top tax rate on dividend income being equal to 15%. In 2013, dividends will be taxed the same as other “ordinary” income. Therefore, the top tax rate on dividends could increase to 39.6%.

Itemized Deductions. Under current law, the prior limitations on itemized deductions (e.g. the common “Schedule A” deductions for things like state taxes, mortgage interest, and charitable contributions) were phrased out completely. In 2013, these limitations return, providing that itemized deductions are reduced by an amount equal to 3% of adjusted gross income over a certain threshold, but not in excess of 80% of the itemized deductions.

Estate & Gift Taxes. Under a December 2010 compromise between Congress and the Obama Administration, the estate tax exemption was increased to $5 million ($5,120,000 under 2012’s inflation adjustment) with a top rate of 35%. In 2013, the estate tax exemption will revert to $1 million, and the top rate will increase to 55%. The current gift tax exemption in 2012 is $5,120,000, and the top gift tax rate for gifts exceeding the exemption amount is 35%. In 2012, similar to the estate tax, the gift tax exemption amount will drop to $1 million, and the top gift tax rate will rise to 55%.

Payroll Taxes. On Feb. 22, 2012, President Obama signed the “Middle Class Tax Relief and Job Creation Act of 2012” into law. It extended the 2-percentage-point payroll tax cut through the end of 2012 (earlier legislation had extended it for only the first two months of 2012). Thus, the 2-percentage point payroll tax reduction will expire at the end of 2012. For 2013, this tax is scheduled to revert back to its prior level of 6.2%.

The Bottom Line. Unless Congress acts, taxes will increase in 2013. While there is a possibility of a “Lame-Duck” Congress passing curative legislation after the November elections, I would not count on it this time around. Therefore, one might actually consider accelerating income and making larger estate planning gifts in 2012.
 

The Accidental (Tax-Free) Billionaire

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Dan Duncan was the son of an oil-field roughneck. From humble beginnings, Mr. Duncan started his own oil and gas business in 1968 with $10,000 and a truck. Over the years, Duncan grew that business into a prosperous venture which is now known as Enterprise GP Holdings L.P., a publicly traded company (Ticker EPE). At his death on March 28th of this year, Duncan had an estimated net worth of $9 billion and was ranked No. 74 on Forbes list of the world’s richest individuals. It appears that Duncan is the first American billionaire to pass his wealth free of the estate tax since the modern estate tax was originally imposed in 1916.

As we have previously discussed in WealthLawBlog, the federal estate tax is on a one-year hiatus in 2010. In 2009, the first $3.5 million in net worth was exempt from the estate tax, with a top tax rate of 45%. In 2011, the estate tax returns with only a $1 million exemption and a top rate of 55%. Hence, if Duncan had died three months earlier or nine months later, his estate would have been liable for billions in federal estate taxes. 

However, Duncan’s death is not entirely tax free. One quirk in the 2010 estate tax law is an anomaly referred to as “carryover basis.” Generally, under the modern estate tax regimen, while estates are subject to the estate tax, the assets that are subjected to the tax receive a “step-up” in their tax bases equal to the value of such assets as of the decedent’s date of death. This means that the heirs receiving these assets can sell those assets and pay capital gains taxes on only the appreciation in the value of those assets exceeding the stepped-up bases. In 2010, assets receive no step-up in basis except for a limited step-up of $3 million for assets passing to a surviving spouse and $1.3 million for assets passing to other heirs.

In the case of Duncan’s estate, except for these limited exceptions to the step-up basis rule, Duncan’s heirs will inherit the assets in Duncan’s estate with carryover tax bases. If the Duncan heirs sell these assets, then they will pay capital gains taxes on the difference between the sale price of the assets and Duncan’s original basis. Based upon the presumption that much of Duncan’s estate consists of his company shares with a very low basis, the ultimate capital gains taxes payable by Duncan’s heirs could be substantial. Nevertheless, even if the taxes are paid at the increased capital gains rate for 2011 of 20% (increasing to 23.8% in 2013), these taxes are certainly much less than the estate tax rates of 45% to 55%. 

The bottom line: death and taxes are still inevitable. It’s only their timing and severity that varies.

The Bridge is Out! Senate Fails To Compromise on Estate Tax Fix

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As reported in a recent article in TheHill.com, bipartisan negotiations over a potential compromise relating to the federal estate tax have broken down. According to Senate Minority Whip Jon Kyl (R-AZ), Senate Democrats are not allowing any legislation to reach the Senate floor which is not supported by a majority of Senate Democrats.

President Obama has previously proposed that the estate tax be continued at 2009 levels, with a total exemption from the estate tax of $3.5 million (potentially $7.0 million for a married couple) and with a top bracket of 45%. While the terms of the failed compromise were not released publicly, it has been reported from a number of sources that the compromise would begin at President Obama’s proposed levels, but then the exemption would increase over a number of years to $5 million with a 35% top bracket. In order to make the reduction deficit neutral, the Senate proposal would have also allowed individuals to prepay the estate tax during their lifetime at a rate of 35%. Presumably, this prepayment proposal would have been accomplished through some type of a “prepayment trust,” in which taxpayers would transfer assets to an irrevocable trust and pay the estate taxes in the year of transfer.

If Congress takes no further action on the estate tax (a possibility which I have discussed in a previous WealthLawBlog article), the estate tax will remain “repealed” for the balance of 2010, but then will return on January 1, 2011 with an exemption of only $1 million and a top bracket of 55%. Some Senators have stated publicly that they are in support of a reduced estate tax exemption. For instance,

Sen. Bernard Sanders (I-Vt.) recently stated: “The idea that we would make significant exemptions within the estate tax to give more tax breaks to the top three-tenths of 1% is nauseating. I will do everything I can to stop that.”

With approximately 11 “legislative weeks” for Congress to accomplish a “fix” to the estate tax, it seems to me that two things are becoming increasingly likely. First, the estate tax will likely remain “repealed” for the balance of 2010. Second, as the champagne flows and 2011 is ushered in, the “new” estate tax will return with the $1 million-55% parameters.
 

2010 ESTATE TAX REPEAL STILL ON SCHEDULE!

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On December 16, 2009, the Wall Street Journal reported that the Democrats’ attempt to extend the Federal Estate Tax exemption of $3.5 million into 2010 has been blocked by the Republicans. Senator Max Baucus is quoted as saying, “We clearly will work to do this retroactively, so that when the law is changed, it will have retroactive application.” 

The Republicans believe that the repeal should be allowed to take effect as provided under current law, and Senator John Kyl (R, Arizona) stated, “The problem doesn’t have to exist. They’ll just leave the existing law alone and let the rate go to zero, where everyone wants it anyway.”

 Thus, as the law stands today, Federal Estate Tax will be

  • zero in 2010;
  • with certain exceptions the tax basis step-up will be repealed for 2010;
  • The estate tax exemption will return to $1,000,000 in 2011.

It is an interesting and continuing revelation about the extent of the massive gridlock in the current Congress when the Democrats could not even muster enough votes to pass a mere extension of the $3.5 million exemption for the first three months of 2010.

 

It remains to be seen whether or not enough votes can be mustered to make any estate tax changes in 2010. If the Senate could not pass an estate tax bill with a 60 vote majority, I am skeptical that it will get accomplished in 2010. 

Recent Ruling: Fed. Estate Tax Not Binding

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From time to time, we will publish blurbs on recent local court opinions and state legislation: 

Force v. Dep’t. of Rev., 2008 WL 5191844 (Or.Tax Magistrate Div.) (pdf)

Background: Decedent’s personal representative completed federal and state estate tax returns resulting in no tax owed on decedent’s farm. The state of Oregon issued a notice of deficiency for approximately $27,000. The personal representative argued that the state of Oregon, by statute, had to use the federal valuation method, which would result in $0 in state tax. 

 

Holding: The federal determination of federal estate tax is not binding upon the state in its separate and distinct calculation of the Oregon inheritance tax. Instead, the state tax imposed is appropriately determined based upon the formula contained in IRC section 2011(b)(1) (2000) as expressly adopted in ORS 118.010(2).

New House Bill Would Reform Estate Tax

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Charlie Rangel, House Ways and Means ChairmanOn October 22nd, a bill to permanently extend the federal estate tax for 2010 and beyond was introduced by a bipartisan group of Congressional Representatives. All four Representatives are also members of the House Ways and Means Committee – the tax-writing committee in the House. The bill would rescind 2010’s scheduled repeal of the estate tax. In addition, over the next ten years, the bill would increase the federal estate exemption amount and reduce the top estate tax rate as indicated in the table set forth below:

YEAR

  

EXEMPTION

  

RATE
   

AMOUNT

    

2009

  

$3,500,000

  

45%

2010

  

$3,650,000

  

44%

2011

  

$3,800,000

  

43%

2012

  

$3,950,000

  

42%

2013

  

$4,100,000

  

41%

2014

  

$4,250,000

  

40%

2015

  

$4,400,000

  

39%

2016

  

$4,550,000

  

38%

2017

  

$4,700,000

  

37%

2018

  

$4,850,000

  

36%

2019 or thereafter

  

$5,000,000

  

35%

After 2019, the $5 million exemption amount would be indexed for inflation. While the introduction of such legislation is often the last time it sees the light of day, the fact that a bipartisan group (two Democrats and two Republicans) introduced the legislation, combined with their common membership on the Ways and Means Committee, may give the bill some traction. Ultimately, Ways and Means Chairman Charlie Rangel will be instrumental in deciding the nature of any legislation that moves out of the committee. Stay tuned!

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