In the light of the confusion arose since the trial IRS/Estate of Michael Jackson started, we are going to summarize the issues going and that brought this trial set
The Michael Jackson Estate filed an Estate tax return with a date of death valuation date of June 25, 2009 e reported a total gross estate of $57,203,929 with deductions of $57,203,929, which resulted in a taxable estate of $0.00.
IRS issued a statutory notice of deficiency on May 13, 2013. In the notice, IRS increased the values of various assets. The Michael Jackson Estate filed a petition on July 26, 2013.
Main issues to be solved:
- Michael Jackson name and likeness;
- Michael Jackson’s interest in New Horizon Trust II (Sony/ATV’);
- Michael Jackson’s interest New Horizon Trust III ( Mijac);
- Associated penalties
The main and most difficult point of this trial it will be to find a fair compromise on the “Name and Likeness”. The Estate based his defense on some exemptions such “Copyright Preemption and First Amendment” which are strongly contested by IRS.
IRS say that “Michael Jackson name and likeness have to be valued as a bundle of rights. The valuation of this property right is governed by several areas of law. The laws regarding the right of publicity arose due to celebrities desire to protect the name, likeness and unique characteristics they have built as public figures.
The right of publicity bundle of rights can also include trademarks which are registered and protected under the Lanham Act and State common law. False endorsement claim are actionable under the Lanham Act.
For example, in the film Michael Jackson’s: This is It the work is offered to the public “with the permission of the Michael Jackson Estate” and the opening credits before the title state that it is presented “In Association with the Michael Jackson Company and AEG Live”. Absent any permission from an entity affiliated with Michael Jackson or his estate, those statements would be false and, hence, actionable under the Lanham Act. Michael Jackson: ONE by Cirque du Soleil: the Mandalay Bay hotel and casino uses Michael Jackson’s name and likeness throughout its facility.
The casino features signs directing play-goers to the “Michael Jackson: ONE Theatre; a “Michael Jackson: ONE store adjacent to the theatre sells every sort of Michael Jackson merchandise, most of which are labelled as being made “under license’ from the Estate of Michael Jackson; when those items of merchandise are purchased, they are placed into bags imprinted with Michael Jackson’s name and likeness; theatre patrons are invited to pose in front of an image of Michael Jackson and then to pay for souvenir photos of themselves, on which his name is further superimposed.
The hotel reception is located in a lobby dominated by a giant statue of Michael Jackson, playing video of him on all four sides, featuring his name, and proclaiming its authorization from the Estate of Michael Jackson.
Absent any permission, the above extensive use of Jackson’s name and likeness would be actionable as a false endorsement. In addition to the considerations just set forth, the gross estate contains trademark registrations for Michael Jackson’s name, signature, and initials, thus rendering the casino’s unauthorized use of those masks a potential infringement of the Estate’s registered rights, if undertaken without permission infringement.
Also, trademarks that existed at the time of Michael Jackson’s death illuminate exploitations he made during his lifetime. But trademarks exist regardless of registration, so the business person must also consider the extent of Jackson’s (now his Estate’s) unregistered trademarks.
Likewise, absent a license, the use of Michael Jackson’s name and likeness in a video game also raises right of publicity pitfalls. The exemption available under California Civil Code does not specifically mention “video games”. Possibly, a video game would receive an exemption under the statute as an “audiovisual work” but a defendant would have to convince the court of this reading, given that no published decision as of 2009 determined whether a video game counts as an audiovisual work under California’s post-mortem right of publicity statute.
The following foreseeable post-death events corroborate respondent’s expert ‘s conclusion of value of Michael Jackson’s name and likeness: within days of MJ’s death, agreements were reached and contracts were signed specifically allowing use of the Michael Jackson name, likeness and trademarks. Immediate authorized uses of his name and likeness consisted of a movie, a traveling show, merchandising and exhibitions. Uses which were Estate-sponsored were allowed and the Estate was compensated. Any unauthorized use was met with cease and desist letters and lawsuits by the Estate.
In August 2009, John Branca reached out to Cirque du Soleil to do a Michael Jackson themed show. Cirque du Soleil’s subsequent presentation materials to the Estate of Michael Jackson were based on the business principles of The Beatles LOVE show by Cirque du Soleil. It was foreseeable at the time of Michael Jackson’s death that a Cirque du Soleil Michael Jackson themed show would eventually occur due to the already previous negotiation in 2009 with Michael Jackson himself.
The Estate own actions further corroborate IRS view. MJ Estate actually licensed Michael Jackson’s name and likeness for use in Cirque du Soleil shows and a video game. Yet MJ Estate seek to make a scholarly argument about the purported scope of legal rights involved with these ‘exempt’ categories. All known and foreseeable facts should be considered in valuing Michael Jackson’s image and likeness rights.
For the above reasons IRS state that “Copyright Preemption is not an effective defense”.
“The task of applying this constitutional provision is itself fraught with innumerable legal twists. Lower courts apply at least three balancing tests to evaluate a First Amendment defense. An example is the California Supreme Court explicitly adopted the ‘transformative test’ in the context of artworks, asking “whether the celebrity likeness is one of the ‘raw materials’ from which an original work is synthesized, or whether the depiction or imitation of the celebrity is the very sum and substance of the work in question.) There, the court opined that Andy Warhol’s reproductions of celebrity portraits may be sufficiently transformative, but defendant’s “lithographs and T-shirts bearing a likeness of The Three Stooges reproduced from a charcoal drawing be had made’ were not, and thus publicity rights prevailed over the First Amendment. Indeed, the court seemingly stepped into the role of an art critic when it opined, ‘Warhol was able to convey a message that went beyond the commercial exploitation of celebrity images and became a form of ironic social comment on the dehumanization of celebrity itself. This example highlights the subjective nature of the transformative test, which creates further uncertainty for the business person tasked with evaluating the First Amendment defense.
Suffice it to say that each and every one of the cases discussed above arose against the backdrop of the First Amendment. Accordingly, important as the First Amendment may be, it fails to qualify as a get-out-of-jail-free card for a business person facing a decision as to how to proceed in this domain.
For the above reasons IRS state that First Amendment is not an effective defense
New Horizon Trust II (Sony ATV)
Michael Jackson shared the 50% control with Sony Music Publishing Co. (“Sony”). His 50% share gave him rights to appoint an equal number of directors as Sony and vote on major decisions. The Sony/ATV Operating Agreement included buy/sell provisions. Both members’ interests were subject to the buy/sell agreement. Under Sony’s purchase option clause, if Michael Jackson’s half was sold while still encumbered by debt, Sony was given a specific option price to acquire 25% of the company (half of Mr. Jackson’s half) at the “option price.” The value of the purchase option price for 25% was calculated by Mr. Anson to be $242,075,000. Mr. Anson valued Michael Jackson remaining 25% interest using the discounted cash flow analysis. Mr. Anson’s valuation of ones-half of the decedent’s interest in Sony/ATV at the option price was a conservative valuation of this half of the asset, because the option price would only apply if the debt remained at the time of a hypothetical sale. Under any other scenario, the full 50 percent interest would be valued as one, and would therefore result in a higher price. (IRS expert calculates the fair market value with and without the use of the option price.)
The buy/sell process could be initiated by either Michael Jackson or Sony. This process provided a right for either 50% owner to dispose of their interest for full undiscounted value and/or to obtain ownership of the entire company. The key differences between IRS and The Michael Jackson experts concern whether, under the income approach, it is more appropriate to use NPS or EBITDA; the discount rate to be applied to the discounted cash flow analysis; whether discounts for lack of control and lack of marketability are appropriate; and whether the income stream should be tax affected.
You can read in details the buy out clause here:
The Michael Jackson Estate expert applied discounts for lack of marketability (25%) and minority interest (20%) to the decedent’s interest in Sony/ATV.. IRS expert has opined that it is not appropriate to apply such discounts for the reasons set forth in his report, rebuttal report and supplemental report.
The hypothetical buyer and seller are presumed to be aiming to achieve the maximum profit from the hypothetical sale of the property. This is realized when the Buy-Sell provision is invoked as per Section 7.8 of the Operating Agreement. The provision essentially provides for either an internal sale (Section 7.8(d)(i) or (iii)) or an external sale (Section 7.8(d)(ii))of all interests. In either scenario, the ultimate hypothetical buyer will control a 100% interest in the entity. This results in a controlling, marketable position, making it inappropriate to deduct any discounts in determining the fair market value of the 100% interest.
The operating agreement at Section 7.8(b) explicitly provides that no discounts apply in arriving at a Pair Value for the company when computing the selling price under the buy/sell provisions of the operating agreement. Fair Value is used to value the ‘whole’ Company in determining value in the event there is an internal purchase of the interests.
In the event there is an external sale of the interests, the hypothetical transaction of the entire interest in Sony/ATV is assumed to occur in a hypothetical market. Sony/ATV’s primary asset is a song catalog, containing over 750,000 songs, as of the valuation date. Included within the catalog are song rights from such highly successful groups and artists as The Beatles’ and other well-known artists. According to IRS expert, the hypothetical market for the interest in Sony/ATV would be intense and create a buyer bidding war. As a result, a market adjustment (i.e. premium price) would result to reflect the high demand for these music publishing assets and the premium nature of the catalog, thus offsetting any potential discounts.
New Horizon Trust III (MIJAC Catalog)
This one consisted of Michael Jackson interest in Mijac Music, $72,152,649 in liabilities, and cash. This is the property interest to be valued. As the amount of cash and debt is not in dispute, the only issue is the value of Mijac. Mijac is a catalog of the publishing rights associated with 527 compositions written by a variety of song writers. The catalog includes songs written by Michael Jackson, as well as songs written by other writers which were later acquired by Michael Jackson. Moss Adams LLP (‘Moss Adams’), which was retained by the Estate to value Mijac Music, identified 167 songs written by Michael Jackson, and 327 songs written by other writers, which were income producing in the five years prior to Michael Jackson’s death. The catalog is held in NJ Music Publishing LLC, a single member LLC whose sole member is New Horizon Trust III.
The key differences between IRS and the Michael Jackson Estate experts concern identifying the correct number of songs, inconsistencies in bow historical royalties are calculated and presented; the extent of the post-death spike; whether tax affecting is appropriate; the discount rate to be applied; and the extent and value of the unpublished songs.
The Michael Jackson Estate produced a number of valuation reports since 2010, with each report identifying a different number of songs. For example, in the category of Songs written by Michael Jackson, the report filed with the Estate tax return, prepared by Owen Dahl, indicated 138 songs. In a subsequent report dated March 31, 2014, prepared by Owen Dahl, the number of such songs increased to 167. Finally, in the last Michael Jackson Estate expert’s report dated October 17, 2016, the number decreased to 117. The Estate failed to provide any explanation for the inconsistencies.
In determining the post-death spike in sales, the MJ EState expert inappropriately relied on a study published in 2014, five years after the valuation date, and which included artists from different genres and segments of music, many of whom were not readily comparable to Michael Jackson. Revenue Ruling 59-60 provides for ‘both parties having reasonable knowledge of relevant facts. Since the study was published in 2015, it would not have been known or knowable by either party as of the valuation date.
The MJ Estate expert tax affected the cash flows and discount rate, while respondent’s expert did not. A discussion on the appropriateness of tax affecting was previously presented.
The MJ Estate expert also assigned a $1,143,581 value to unpublished songs, but failed to include this value in its concluded value. Conversely, the IRS expert determined that the unpublished songs had a fair market value of $22,204,296.
Estate of Michael Jackson rebutted and explained the value of New Horizon Trust III, which owns the Mijac music catalogue saying that IRS expert made his valuation of the Mijac music catalogue including revenue that would be payable for “artist royalties” and “joint venture income with Sony.”
“Artist royalties” represent the income payable to the owner of the performances embodied in master sound recordings.The Mijac catalogue does not include any interest in artist royalties or joint venture income and includes an interest only in the writer’s share of those compositions underlying sound recordings. As such, the Mijac catalogue is entitled only to music publishing royalties on compositions.
“Joint venture income with Sony” represents income from the exploitation of Master Recordings under a joint venture agreement between Sony Music Entertainment and MJJ Ventures. Inc. “Artist royalties” were valued as part of the Master Recordings and “joint venture income” was included in the value of MJ Ventures in the Federal Estate Tax Return attributable to the interest in a joint venture with Sony.
- The Internal Revenue Code imposes a penalty equal to 20% of the portion of a tax underpayment attributable to certain items that are not accurately reported on the return.
- The penalty applies to underpayments due to the substantial understatement of value for estate and gift tax purposes.It also applies to negligence or disregard of the rules or regulations.
- Substantial devaluation for estate and gift tax purposes occurs when the value of any property claimed on any return is 65% or less of the amount determined to be the correct valuation.
- Negligence is defined as any failure to make a reasonable attempt to comply with the tax laws. Disregard for the rules and regulations can be careless, reckless or intentional disregard.
- The accuracy-related penalty increases to 40% of the tax underpayment in cases of gross valuation misstatements. A gross valuation misstatement occurs when the value of any property claimed on any return is 40% or less of the amount determined to be the correct valuation.
- The penalty is inapplicable, however, if the taxpayer shows that there was reasonable cause for the underpayment and that he or she acted in good faith.
- The determination of whether the taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances. The most important factor is the extent of the taxpayer’s effort to assess the proper tax liability for that year.
- Reliance on the advice of a professional tax advisor or appraiser does not necessarily demonstrate reasonable cause and good faith, if under all circumstances, such reliance was unreasonable. Reasonable cause and good faith ordinarily is not indicated by the mere fact that there is an appraisal of the value of property. Other factors include the methodology and assumptions underlying the appraisal, the appraised value, the relationship between the appraised value and purchase price, the circumstances under which the appraisal was obtained, and the appraiser’s relationship to the taxpayer or to the activity in which the property is used.
- IRS has the burden of production in any court proceeding with respect to any penalty posed by the Internal Revenue Code. In order to meet that burden, the Commissioner must offer sufficient evidence to indicate that it is appropriate to impose the penalty. However, once respondent meets this burden of production, the taxpayer bears the burden of proving error in the determination to impose a penalty, including proving reasonable cause, substantial authority, or other exculpatory factors.
- MJ Estate valued decedent’s name and likeness at $2,105, valued decedent’s interest in New Horizon Trust II at $0.00 and decedent’s interest in New Horizon Trust III at $2,207,351. Each of these values is significantly less than 40% of the actual fair market values of these assets. Therefore, the gross valuation misstatement penalty applies.
- Alternatively, each of these values is significantly less than 65% of the actual fair market values of these assets. Therefore, the substantial valuation misstatement penalty applies.
- Regarding negligence, petitioner did not make a reasonable attempt to correctly value the assets at issue herein.
- Whether petitioner is liable for the gross valuation misstatement penalty of 40 percent under I.R.C. S 6662.
- Alternatively, whether the petitioner is liable for the accuracy related penalty under I.R.C. S 6662.
- The remaining issues raised in the statutory notice of deficiency have been settled between the parties, pursuant to the Stipulations of Settled Issues filed with the Tax Court on October 20, 2014, April 27, 2015, and December 11, 2015. In addition, the amount of Petitioner’s charitable contribution deduction, claims and administrative expenses and losses allowable under Sections 2053, 2054 and 2055 of the Internal Revenue Code, will be deferred until entry of the decision in this matter. Such matters will be determined by agreement of the parties or in a supplemental proceeding
ISSUES THAT HAVE BEEN SETTLED:
I. The value of the real property located at 4641 Harvenhurst Abe.Encino. CA.
2. The value of the Estate’s interest in Sycamore Valley Ranch Company, LLC.
3. The value of Policy B0638C09195.
4. The amount of additional cash recoverable by the Estate.
5. The value of MJJ Ventures, Inc.
6. The value of decedent’s share of artist mechanical royalties related to Jackson 5 master recordings.
7. The value of Michael Jackson’s master recordings. (to be discussed again during the trial)
8. The value of tangible personal property.
9. Penalties related to the settled issues.
ISSUES THAT HAVE BEEN DEFERRED
1. The amount of MJ Estate charitable contribution deduction.
2. The amount of claims and administrative expenses.
3. The amount of losses allowable under Sections 2053, 2054 and 2055 of the Internal Revenue Code.
As of today the new values in dispute, with IRS revised figures, are as follows:
Image & likeness Usd. 161,307, 045
Interests in New Horizont Trust II Usd. 206,295,934
Interests in New Horizont III Usd. 114, 263,615
P.S. The blog will be subject to update as the new discoveries during the trial