Taxgirl is running an interesting experiment in which she lets her readers post blog entries answering the question, "Hey Congress why don't you. . .?" There are lots of thoughtful comments. Sometimes, we attorneys and CPAs get mired in the overly technical and complex details of the Internal Revenue Code, and fail to see the big picture that the public does.
So check it out -- Start Here.
One of the blogs on my daily reading list is the “Tax Girl” (a/k/a Kelly Phillips Erb, a Philadelphia tax attorney). She has a regularly occurring feature on her blog called “Ask the Tax Girl” which she uses to answer readers’ tax questions (and sometimes, when necessary, gives her readers the motherly advice that they deserve ). She recently tweeted that she had received a tax question about Michael Jackson, and I replied that I’ve been blogging about the estate tax issues involved in the case and that I would be happy to answer her reader’s question.
Sigh. Me and my big mouth.
Note to self: Never underestimate the sophistication and intelligence of Taxgirl’s readers. While I was expecting a rather basic, easy to answer, yes or no question, what I got instead was:
Not necessarily the easy yes or no answer that I had hoped for, but hey, if it were an easy question, the reader wouldn’t have had to ask it. First some background information.
For “ordinary run-of-the-mill” estates, the estate deducts the costs of the funeral from the gross estate on the estate tax return. But in death, as in life, there is nothing “ordinary run-of-the-mill” about Michael Jackson. What the reader is asking is whether Michael Jackson’s estate can deduct the millions of dollars associated with not just the funeral, but with the memorial service that was held yesterday.
Section 20.2053–2 of the Treasury Regulations provides that for an estate to take a deduction for funeral expenses, the amounts paid must actually be expended out of property subject to claims. In other words, in order to take the deduction, the estate itself has to pay the costs. Also, those costs must be out of property that are “subject to claims,” that is property that can be used to pay creditors under local law. So first of all, any of the costs involved that were not paid by the estate but instead was paid by the taxpayers of the state of California or the city of Las Angeles are obviously not deductible.
The regulation continues, “A reasonable expenditure for a tombstone, monument, or mausoleum, or for a burial lot, either for the decedent or his family, including a reasonable expenditure for its future care, may be deducted under this heading, provided such an expenditure is allowable by the local law. Included in funeral expenses is the cost of transportation of the person bringing the body to the place of burial.”
While there is a requirement for the costs to be “reasonable” that determination is made on a case by case basis. Reasonable for you and me is not necessarily reasonable for someone with a few hundred million dollars. So will the costs be deductible? Like many other tax questions, and many other questions about Michael Jackson, the answer is going to be — it depends.
Here is my take:
Phew. Thanks for letting me assist, Taxgirl. I think.
In my previous post, I wrote that contrary to media reports, that it was highly likely, if not impossible that the Michael Jackson Family Trust (which has not yet been released) distributed his assets to his mother and his children outright. (Various sites are reporting that the mother “gets” 40%, the three children receive 40% between them and that various charities will receive 20%). I showed that his estate has to pay an estate tax of 45%, and if a distribution was made outright to his 79 year old mother of 40% of his assets (which could possibly be over $100 million) then when she dies, there would be another tax of 45% on the value of her estate.
Again, as the Trust has not yet been released, everything I write is pure speculation.
Most people don’t expect to die before their parents, and I can assume that when drafting his Will and Trust, Michael Jackson felt the same way. However, he loved his mother and wanted to take care of her for the rest of her life should he pre-decease her. But giving her the money outright would be a tax disaster (and a bad idea for other reasons that I will discuss in later posts). The solution? Leave the property to her in a trust with certain rules.
Without going into too many technical details, when a person dies their estate is subject to tax on property they own, and ownership is largely determined by control. If Katherine Jackson is distributed the property directly, she certainly controls it. Also, if it is distributed to her in a trust in which she is the sole trustee and has unfettered access to the principal, she is in control.
However, if the property is distributed to a trust in which an Independent Trustee is responsible for determining when, and for what purposes, the trust assets are distributed to her, then upon her death, the property in the Trust will not be subject to the estate tax a second time. In fact, Katherine Jackson can even be the Trustee herself and make distribution decisions, if the reasons for the distributions are limited to what are known as certain “ascertainable standards.” This means that a trust could be created in which she has the power to withdraw property for her health, education, support, and maintenance. Upon her death, the property in the trust would not be subject to the estate tax, however, anything that she withdrew from the trust and still owned would be.
By engaging in proper estate planning, Michael Jackson could take care of his mother so that she lives not just comfortably, but in absolute luxury for the rest of her life, and then upon her death, those assets would not be subject to the estate tax a second time.
In a future post I’ll discuss the non-tax reasons why this type of planning is a good idea for everyone, even if you do not have millions of dollars. This involves protecting the assets from your heir’s potential creditors, and controlling the ultimate disposition of them.
I have previously written in the blog about the Estate Tax, but I’d like to revisit the subject using the real life example of the Michael Jackson estate. First, some review of the basics.
The estate tax, which is often, but inaccurately called the “death tax” by people who oppose it, is not an income tax. It is an excise tax on the value of assets transferred by an individual at the time of their death. This includes not just money in the bank, but all assets owned by the individual, i.e. cash, stocks, bonds, real estate, Beatles songs, and Elephant Man bones.
A person dying in 2009 has a lifetime exemption, that is the amount of assets they can transfer at death before the estate tax applies, of three million five hundred thousand dollars ($3,500,000). After that, the rate of tax on that person’s assets is 45%. Interwoven with the estate tax is the gift tax which is a tax based on inter vivos (which means lifetime) transfers. However, for the sake of simplicity, I will assume that Michael Jackson did not make any taxable gifts, that is, he did not make any gifts that would affect the estate tax.
Much of the public debate over the estate tax involves the lifetime exemption. The higher the exemption is, the fewer people there are that would be subject to the estate tax. A decade ago, the lifetime exemption was only $600,000, so a great many people were subject to the estate tax. As it is now, very few Americans have estates that are worth $3,500,000 (especially with the stock market and real estate crash). A married couple that engages in proper estate planning can leave $7,000,000 to their children (or to anyone they want) tax free.
But for the Michael Jackson’s of the world, the amount of the exemption is irrelevant. When you have hundreds of millions of dollars in assets, it does not matter whether the lifetime exemption is $1,000,000 or $3,500,000 or even $10,000,000. What really matters is the rate, that is what percentage of the assets will be subject to the tax. As I wrote earlier, Michael Jackson’s estate is looking at a possible estate tax liability of 45% on his taxable estate. And the IRS doesn’t take payments of Red Zippered suits. Cash only please.
There are a few things that should lessen the amount of the estate tax that he owes however. First, the tax is only imposed on the net value of his assets. The estate can deduct from the value of the assets any liabilities that the decedent had at the time of his death. And according to published reports, Michael Jackson had very significant liabilities. In fact, his liabilities may be so large that his estate could be worth far less than anyone would expect. Second, just like there is an income tax charitable deduction, there is also an estate tax charitable deduction. Any money that Michael Jackson left to charity will be deducted from the value of his taxable estate, and thus reduce the amount of estate tax that he owes. Third, the estate may deduct the costs involved in administering the estate, which I also suspect will be substantial.
Although news reports say that it will take years and years to sort all of this out, the estate tax is due and payable nine months after death before interest and penalties (which are substantial) start kicking in. So whoever is in charge of the Form 706 Estate Tax Return has their work cut out for them.
In a future post I will talk about the essential question of valuation, that is how do you determine what an asset is worth. Cash and stocks and bonds are easy to value and even real estate has comps. But how do you value the future income stream of the Beatles catalog? What is the likeness and image of Michael Jackson himself worth?
Tough questions. Stay tuned.
I'll write more on this myself as it develops, but here are some articles to check out:
Smart Money: Michael Jackson's Death and Your Estate Plan
Reuters: Hello Goodbye: Jackson's Beatles rights at risk
Wall Street Journal: Getting Personal: Jackson Estate a Tangled Affair
Business Week: Settling Michael Jackson's Estate may be a Thriller.
At this point, all anyone is doing is speculating. No one knows if he had a will or where it is. At least no one who is talking. There is a "rumor" going round the internet that "Michael Jackson willed his control of the Beatles songs to Paul McCartney." That is almost certainly not true.
First, unless MJ specifically said this somewhere, how would anyone know it?
Second, the asset is highly leveraged with many secured creditors.
Finally, it's probably the most valuable thing that he owns. Why would he do that to his children?
This is going to be fascinating from an estate planning and tax and administration perspective. And I haven't even talked about what happens to his children yet.
Stay tuned.
In writing a blog, or in writing anything, the most important question is "Who is your audience?" So far, my posts have been aimed towards what I call "the sophisticated layman." I have been writing for the educated reader who is not an expert in matters regarding estate planning or tax, and is interested in learning more.
But every now and then there is "breaking news" in the estate tax world, that most laymen, sophisticated or not, probably would not be interested in, but would be of interest to estate planning and tax experts. This is one of those times.
Yesterday, the US Tax Court's issued its opinion in Estate of Jorgensen v. Commissioner, ruling that the entirety of assets transferred to a family limited partnership were included in the gross estate of a decedent under s. 2036(a)(1) of the Internal Revenue Code.
Like many other cases in which there is a complete victory for the Government, the most important lessons in this case for Estate Planning attorneys is "Don't do this."
More after the jump
Continue Reading...For most people, taxes are relatively straightforward. Not easy, not pleasant. But straightforward. If you have a bank account that earns interest during the year, then at the beginning of the following year your bank sends you a Form 1099-INT reporting the interest that you earned, and sends a copy of that same form to the IRS.
Now there are some people out there who aren't big fans of the whole "bank sends 1099 to the IRS" regime. Or, in some circumstances they don't want the IRS to know about where the original money came from at all. Many of these people place their money in banks located in other countries or "offshore" accounts. Since these banks are in foreign countries, they generally do not report interest earned on their accounts to the IRS.
Before going further I want to point out that there are plenty of legitimate reasons to open an offshore account and that most people who do open offshore accounts properly report and pay their tax obligations. But there are some that don't. UBS has been in the news lately for the 52,000 "secret" accounts that it holds for US taxpayers. How many of them are owned by people who haven't been properly reporting their income? No one knows.
The IRS and UBS have been wrangling over whether or not UBS will be required to turn over the information to the US government, or whether Swiss Banking laws prohibits it from doing so. People who have these accounts and have not reported their income or paid their taxes are subject to massive civil and criminal penalties and possibly criminal prosecution.
Today, the IRS is offering the carrot instead of the stick. Or maybe just a very sharp carrot. IRS Commissioner Douglas Shulman [no relation] announced that for taxpayers who "voluntarily disclose" their accounts (before the IRS catches them first), the IRS is willing to reduce some of the penalties.
From the Wall Street Journal Article:
In its definition of "voluntary disclosure," the IRS says taxpayers must come forward before the IRS has been given their name by a third party. However, in a call with reporters, IRS spokesmen said that UBS customers whose names already have been divulged to the IRS may still qualify under the "voluntary disclosure" guidance issued Thursday.Taxpayers who come forward voluntarily will face a 20% penalty on their foreign account assets in the year with the highest account value, down from the current 50% penalty levied on account assets in each year the taxpayer failed to disclose the account.Other penalties continue to apply for people who come forward, including either a failure to file penalty of 25% or an accuracy penalty of 20%. Taxpayers will also be responsible for back taxes and interest going back six years, the IRS said.These rules, in effect for six months, "make sure that those who hid money offshore pay a significant price, but also allow them to avoid criminal prosecution if they come in voluntarily," Shulman said.
Of course, for the average person who doesn't have millions in an offshore account, the IRS is just as friendly as ever with regards to penalties imposed.
I found this article from Newsday interesting. They list six ways to save taxes, based mostly on depressed asset values, something that I've written about before.
Each of these may be a good idea depending upon your individual situation. Before going through with any of them you should see an expert -- a tax attorney, CPA, or financial planner that specializes in this area.
In testimony before Congress this morning, IRS Commissioner Douglas Shulman [No Relation] testified that the Service will be issuing guidance as to how victims of Ponzi schemes can treat their losses for tax purposes. According to the New York Times:
The plan, which applies to victims of all Ponzi schemes, is likely to provide major relief to the victims of Mr. Madoff, who pleaded guilty last week to orchestrating what prosecutors say is the largest Ponzi scheme ever — one that could reach $65 billion and cover 13,000 investors.
The plan would ease existing rules governing what are known as theft-loss deductions, which are losses claimed by investors who are cheated by their investment advisers and others in Ponzi schemes and other frauds.
Under the plan, which has been reviewed by the congressional offices, the I.R.S. will allow investors who are not suing Mr. Madoff to claim a theft-loss deduction equal to 95 percent of their investments, minus any withdrawals, reinvested gains and payouts from Securities Investor Protection Corporation, the government-chartered fund set up to help protect investors of failed brokerage firms.
Investors who are suing Mr. Madoff, and who thus may have some prospect of recovery, can claim a deduction equal to 75 percent of their investments.
The I.R.S. is also relaxing the rules on how far back the losses can be carried. Current theft loss rules typically allow loss to be carried back 2 years and forward 20 years, but under the plan, the I.R.S. will allow losses to be carried back 5 years as well as forward 20 years.
Under the plan, investors must claim the loss as having happened in 2008.
I will post any original sources when I find them.
UPDATE: The IRS has issued a Revenue Ruling (Rev. Rul. 2009-09) and a Revenue Procedure (Rev. Proc. 2009-20) (Thanks to Joe Kristan of Roth CPA for the links). Joe did his own reading and analysis of the releases. My quick read is as follows:
First, the Service issued both a Revenue Ruling and a Revenue Procedure. A Revenue Ruling generally states what the Service's posistion is on a specific area of law. A Revenue Procedure sets forth methods for Taxpayers to comply.
Rev. Rul. 2009-09 answers the following questions:
The Revenue Ruling also discussed Net Operating Losses, the Claim of Right doctrine, and the Statute of Limitations. It provides that a taxpayer can treat these losses as a NOL, that there is NOT a benefit under s 1341 (the Claim of Right Doctrine), and that a Taxpayer can take a decution in 2008 for amounts taken into income for past years, even if the statute of limitations has expired.
The Revenue Procedure provides a "safe harbor" for Taxpayers -- meaning that if Madoff victims follow it, their returns will not be challenged by the IRS. It provides for a deduction of 95% of the "qualified investment" a term defined in the Rev. Proc, if the taxpayer is not going to sue Madoff, and 75% if they are going to sue Madoff (or other Ponzi promoters).
The Trustee shall distribute the principal. . . of any Exempt Trust and any part of the principal of the Non-Exempt trust not otherwise subject to appointment to or in trust for the benefit of such of my descendants as the Primary Beneficiary may appoint under Will bey specific reference to this power. (Emphasis Added)The "mistake" if there even is one is subtle. Because the Primary Beneficiary is one of the Grantor's descendants, then this paragraph may be interpreted as giving the Beneficiary a General Power of Appointment (which would cause estate tax inclusion) as opposed to a Limited Power of Appointment. The PLR stated that the Trustee would petition a local court to modify the Trust to clear up this ambiguity. The Trustee also asked the IRS for a ruling stating that as a result of the reformation, the Primary Beneficiaries will not possess nor will have ever possessed a general power of appointment with respect to the Exempt Trusts, and that as a result of the judicial reformation the exempt status of the Exempt Trusts for GST purposes will not be affected. The IRS ruled favorably. While that is all well and good, note that the user fee for a private letter ruling is $10,000; plus the costs involved paying the attorneys to prepare the PLR and petition the court for modification. The lesson is that it is important to make sure the documents are correct the first time; and to be careful, because even innocent "mistakes" could result in serious consequences.
Taxgirl, the nom de blog of Kelly Phillips Erb, an attorney and tax blogger and among my daily tax must reads, is twittering tax tips between now and April 15. Tip #1, Sign your Return.
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