Days after the Internal Revenue Service filed an answer response to the Estate of Michael Jackson’s Petition in U.S. Tax Court, we now know how much of a gap exists between the two: over $700 million. That is the deficiency between what was actually paid with Jackson’s 2009 federal estate tax return, the federal form 706, and how much the IRS believes should have been paid.
At issue is a matter of valuation. The federal estate tax is calculated based on the date of death values for the estate – or based on the value as of the Alternate Valuation Date (AVD), which is six months after the date of death. For valuation purposes, all assets under the control of the decedent at his or her death are considered taxable and that would include corporate interests, real estate, and contracts for future earnings.
The federal estate tax is calculated by adding up all of those assets (sometimes called the gross estate), deducting the debts owed by the decedent at his or her death, and then deducting reasonable costs of administration. The latter would include attorney’s fees, trustee’s fees, accountant’s fees, appraiser’s fees, and the like. The difference, the net of the gross estate less debts and expenses, and any other applicable deductions, is then deducted from the personal exemption amount (after taking into account any adjustments such as those made for taxable gifts during lifetime), and that is considered the taxable estate.
The federal estate tax is calculated based on a progressive rate just like your federal income tax. In other words, the more that you own at death, the more that you owe. In 2009, the federal estate tax exemption was $3.5 million which means that a taxable estate would be subject to tax at $3,500,001. In that event, the taxable estate would be roughly $1 (remember, you get the benefit of the exemption amount). In 2009, federal estate tax rates started at just 18% but the rate climbed to 45% on taxable estates worth more than $2,000,000.
According to reports, the federal estate tax return for Jackson’s estate reported a taxable estate of approximately $9 million. That’s pretty amazing considering that most estimates placed his worth at the low end at $400 million.
The IRS, however, believes that the estate was worth even more than that. They claim that the estate significantly undervalued assets for reporting purposes and, as a result, issued a Notice of Deficiency to the estate demanding nearly $700 million. That figure includes interest and a penalty – likely close to 40% – for not properly reporting the amounts due (that’s the equivalent of the IRS’ punishment to the estate for trying to get away with an undervaluation). Assuming that the increase in tax due alone was worth nearly $500 million, that suggests the IRS values Jackson’s estate at nearly $1.25 billion. To quote Jon Lovitz from A League Of Their Own: that would be more.
Since the Estate doesn’t agree with the Notice of Deficiency, the Executors for the Estate have filed a petition in U.S. Tax Court to formally contest the difference. This was done, reportedly, after the two sides have bickered for months over the real valuation.
Tax Court is a real federal trial court and, as such, operates like one. There will be a federal judge assigned to hear the case which will involve lots and lots of filings, depositions, and – unless the matter settles – testimony. The testimony will involve, at a minimum, a battle of qualified appraisals, each explaining exactly how the figures were determined. For math, tax, and pop geeks alone, the case will no doubt be a draw.
It is, of course, to the advantage of the Estate (and thus, Jackson’s heirs who are made up largely of his children) for the court to agree with a low valuation. A low valuation means less tax is due and thus more money passes to the heirs. A higher valuation would result in more tax due and less money passing to his heirs. As discussed in the comments previously, valuation is subjective, which is what will make the testimony going into this case so fascinating.
Stay tuned, I’ll keep you posted.
