Finally, the IRS matter close, and the Michael Jackson Estate can soon go out of the probate court rules after nearly 12 years. In the dispute between the Michael Jackson Estate and IRS, nobody won the judgment case (although the media and some fans saw it as a win-lose battle).
The executors of the Michael Jackson Estate went under IRS scrutiny because of implementing values to some assets completely out of the real market resulting in a necessary detailed comparison and negotiation. The figures were ridiculously in excess by both sides. The below recap is about the figures discussed on the main issues only. Most of the depositions/testimonies are published at teammichaeljackson.com for those who wish to go deep and have a personal opinion.
Here a summary of the issues that led to this trial:
- The Michael Jackson Estate filed a 2009 tax return reporting a total gross turnover of 57,203,929 dollars 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, and increased the values of various assets, overcompensating.
- The Michael Jackson Estate filed a petition on July 26, 2013.
- IRS filed Amendments to Answer on July 21, 2014, and June 10, 2016. Between 2014 and 2015, the parties solved several issues, such as the value of the real property is located at Harvenhurst Abe. Encino. California, the Estate’s interest in Sycamore Valley Ranch Company, LLC., an insurance Life Policy, the amount of additional cash recoverable by the Estate, the value of MJJ Ventures, Inc., the value of Michael Jackson’s share of artist mechanical royalties related to Jackson’s 5 master recordings, the value of Michael Jackson’s master recordings, the value of the tangible personal property and the penalties related to the settled issues.
The trial was called after the Estate tried to strike the report of experts Mr. Anson and Mr. Nimmer, totally rejecting the adjusted but still excessive values the IRS proposed after documents evaluation. The Estate challenge has been answered by calling them on trial for February 6, 2017. The main and most difficult point of this trial was to find a fair compromise on the Name and Likeness.
Name and Likeness
The Estate valued Michael Jackson’s name and likeness at 2,105 dollars and based his defense on some exemptions such as Copyright Preemption and First Amendment, which IRS strongly contested.
IRS said that Michael Jackson’s name and likeness had to be valued as a bundle of rights. Several areas of law govern the valuation of this property right. 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 publicity bundle of rights can also include registered and protected trademarks under the Lanham Act, and state common law and false endorsement claims are actionable.
To understand the Lanham Act, IRS principally brought up the “This Is It” documentary that was offered to the public with the permission of the Michael Jackson Estate. The opening credits before the title stated that it was presented In Association with the Michael Jackson Company and AEG Live.
Another was Michael Jackson ONE by Cirque du Soleil: the Mandalay Bay Hotel and Casino used Michael Jackson’s name and likeness throughout its facility. The Casino featured signs directing play-goers to the Michael Jackson: ONE Theatre; a Michael Jackson ONE store adjacent to the theatre sold every sort of Michael Jackson merchandise, most of which are labeled as being made under license from the Estate of Michael Jackson and when purchased, they were placed into bags imprinted with Michael Jackson’s name and likeness; theatre patrons were invited to pose in front of an image of Michael Jackson and then to pay for souvenir photos of themselves, on which their name is further superimposed.
The hotel reception was located in a lobby dominated by a giant statue of Michael Jackson, playing a video of him on all four sides, featuring his name, and proclaiming the authorization by the Estate of Michael Jackson.
Trademark registrations for Michael Jackson’s name, signature, and initials existed at the time of Michael Jackson’s death because he himself implemented and used it during his lifetime and therefore belonged to the Estate.
There was also the use of Michael Jackson’s name and likeness in a video game. In the absence of permission from an entity affiliated with Michael Jackson or his Estate, those statements would be false and, hence, actionable under the Lanham Act.
All these activities raised the 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 it would need to convince a 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 corroborated the IRS expert’s conclusion of the value of Michael Jackson’s name and likeness: few days after MJ’s death, agreements were reached, and contracts were signed specifically allowed the 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. The Estate allowed the use and was compensated. Any unauthorized use was met with cease and desist letters and lawsuits.
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 Michael Jackson’s Estate were based on the business principles of The Beatles LOVE show by Cirque du Soleil.
Cirque du Soleil Michael Jackson-themed show was expected eventually, especially because Michael Jackson himself was already in negotiation with them since the beginning of 2009.
The MJ Estate tried to make a scholarly argument about the purported scope of legal rights involved with these exempt categories, and all known facts had to be considered in valuing Michael Jackson’s image and likeness rights, but IRS stated that Copyright Preemption was not an effective defense.
The IRS arguments were certainly valid, but in essence, the activities started in 2009 after MJ’s death were just beginning and still in progress; only partial plus value would apply for the 2009 tax return and surely not in the numbers aimed by IRS.
New Horizon Trust II (Sony ATV)
The Estate valued MJ interest in New Horizon Trust II at $0.00. The Salter Group appraisal confirmed the above amount.
Michael Jackson shared the 50% control with Sony Music Publishing Co. His 50% share originally gave him the right to appoint an equal number of directors as Sony and vote on major decisions. He apparently lost this benefit after 2007, when he ended his recording artist contract with Sony/Epic.
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.
IRS expert Mr. Anson calculated the value of the purchase option price of 25% to be 242,075,000 dollars and valued Michael Jackson’s remaining 25% interest using the discounted cash flow analysis. Mr. Anson’s valuation of one-half of the MJ’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 result in a higher price. (IRS expert calculated 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 obtain the entire Company’s ownership.
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. In 2006 Fortress bank applied to NPS use, and you can read here the Managing Director testimony.
The Michael Jackson Estate expert applied discounts for lack of marketability (25%) and minority interest (20%) to Michael Jackson’s interest in Sony/ATV. IRS expert has opined that it is not appropriate to apply such discounts for the reasons outlined in his report, rebuttal report, and the supplemental report.
The hypothetical buyer and seller are presumed to be aiming to achieve the maximum profit from the hypothetical sale of the property, which is realized when the Buy-Sell provision is invoked as per Section 7.8 of the Operating Agreement. The provision essentially provided 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, which 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 provided 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 if there is an internal purchase of the interests.
If there is an external sale of the interests, the hypothetical transaction of the entire interest in Sony/ATV was assumed to occur in a hypothetical market. Sony/ATV’s primary asset was a songs catalog containing over 750,000 songs as of the valuation date.
According to IRS experts, 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 have reflected the high demand for these music publishing assets and the premium nature of the catalog, thus offsetting any potential discounts. In reality, due to the huge corporate debt of Sony/ATV (not Michael Jackson personally), the catalog was difficult to evaluate.
However, having Sony access to most of Michael Jackson’s cash flow due to the various J&V, the Estate could provide the right documents to show Jackson’s spending and passivity. Once a crook, always a crook…
New Horizon Trust III (MIJAC Catalog)
This one consisted of Michael Jackson’s interest in Mijac Music, 72,152,649 Usd in liabilities, and cash and was the property interest to be valued. As the amount of cash and debt was not in dispute, the only issue was the value of Mijac. Mijac is a catalog of the publishing rights associated with 527 compositions written by Michael Jackson and other writers, which Michael Jackson later acquired.
Moss Adams LLP, which the Estate retained to value Mijac Music, identified 167 songs written by Michael Jackson and 327 songs written by other writers, which were income-producing before Michael Jackson’s death. The catalog was under MJ 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 concerned identifying the correct number of songs, inconsistencies in historical bow royalties calculated and presented; the extent of the post-death spike; whether tax affecting was appropriate; the discount rate to be applied; and the extent and value of the unpublished songs.
The Michael Jackson Estate produced several 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, which included artists from different genres and music segments 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 IRS’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 Usd 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 Usd.
Estate of Michael Jackson rebutted and explained the value of New Horizon Trust III, which owns the Mijac Music catalog saying that IRS expert made his valuation of the Mijac Music catalog 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 catalog 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 catalog is entitled only to music publishing royalties on compositions.
Joint venture income with Sony represented 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 real nerve was the Penalties that could have removed the executors from their positions in the worst case if proved. In short, no matter how the taxable values of the assets could be decreased and adjusted in 2017, the penalties percentages were still at the maximum.
At the end of the trial, the following issues had been deferred in the statutory notice of deficiency settled between the parties, according to the Stipulations of Settled Issues filed with the Tax Court on October 20, 2014, April 27, 2015, and December 11, 2015.
The charitable contribution deduction, claims, administrative expenses, and losses allowable under Sections 2053, 2054, and 2055 of the Internal Revenue Code. Such matters were determined by agreement of the parties or in a supplemental proceeding. There was a stipulation regarding this subject. To be precise, the charity deductions had nothing to do with the 20% to be devolved to the charity’s organization as per Michael Jackson Will. Being the Estate still in probate, nothing related to the Will has ever been executed.
The original notice of deficiency didn’t change at the trial’s opening, although various adjustments had already been applied to the values of the taxable assets.
The original notice of deficiency was $505,142,894.00 million in taxes and $196.910,310.00 million in penalties for an overall Estate evaluation of about 1’170’000’000.00. The penalties were based on due taxes, so if the tax charges go down, the penalties go with it.
In 2009, the year Michael Jackson died, the exemption amount was $3,500,000, and assets above that amount were taxed up to 45 %. The Estate’s initial evaluation of MJ assets was around $7,000,000. From 2010 the Estate’s tax rate decreased to 40%. Only net value – assets minus liabilities – is subject to tax, which means: if an estate includes an asset worth $100 million, but there are $50 million of debt, $50 million will be subjected to taxes. A detailed list of debts is the variables key for estates, and this was the case of MJ having many high-value assets and large liabilities. MJ owned a 50 percent share in Sony/ATV, his own music catalog MIJAC, real estate, and art pieces.
The battle between the MJ Estate and IRS figures and subsequent revisions in numbers:
Name and Likeness
- The Estate evaluation: 2,150 Usd.
IRS Original Notice of deficiency valued MJ name and likeness at 434,264,000.00 Usd
Then revised the value as of the date of death at 161,307,045.00 Usd. The Estate them proposed 3 million dollars.
Final value: 4.15 million dollars
- The Estate evaluation: 0
- IRS Original Notice of deficiency valued MJ interest in Sony/ATV at 469.005,086.00 Usd
- Then revised the value as of the date of death at 206,295,934.00 Usd
Final value: 0
- The Estate evaluation: 2,207,351 Usd.
IRS Original Notice of deficiency valued MJ interest in MIJAC Music at 60,685,944.00 Usd
On July 8, 2016, Court granted IRS to increase MIJAC to value 114,263,615.00 Usd
Final value: 107 million Usd.
Associated penalties: no penalties
It was clear since the beginning that IRS had no intention to put the Estate into bankruptcy proceedings to get his taxes. The Estate of Michael Jackson is an excellent source of revenue, and it will be so for years to come considering the pompous media reviews any time a deal is closed.
Sure is that this trial was a financial detriment for the Estate, leading to 12 years of unnecessary compliances (legal fees, accountants, expert, reports). Money should have otherwise spent than in fighting the IRS. However, the Estate decided it was worth the risk. And it worked.