IRS: We Made A Mistake Valuing Michael Jackson's Estate

The U.S. federal tax agency, the IRS, responsible for collecting taxes from citizens, has announced that it made a calculation error in estimating the taxes and tax penalties Michael Jackson’s foundation was supposed to pay.

In what you read this past Mordad, the organization demanded an astronomical $702 million from the King of Pop’s foundation. Michael’s foundation filed a lawsuit against the IRS in court to reduce the amount and the tax penalty.

No, Uncle Sam hasn’t backed down from his $702 million. Instead, by adding $29 million to it, he has raised the total to $731 million.

In the IRS legal documents submitted to the court—documents that had not previously been reported by the media—it states that the organization initially believed that at the time of his death, Michael Jackson owned only 50% of his music pieces. The IRS then realized that Mr. Jackson owned 100% of his songs. The organization says that is why an error occurred in their calculations, and that they set the tax amount lower than what it should have been. The IRS says it calculated the taxes on these songs based on 100% ownership, at $91 million, whereas Michael Jackson’s foundation had declared their value as $11 million in its tax filings.

The change brings the IRS' valuation of Jackson's estate and lifetime taxable gifts up to $1.178 billion, compared to the $7 million the estate reported. The IRS now wants a total of $525.6 million in tax and $205.1 million in gross valuation misstatement and negligence penalties. (Any interest owed will be on top of that.) Of course both the IRS and the estate's values are best regarded as opening bids in what could be a long negotiation. A trial, if there is one, is far off.

Indeed, in a joint status report filed with the Tax Court last month, lawyers for the government and the estate say that while they're close to settling four relatively small issues and have dueling appraisers discussing the value of Jackson's personal tangible property, they don't expect a speedy resolution of the big-dollar issues in the case. Those involve the value of Jackson's intangible and intellectual property (his name, likeness and his interests in music he wrote or performed) as well as the value of two trusts he apparently set up to borrow against his assets and to transfer assets to his heirs at minimal tax cost during his life.

The two trusts hold Jackson's music publishing rights as well as his 50% interest in a joint music publishing venture with Sony Corp. Known as Sony/ATV Music Publishing, the venture is the largest music publishing company in the world and owns or administers millions of songs, including Beatles songs Jackson bought back in the 1980s. The estate placed the value of the assets transferred through the two trusts at just $2.2 million, whereas the IRS says the taxable value was $527.5 million.

Forbes senior editor Zack O'Malley Greenburg, who wrote a recent book on the Jackson business empire, estimates the Jackson estate has earned more than $700 million since the singer's death, as his music has had a resurgence, with new releases, two Cirque du Soleil shows based on his work, the concert film This Is It and even an endorsement deal with PepsiCo PEP +0.95%. But at the time of his death, the economy was in the dumps and Jackson's image was considerably less golden, in part due to allegations of child molestation. It's the value of his image at death that matters for estate taxes.

The estate valued Jackson's name and likeness at a trifling $2.105, whereas the IRS contends they were worth $434 million. Despite the unique circumstances surrounding Jackson, the resolution could well affect how other celebrity estates are taxed in the future.

The value of a celebrity's image was also at issue in two recent U.S. Tax Court decisions involving the income taxation of endorsement and appearance fees paid to professional golfers Sergio Garcia and Retief Goosen and is an issue in an ongoing Tax Court case involving best selling crime writer Karin Slaughter. Ironically, in those cases, the IRS has tried to maximize Uncle Sam's tax take by minimizing the value of such intellectual property, while taxpayers have argued (and Tax Judges have agreed) that a celebrity's image has substantial value.