On May 3, 2021, the Tax Court issued a Memorandum Opinion in the case of Estate of Jackson v. Commissioner (T.C. Memo. 2021-48). Two primary issues were dealt with in this gargantuan (271 pages) opinion by Judge Holmes.

The primary issue in Estate of Jackson v. Commissioner was the valuation of three contested assets, Michael Jackson’s image and likeness, and the estate’s interest in two trusts through which the estate held an interest in Sony/ATV Publishing and an interest in Mijac Music, a music publishing catalog that owned the copyrights to compositions that Jackson wrote or cowrote, as well as compositions by other songwriters.  The secondary issue was whether, due to the huge discrepancy (hundreds of millions) in valuations, the estate was liable for a $200 million penalty.

Judge Holmes’ Magnum Opus

If you have read Briefly Taxing with any regularity, you will know two things.  I have a judge crush on Judge Holmes, and I was classics major at Wake Forest.  Thus, beginning the opinion with a quote from Plutarch bodes well…because why wouldn’t a 271 opinion on the King of Pop begin with a quote from the greatest historian about the nature of the arts?

The Effect of Alleged “Noisome Acts” in Estate of Jackson v. Commissioner

The Tax Court refrained from making any particular judgment about what Jackson did or is alleged to have done; instead, it limited its review to whether (and how much) those “noisome acts” (alleged and/or actual) affected the value of what he left behind.

The Rise

The first album Jackson released as a solo artist was Off the Wall in 1979.  Around the same time, he formed the Mijac Music catalog, which contained the publishing rights for a number of composers including himself.  In June 1980, Warner Brothers Music became the administrator of Mijac and would continue in that role through Jackson’s death.  “But Off the Wall was as the widow’s mite to the temple treasury that was his next album—Thriller.”  Thriller ended up certified as 33x Multi-Platinum.

Decades later when the Tax Court tried this case, Thriller was still the top-selling album in history.  Jackson’s legal team used their power wisely, and his main attorney, John Branca, renegotiated Jackson’s contract with CBS Records to transfer ownership in Jackson’s master recordings to a corporation—MJJ Productions, Inc.—that Jackson himself owned.

Jackson recognized the other opportunities that his financial success presented. He sought the advice of Branca and his team, and he made two decisions that are important to this case. The first was to buy up copyrights in musical compositions of other artists and music catalogs.

After making a number of smaller purchases, Branca told Jackson that the ATV Music Publishing Catalog was for sale. The special asset in this catalog was at least 175 Beatles songs written by Paul McCartney and John Lennon. Jackson bought the catalog for $47.5 million.

The money also let Jackson begin to indulge some of his eccentricities–he purchased a chimpanzee that he took along on part of a tour, installed a hyperbaric sleeping chamber, and placed a bid to buy the bones of a 19th-century medical curiosity (John Merrick, the so-called “Elephant Man”). By the mid-1980s tabloid references to him as “Wacko Jacko” started to emerge.

The Fall

In the summer of 1993, the family of 13-year-old Jordan Chandler sued Jackson for torts that included sexual battery and seduction. The allegations exploded into the press. Jackson denied any wrongdoing and he was not charged with any crime, although a criminal investigation did begin. The allegations had lasting effects.

In November 1995 he signed an agreement with Sony Music Publishing Company and its affiliates to form Sony/ATV Music Publishing Company, LLC (Sony/ATV). Jackson and Sony each received half of Sony/ATV. Sony paid Jackson $115 million as an equalizing payment. Sony also promised to pay him $32.5 million over the next five years. By the end of 1998, his interest was burdened by $140 million in debt to Bank of America. It rose over $450 million.

In the summer of 2003, a criminal investigation was launched into allegations that Jackson had molested another 13-year-old, this one named Gavin Arvizo. Jackson faced seven counts of child sexual abuse and two counts of administering an intoxicating agent. He pleaded not guilty and was tried in January 2005. In June he was acquitted of all counts.

On June 25, less than three weeks before the tour was to begin, Jackson was killed by an injection of propofol and benzodiazepine administered by his personal physician, Dr. Conrad Murray. His death was ruled a homicide.

Estate Sells Jackson’s Interest in Sony/ATV to Sony

In 2011, Sony/ATV acquired EMI Music Publishing. With this acquisition, Sony/ATV went from the fourth largest music-publishing business to number one. Five years later, and seven years after Jackson’s death, Sony and the Estate signed a deal for Sony to acquire the Estate’s interest in Sony/ATV and become the 100% owner of Sony/ATV. Sony paid $750 million.

The Estate Tax Return

After Jackson died the Estate hired the accounting firm Crowe Horwath to prepare its return. The Estate retained Moss Adams, a large accounting and consulting firm, to value Jackson’s image and likeness and his interest in Mijac. Relying entirely on the income approach to valuation, Moss Adams valued Jackson’s image and likeness at $2,105 and Mijac at $70,860,000.

To value Jackson’s ownership interest in Sony/ATV, the Estate selected the Salter Group, an independent financial and strategic advisory firm that specializes in valuations. The Salter Group also chose to use only the income method, which led it to value Jackson’s ownership interest in Sony/ATV at $0.

Using these valuations, the Estate, on its 2009 Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, reported the value of Jackson’s image and likeness at $2,105; NHT II, which held Sony/ATV, at $0; and NHT III, which held Mijac, at $2,207,351.

The Largest Deficiency EVER

I have not verified that caption, but the IRS issued a notice of deficiency of over $1.1 billion (with a “b”) dollars ($1,125,006,431 to be exact). This adjusted valuation led the IRS to conclude that the Estate had underpaid Jackson’s estate tax by a shade more than $500 million. The IRS also determined that some of the valuations were so far off that the IRS tacked on penalties of nearly $200 million.

So, to be clear, we’re talking about a cool $700 million at issue here.

The Estate’s Experts

The Estate and the IRS did not skimp on their experts.  To value Jackson’s image and likeness, the estate hired two experts—Roesler and Fishman.  Roesler is the founder and CEO of an international licensing and rights-management company that specializes in representing celebrities both dead and alive, including Marilyn Monroe, James Dean, Buddy Holly, Chuck Berry, Princess Diana, and Jackie Robinson. Fishman has been a professional appraiser since 1974 and is a managing director of a firm that provides business-valuation, forensic-accounting, and litigation-consulting services.  Neither is what you would call a “slouch” at the appraising game.

To value the ownership in Sony/ATV, the estate hired Wallis, who has valued businesses for over thirty years and leads the Media and Entertainment team in Ernst & Young’s UK valuation practice. In that role, he values media-related intellectual property (including copyrights), and content and character licenses. Over the course of his career, he has valued approximately 100 music-publishing and master-recording catalogs.  So, again, no slouch.

Finally, to value Mijac, the Estate hired Dahl,who is the president and founder of a full-service valuation-consulting firm. From 1999 to 2012 Dahl was a principal at Moss Adams, where he specialized in the appraisal of intellectual property.

During his career he has valued various high-profile music catalogs, including Cherry Lane Music Publishing (Kenny Rogers, The Black-Eyed Peas, John Denver, Elvis Presley, John Legend, Quincy Jones, Barbra Streisand, John Mayer, White Stripes, Dave Matthews Band, Metallica, and Jack Johnson) and Holland-Dozier-Holland (pretty much all of Motown, James Taylor, Linda Ronstadt, Phil Collins).

The Estate’s Processes

To do his job, Roesler projected 10 years of postdeath revenues from the exploitation of Jackson’s image and likeness under California law, see Cal. Civ. Code § 3344.1, and from some associated trademarks. Fishman then used Roesler’s revenue projections as the starting point for his own use of the income method to value Jackson’s image and likeness. After he figured out future cashflows, Fishman discounted the stream to present value and came up with a higher value for this asset than the Estate had on its return (about $3 million instead of $2,105).

Wallis valued Sony/ATV using two different valuation methods—the market approach and the income approach. The first required him to compare Sony/ATV to comparable companies and comparable transactions. Wallis viewed Sony/ATV as an operating music-publishing company. This required him to calculate Sony/ATV’s earnings before interest, tax, depreciation, and amortization (EBITDA) as a key figure in his calculations.

The second method required him to project Sony/ATV’s future cashflows. His basis for these projections was Sony/ATV’s own internal projections as of 2009. He concluded that Sony/ATV’s enterprise value was $1.1 billion. He then reduced that value by Sony/ATV’s net debt to arrive at the company’s equity value.

Because Jackson was a 50% owner, he halved the equity value, which equaled $254 million. But remember that Jackson owed debt secured by his interest, and he had further encumbered that interest with restrictions on his power to control the joint venture or sell his stake in it. After Wallis analyzed these facts, he concluded that NHT II was worth nothing when Jackson died.

Dahl valued Jackson’s interest in Mijac, and he also used the income approach. He identified five sources of income:

1. Jackson’s compositions which he also performed that were released before his death,
2. Jackson’s compositions which he didn’t perform that were released before his death,
3. major works by other songwriters,
4. minor works by other songwriters,
5. Jackson’s unreleased compositions that he performed.

Dahl then analyzed how much income each of these sources would produce. He calculated Mijac’s value to be about $71 million. After he added cash on hand and subtracted the debt that Mijac secured, Dahl concluded that the fair market value of NHT III was about $2.7 million. Each of the Estate’s experts reduced the cashflows produced by the assets to reflect the tax implications to a hypothetical buyer—a process known as tax affecting.

The IRS Picks a Real Winner

The IRS “faced this chorus of experts with a soloist.” Weston Anson is the chairman of an intellectual-property consulting firm that specializes in trademark, patent, and copyright valuations. For more than 25 years, he has valued intangible assets including those of Dr. Seuss, Andy Warhol, Tupac Shakur, Audrey Hepburn, Marlon Brando, and Woody Allen.

To value Jackson’s image and likeness, Anson considered five “opportunities” that he believed a hypothetical buyer could reasonably foresee at Jackson’s death:

• themed attractions and products,
• branded merchandise,
• a Cirque du Soleil show,
• a film, and
• a Broadway musical.

According to Anson, image and likeness encompasses a broad bundle of allied rights, including U.S. trademarks, state or common-law trademarks, copyrights, licensing rights, endorsement rights, franchising rights, and international trademarks. Employing the income approach, Anson determined the value of Jackson’s image and likeness to be $161 million.

Anson valued Jackson’s interest in Sony/ATV through both the income and market approaches. In his market approach he viewed Sony/ATV as a music catalog rather than an operating music-publishing company. This meant that he calculated the venture’s enterprise value by its net publisher’s share (NPS) and not EBITDA. Anson’s income approach also differed from the Estate’s in using Sony/ATV’s historical financial data to predict future cashflows.

Anson made no discounts based on lack of control or marketability, but it did make a discount based on Sony’s option to buy half of Jackson’s interest in Sony/ATV. He valued NHT II at $206 million.

Anson valued Jackson’s interest in Mijac using only the income approach. His major disagreement with Dahl was about the size and duration of a postdeath boom in demand for Jackson’s music, as well as the number of unreleased compositions that he thought Jackson had left behind. In the end Anson valued Jackson’s interest in Mijac at $114 million.

The Chickens Come Home to Roost

The IRS really should not have hired Felicia’s cousin, Weston Anson.  Anson was the IRS’s only expert witness; thus, Anson’s credibility was an especially important part of the case. As Judge Holmes notes, said credibility “suffered greatly at trial.”

His problems began when he was asked about the effect on himself and his firm if the IRS prevailed in the case. He responded:

“I have no idea. I’ve never worked for the Internal Revenue Service before.”

Later when asked whether he or his firm had previously been retained by the IRS to write an intellectual-property valuation report in Whitney Houston’s estate-tax case, Anson replied:

“No. Absolutely not.”

That was, in short, a vile and odious lie.

Approximately two years before he testified, the IRS had retained Anson to write a valuation report titled, “Analysis of the Fair Market Value of the Intangible Property Rights Held by the Estate of Whitney E. Houston as of February 11, 2012 For Estate Tax Purposes.” It was only after a recess and advice from the IRS’s counsel that Anson admitted to this.

Anson also testified that neither he nor his firm ever advertised to promote business. As Judge Holmes succinctly notes, “[t]his was also a lie.” In fact, in the midst of trial, Anson’s firm touted his testimony in the following email blast:

What has been described as the “tax trial of the century” by the Hollywood Reporter, the case between the IRS and the Estate of Michael Jackson began in Tax Court this week. Weston Anson is the “expert of the century” and will be testifying on behalf of the IRS.

Not to be outdone by himself, in a lecture given before trial Anson referred to his valuation in this case, stating:

“I’m sitting today in a deposition in what’s known as the ‘Billion Dollar Tax Case.’ We’ve just spent the last year valuing the estate of Michael Jackson.”

When asked at trial whether he had in fact referred to this case as a billion-dollar case, Anson replied with his own question:

“Would you like to be called the lawyer of the century?”

The Estate moved to strike all of Anson’s testimony, including his expert reports, as tainted by perjury. The Tax Court denied the Estate’s motion finding it “too severe.” The Tax Court instead stated that a more proportionate remedy would be “to discount the credibility and weight we give to Anson’s opinions.”

As Judge Holmes observes, there is nothing wrong about marketing one’s services or taking on another case for the IRS while working on this one. However, Anson did undermine his own credibility in being so “parsimonious with the truth” about these things, which, Judge Holmes points out, Anson didn’t even benefit from being untruthful about, as well as in not answering questions directly throughout his testimony.

To be clear, a leopard seal stalking a waddle of penguins would not have been so “parsimonious with the truth.”

Estate Tax Valuation Principles

Under the Code, there is a tax levied on “the transfer of the taxable estate of every decedent who is a citizen or resident of the United States,” which defines the taxable estate as “the value of the gross estate” less applicable deductions. IRC § 2001(a) (estate tax generally); IRC § 2051 (definition of “gross estate”). The value of the gross estate of a decedent is “the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated,” to the extent provided in IRC § 2033 through IRC § 2045. IRC § 2031(a).

To that end, IRC § 2033 includes in the gross estate the fair market value of “all property to the extent of the interest therein of the decedent at the time of his death.” And the regulations tell us to value a decedent’s property at its fair market value. Treas. Reg. § 20.2031-1(b).

Fair market value is the “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” Id.

Under this standard, the hypothetical willing buyer’s knowledge extends beyond just those facts publicly known, as he is “presumed to be ‘reasonably informed’ and ‘prudent’ and to have asked the hypothetical willing seller for information that is not publicly available.” Estate of Kollsman v. Commissioner, T.C. Memo. 2017-40, aff’d, 777 F. App’x 870 (9th. Cir. 2019).

Though hypothetical, the Tax Court, nevertheless, must not construct “particular possible purchasers” based upon “imaginary scenarios” about who they might be or how they might act. Estate of Simplot v. Commissioner, 249 F.3d 1191, 1195 (9th Cir. 2001), rev’g and remanding 112 T.C. 130 (1999); see also Morrissey v. Commissioner, 243 F.3d 1145, 1148 (9th Cir. 2001), rev’g Kaufman v. Commissioner, 77 T.C.M. (CCH) 1179 (1999); Cave Buttes, L.L.C. v. Commissioner, 147 T.C. 338, 357-58 (2016).

Property is valued as if in the decedent’s hands at the time of its transfer by death. Estate of Simplot, 249 F.3d at 1194-95. Because property is valued precisely at the moment of death, it is inappropriate, as a general matter, to ascribe value based upon post-death evidence. See Estate of Gilford v. Commissioner, 88 T.C. 38, 52 (1987); Estate of Gallagher v. Commissioner, T.C. Memo. 2011-148.

Still, the prohibition is not absolute; a court may for instance consider subsequent events “to the extent that they were reasonably foreseeable” at the decedent’s death. Trust Servs. of Am., Inc. v. United States, 885 F.2d 561, 569 (9th Cir. 1989) (citing Gilford, 88 T.C. at 52). Whether a subsequent event was reasonably foreseeable is a question of relevance, insofar as evidence of the actual price for a sale after death can be relevant “so long as the sale occurred within a reasonable time after death and no intervening events drastically changed the value of the property.” First Nat’l Bank of Kenosha v. United States, 763 F.2d 891, 894 (7th Cir. 1985).

Expert Opinions

Although experts are helpful in valuing an estate’s worth, the Tax Court is not bound by any particular expert opinion. Hunt & Sons, Inc. v. Commissioner, T.C. Memo. 2002-65; see also Helvering v. Nat’l Grocery Co., 304 U.S. 282, 295 (1938). Indeed, the Tax Court is free to accept or reject an expert’s opinion based on its “sound judgment,” which, of course, incudes the well-honed “smell test.” Estate of Hall v. Commissioner, 92 T.C. 312, 338 (1989).

The Tax Court is likewise free to accept only a portion of an expert’s opinion. Parker v. Commissioner, 86 T.C. 547, 562 (1986); Ames v. Commissioner, T.C. Memo. 1990-87, aff’d sub nom. Hildebrand v. Commissioner, 967 F.2d 350 (9th. Cir. 1992).

There are three approaches that courts and appraisers use to value unique assets: income, market, and cost. See, e.g., Cave Buttes, 147 T.C. at 358. These three approaches can be summarized as follows:[1]

1. The income approach values an asset by calculating how much revenue it will produce in the future and discounting that revenue back to its present value, because a dollar today is worth more than a dollar in the future. (This is the method used by all of the experts in Jackson)
2. The market approach values an asset by comparing it to the prices at which similar assets have changed hands in arm’s-length transactions close in time to the date of death.
3. Finally, the cost approach values an asset by computing the cost of recreating it.

The income approach has two variations: discounted cashflow (DCF) and capitalization. See Cave Buttes, 147 T.C. at 358. Both parties here use only the DCF method. The DCF method has two main variables: the projected future cashflow stream and the discount rate. The parties here largely disagree about each of the three assets’ future cashflow projections.

Projections of cashflow are distinct from the selection of an appropriate discount rate–a variable that can have a large effect on the outcome of a DCF analysis. The discount rate accounts for the time value of money in computing the present value of future cashflows an asset is projected to produce. See Shepherd v. Commissioner, 115 T.C. 376, 392 (2000), aff’d, 283 F.3d 1258 (11th Cir. 2002).

Synergy

Valuations do not occur in a vacuum.  All assets of an estate affect the other assets.  Anson kept trying—especially when he discussed the value of Jackson’s image and likeness—to include the value of other assets, such as Jackson’s copyrights in his musical compositions and performances, in the value of the assets at issue. His justification is that these assets all belonged to the Estate and would be more valuable in some circumstances if they could be bundled and exploited together.

From the Estate’s perspective, this kind of valuation is just hindsight, “not even 20/20 hindsight but more like that of an eagle or a spy satellite.” Two problems are presented from this spy-satellite hindsight.

1. How does the Tax Court value any asset that requires active management, understanding that it is tremendously difficult to distinguish between the value of that asset and the value of its management?
2. How does the Tax Court measure the effect that separate assets can have on each other’s value?

The Tax Court observes that the estate tax as a “tax on the privilege of passing on property, not a tax on the privilege of receiving property,” Ahmanson Found. v. United States, 674 F.2d 761, 768 (9th Cir. 1981), and there is nothing in the statutes or in the caselaw that suggests that valuation of the gross estate should consider that the assets will come to rest in several hands rather than one. Id.; see also Estate of Curry v. United States, 706 F.2d 1424, 1427-28 (7th Cir. 1983).

Thus, the Tax Court is taxed with separating facts known or knowable at the date of death from those remoter in time or unforeseeable, and then asking what a hypothetical buyer in possession of these facts would offer for them in an arm’s-length deal with a similarly knowledgeable hypothetical seller. However, the Tax Court will not hypothesize a particular buyer or a particular seller with any particular skills or use for those assets. See Estate of Giustina v. Commissioner, 586 F. App’x 417, 418-19 (9th Cir. 2014), rev’g and remanding T.C. Memo. 2011-141; Estate of Simplot, 249 F.3d at 1195.

Reneging on the Stipulation

The parties spent years in discovery and other pretrial preparation, at the end of which they reached stipulations about some of the estate’s assets. The IRS could have chosen to object to the description of the assets to be valued, or it could have refused to stipulate the values of all these assets rather than agree to some and not agree to others.

What the IRS is not allowed to do, however, is to “renege” on its stipulation and “to cram the value of assets whose value he stipulated into the value of assets whose value he did not stipulate.”

Doing so would undermine the stipulation, which the Tax Court does not allow the parties to do absent mutual mistake, proof that a party was misled, or if justice requires it. See Tax Court Rule 91(e); Stamm Int’l Corp. v. Commissioner, 90 T.C. 315, 321-22; Buchsbaum v. Commissioner, T.C. Memo. 2002-138.

No Tax “Affecting” Here

Each asset in dispute in this case is held by a pass-through entity, which means the Code imposes no tax on the income that these assets produce. Such entities file information returns that report how much income and the amounts of any deductions it had during the tax year. IRC § 701; IRC § 6031(a); Chef’s Choice Produce, Ltd. v. Commissioner, 95 T.C. 388, 392-93 (1990). When one of these entities earns income, it passes right through to its partners, shareholders, or members who themselves have to pay tax on the income at their individual rates. This is in contrast to income from C corporations.

C corporations don’t pass income through to their shareholders; they get taxed on it themselves. Then the Code taxes any income that trickles through to their shareholders as dividends at their individual rates. This two-layer tax on C corporation income is known as “double taxation.” See, e.g., Pierre v. Commissioner, 133 T.C. 24, 30 (2009), supplemented by T.C. Memo. 2010-106. Valuation experts, therefore, refer to the entity-level income of pass-throughs as pretax, and C corporations’ income as after-tax. Investor-level income is always after-tax.

Other things being equal, an income-producing asset would thus be worth more to a pass-through than to a C corporation. But the complications of the real world intrude. Because pass-throughs do not pay tax at the entity level, their projected cashflows will not account for any tax consequences. In general (and in this case, specifically), the rate used to discount projected cashflows to present value is derived from after-tax, publicly available C-corporation information.

Proponents of tax affecting argue that this mismatch between pretax cashflows and after-tax discount rates must be corrected, or “tax affected.” The Tax Court has acknowledged as much. If, in determining the present value of any future payment, the discount rate is assumed to be an after-shareholder-tax rate of return, then the cash-flow should be reduced (“tax affected”) to an after-shareholder-tax amount.

If, on the other hand, a pre-shareholder-tax discount rate is applied, no adjustment for taxes should be made to the cash-flow. Gross v. Commissioner, T.C. Memo. 1999-254, aff’d, 272 F.3d 333 (6th Cir. 2001). Whether, and precisely how, to tax affect a pass-through’s earnings was the subject of significant dispute in Jackson.

There has, it seems, been only one case where the Tax Court allowed tax affecting in a valuation. See Estate of Jones v. Commissioner, T.C. Memo. 2019-101, *41-*42.  The Tax Court ultimately found, as it has found consistently in the past (apart from Estate of Jones), that tax affecting is not appropriate here because the Estate has failed to persuade the Tax Court (by a preponderance of the evidence) that a C corporation would be the hypothetical buyer of any of the three contested assets. Although, the Tax Court observes, it is possible that rehabilitating an image as tattered as Jackson’s had become would require capital outlays more typical of public corporations.

Nevertheless, in the end, the Tax Court did not believe that such a scenario was “more likely than not to be true” (the preponderance of the evidence standard). Therefore, tax affecting is inappropriate on the specific facts of this case.[2]

Rights in Music Intellectual Property…for Tax Lawyers

Before [the Tax Court “plowed ahead” into the complex valuation analysis that lies ahead, Judge Holmes deemed it beneficial to provide “a primer” on three key concepts: composer, performer, and right of publicity.

1. In copyright law, a composer is someone who writes compositions. A composition is the combination of words and music that is performed. A composer gets rights to his composition under copyright law.
2. Publishers (like Mijac) are buyers or assignees of the copyrights to compositions. Publishers gain the power to control the exploitation of a musical composition, and an interest in the income generated from such exploitation. In exchange, they usually agree to provide composers services such as copyright registration, promotion, and a mechanism to collect income throughout the world; and to pay an advance.
3. Finally, a performer, in its most basic sense, is the person (or group) who performs a composition that is recorded on a tangible medium. The tangible medium for a performer is the “master recording,” which is the actual recorded performance of a particular musical composition. The recording artist gets rights in this master recording.

A real word example of the above definitions is “Wagon Wheel.”  In 1973 Bob Dylan recorded a song that fans called “Rock Me, Mama.” It was more of a “chorus” than a “song” made up of lyrics he wrote and a tune he created. Subsequently, Ketch Secor, a member of Old Crow Medicine Show, used the chorus created by Dylan and wrote the verses for a song that eventually became “Wagon Wheel.” About forty years later, Darius Rucker released his own performance of that song. Darius Rucker was performing Bob Dylan’s and Ketch Secor’s composition. So, what rights does everyone have?

Bob Dylan gets composition rights for both versions of “Wagon Wheel,” as his composition (the lyrics and music) are the ones being performed. Ketch Secor also gets composition rights to both versions of the song “Wagon Wheel,” as he wrote verses to the song. Old Crow Medicine Show (as recording artist) gets performance rights in its master recording of “Wagon Wheel.” Darius Rucker (as a recording artist) gets performance rights in his master recording of “Wagon Wheel.”

A performer has no rights to royalties for public performance. See, e.g., Bonneville Int’l Corp. v. Peters, 347 F.3d 485, 487 (3d Cir. 2003). This means that a performer is not paid when his song is played on the radio. See 17 U.S.C. § 114(d)(1)(B)(iii); Bonneville, 347 F.3d at 487.

An exception to this rule is the public performance for sound recordings in digital transmission, which allows a performer to collect royalties for his work if it is played through digital means such as satellite radio or a streaming service. Bonneville, 347 F.3d at 488-89.

The Right of Publicity

The third right in music IP (which is very important in this case) is the right of publicity (ROP). It’s a right that’s not peculiar to musicians, but to celebrities generally. ROP is the right to control the commercial use of one’s identity. It is a creation of state law. C.B.C. Distrib. & Mktg., Inc. v. Major League Baseball Advanced Media, L.P., 505 F.3d 818, 822 (8th Cir. 2007); Zacchini v. Scripps-Howard Broad. Co., 433 U.S. 562, 566 (1977). ROP protects someone’s name, likeness, voice, signature, or photograph. The other component (associated trademarks) are trademarks with respect to the ROP.

ROP originated in a right sometimes recognized at common law as the right of privacy, which was, of course a right to be left alone. When celebrities began to bring these kinds of cases under privacy statutes or the common law, courts struggled with the “right of privacy” label, because the celebrities didn’t really want privacy, but instead wanted the right to control their image, and many of these cases were therefore dismissed. In Haelan Labs., Inc. v. Topps Chewing Gum, Inc., 202 F.2d 866 (2d Cir. 1953), Judge Jerome Frank coined the phrase “right of publicity.” Id. at 868.

Jackson’s legal interest and rights in property are determined under California law. See Morgan v. Commissioner, 309 U.S. 78, 79-80 (1940) (law of decedent’s domicile creates legal interests and rights for estate tax); Milton H. Greene Archives, Inc. v. Marilyn Monroe LLC, 692 F.3d 983, 986 (9th Cir. 2012) (decedent’s domicile defines ROP); Cairns v. Franklin Mint Co., 292 F.3d 1139, 1149 (9th Cir. 2002) (same). In 1979, California supplemented the statutory right with a common-law ROP in the landmark case Lugosi v. Universal Pictures, 603 P.2d 425, 428 n.6 (Cal. 1979).

The case was brought by the surviving spouse and the son of Bela Lugosi, the original American Dracula. The court recognized a common-law ROP; but then held that it did not survive death. Id. at 428-30. The California legislature stepped in and created a statutory ROP that was descendible to heirs and assignees. Comedy III Prods., Inc. v. Gary Saderup, Inc., 21 P.3d 797, 799-800 (Cal. 2001). It is now codified in California Civil Code § 3344.1.34. Since the common-law right still doesn’t survive death, however, it has little effect in Jackson.

The Tax Court begins the ROP analysis with defining “likeness.” In Midler v. Ford Motor Co., 849 F.2d 460, 463 (9th Cir. 1988), the Court held “likeness” means only visual images under the statute. Judge Holmes breaks the fourth wall a bit and observes that “[t]his might seem clear, but then someone came up with the idea of a robot version of Vanna White, the celebrity tile turner.”

The Ninth Circuit held in White v. Samsung Elecs. Am., Inc., 971 F.2d 1395, 1397 (9th Cir. 1992), that a robot that resembled White was not her “likeness” under the statute but left open the possibility that a sufficiently detailed manikin might be. On the other hand, in Int-Elect Eng’g, Inc. v. Clinton Harley Corp., 1993 WL 557639, at *4 (N.D. Cal. 1993), a California court held that “likeness” can mean any unique and readily identifiable artistic creation.

“Voice” under the statute only covers the use of the claimant’s actual voice. See White, 971 F.2d at 1397; Midler, 849 F.2d at 463. “Photograph” is better defined. A photograph is any still or moving film where a person is readily identifiable. That same subsection defines “readily identifiable” as whether someone viewing the photograph with the naked eye “can reasonably determine who the person depicted in the photograph is.” Id.

A play, book, magazine, newspaper, musical composition, audiovisual work, radio or television program, single and original work of art, work of political or newsworthy value, or an advertisement or commercial announcements for any of these works” is not protected. Comedy III Prods., Inc., 21 P.3d at 800. Musical compositions, likewise, are not protected. The Ninth Circuit case of Laws v. Sony Music Entm’t, Inc., 448 F.3d 1134, 1139-43 (9th Cir. 2006), further established that master recordings are not protected because they are governed by the federal Copyright Act.

As Laws suggests, there is friction when this state-created right rubs up against federal law. A person’s name, for example, can be trademarked. Though a name is also protected under ROP, these two rights are not identical. Moreover, federal law can preempt state law. Laws, 448 F.3d at 1141. Thus, federal law (though often overlapping with ROP) is a distinct source of separate rights.

The Taxability of Image and Likeness

This is an issue of first impression for the Tax Court, as it has never directly addressed the taxability of the image and likeness. To that end, the Tax Court could only find one case on point anywhere else. See Estate of Andrews v. United States, 850 F. Supp. 1279 (E.D. Va. 1994).  Nonetheless, the Tax Court does not feel the need to venture in uncharted territory, finding instead that plain language of the Code was enough. IRC § 2051 defines the taxable value of an estate as the value of the gross estate less deductions.

The value of the gross estate includes the value at the time of death of all property, real or personal, tangible or intangible, wherever situated. IRC § 2031(a). Since Jackson’s image and likeness is an intangible right that transfers after death, see Comedy III Prods., Inc., 21 P.3d at 800, it must be included in his gross estate.

The default rule is that the value of a right is its fair market value. Treas. Reg. § 20.2031-1(b); Elkins v. Commissioner, 140 T.C. 86, 114-15 (2013), aff’d in part, rev’d in part, 767 F.3d 443 (5th Cir. 2014). An asset’s fair market value is generally its value in its highest and best use on the valuation date. See Estate of Kahn v. Commissioner, 125 T.C. 227, 240 (2005); Estate of Mitchell v. Commissioner, T.C. Memo. 2011-94.

The Code provides some exceptions. See, e.g., IRC § 2032A (exception for family farms); Van Alen v. Commissioner, T.C. Memo. 2013-235. These exceptions are explicit, and in Jackson, the Tax Court did not find that any exceptions applied.

The value of a person’s image and likeness may not depend entirely on his reputation for the few years before his death. It is a right that his heirs will have for decades to come, and there is some nonzero chance that Antony was speaking antiphrastically[3] when he said: “The evil that men do lives after them; the good is oft interred with their bones.” William Shakespeare, Julius Caesar act 3, sc. 2, ll. 83-84.  The Estate, at the very least, seemed to have thought so.

The Estate considered three main factors in determining a 10-year projection of revenue:

1. predeath revenue;
2. postdeath rights; and
3. growth and decline rates using predeath marketability and a potential postdeath boom.

With respect to marketability, a celebrity’s reputation is paramount. Revenue is greatest when a celebrity is associated with positive qualities or has a good reputation. Bad conduct doesn’t disable a celebrity from exploiting his image and likeness, but it does mean some money will have to be spent rehabilitating it. While there is a range of bad conduct, conduct exhibiting alleged moral turpitude can have long-term effects and may well lead to public rejection.

Appearing on a late-night talk show to be asked “What the hell were you thinking?” and answering “I did a bad thing” may work for a low-grade one-time offense. Jackson’s alleged offenses, however, rose above this level.

The IRS’s expert instead used what he called “foreseeable opportunities” that he said were reasonably expected at the time of Jackson’s death and that would generate revenue from use of his image and likeness. These “opportunities” were:

1. themed attractions and products;
2. branded merchandise;
3. a Cirque du Soleil show;
4. a film; and
5. a Broadway musical.

The IRS argued that these projects were potential opportunities that a rational investor could implement and that would create revenue attributable to Jackson’s image and likeness.

Valuing the “Wrong” Assets

The Tax Court was not persuaded.  Instead, Judge Holmes observed that the Anson “did not value the asset that he should have” because, throughout his report and testimony, he includes assets other than image and likeness in his valuation.  Because California does not give ROP protection to plays, books, magazines, newspapers, musical compositions, audiovisual works, and radio or television programs—exceptions that Anson failed to consider in his valuation—he should have excluded their values from his estimates of potential income from Jackson’s image and likeness.

The Tax Court observed that “even if [the Tax Court] assume[d] that Jackson’s different assets would “work together” to raise each asset’s value, that doesn’t mean that the value of one asset can be substituted for the value of another,” which is what precisely what Anson did.

The IRS argued that Jackson’s image and likeness included U.S. trademarks, state or common-law trademarks, copyrights, licensing rights, endorsement rights, franchising rights, and international trademarks. However, this is “not how that right is defined by California law.”

The Tax Court further noted that the Anson’s “overbroad description of the asset he was valuing was conscious.” Thus, the Tax Court concluded (with reference to earlier draft reports) that he tried to reach a higher number by broadening the rights he valued. “This is not persuasive.”

Unforeseeable Assets

Valuation of image and likeness, however was “also not Anson’s only big mistake.” The Tax Court found that Anson included revenue streams that were unforeseeable at the time of Jackson’s death. Even if these potential revenue streams were traceable to Jackson’s image and likeness, they were not foreseeable when Jackson died.  Ergo, the Tax Court found it inappropriate to include them in the Estate’s gross value.

Treas. Reg. § 20.2031-1(b) defines the fair market value of an estate as limited to what a buyer and seller would have reasonable knowledge of at the time of a decedent’s death. Caselaw tells us to hypothesize a buyer who is reasonably informed and who asks a hypothetical willing seller for information not publicly available. See also, Estate of Kollsman, T.C. Memo. 2017-40. At this point, we reach the most profound line in the entire opinion.  Judge Holmes, a scholar and a gentleman, observes that “foreseeability can’t be subject to hindsight.”

Faulty Calculations

Never one to mince words, Judge Holmes observes that “the last problem with Anson’s report is its math.” Anson incorrectly failed to include necessary management expenses in his future cashflow projections. Anson also failed to take a more holistic approach when he was determining the discount rate. There were also some serious problems with Anson’s analysis of the individual opportunities he chose to value.

In Sum, Judge Holmes at His Saltiest

“Anson’s analysis—quite apart from the taint of his perjury—is unreliable and unpersuasive. It doesn’t value the correct asset, it includes unforeseeable opportunities, and it reflects faulty calculations.”  Well, then…

The IRC § 6751(b)(1) Issue

IRC § 6751(b)(1) provides that no penalty is allowed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination. This written approval must be obtained no later than the date the notice of deficiency is issued or the date the IRS files an answer or amended answer in which he asserted the penalty. Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017); see also Graev v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and overruling in part 147 T.C. 460 (2016).

IRC § 7491(c) places the burden of production on the IRS with respect to the liability for any individual for any penalty. Since an estate is not an individual, Estate of Ramirez v. Commissioner, T.C. Memo. 2018-196, the Estate bears the burden of production here.

The Tax Court observes that this is a “somewhat unusual burden,” insofar as the burden of producing evidence that no evidence exists of the IRS’s compliance with his obligation to show supervisory approval of penalties. Despite the fact that the penalties were over $200 million, it is absolutely shocking to me that the Estate failed to enter any evidence whatsoever that the IRS did not comply with IRC § 6751(b)(1).

When the burden lies on the IRS, the Tax Court has held that it must introduce evidence that it complied with IRC § 6751 to meet his burden of production. See, e.g., Dynamo Holdings Ltd. P’ship v. Commissioner, 150 T.C. 224, 227 (2018) (stating that when the burden of production lies with the IRS, it must enter evidence of supervisory approval); Higbee v. Commissioner, 116 T.C. 438, 446 (2001) (holding that for the IRS to meet its burden of production, it must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty”). The Tax Court saw “no reason the Estate shouldn’t be held to the same standard.”

That means the Estate could have entered into the record its discovery request for any written supervisory approval or other evidence to show that it had raised this issue. See Lew v. Moss, 797 F.2d 747, 751 (9th Cir. 1986) (“[T]he burden of production has the sole effect of forcing * * * [its holder] to produce enough evidence to avoid a direct verdict”); Jordan v. Herrera, 224 F. App’x 657, 658 (9th Cir. 2007); see also Gathright-Dietrich v. Atlanta Landmarks, Inc., 452 F.3d 1269, 1274 (11th Cir. 2006).

The Estate could even have raised the issue in the list of assignment of errors in its petition. See Wheeler v. Commissioner, 127 T.C. 200, 206-07 (2006), aff’d, 521 F.3d 1289 (10th Cir. 2008).

“Thriller is part of the record here. So are demons, vampires, monsters, ghosts, and even the funk of 40,000 years. But the record lacks any evidence that the IRS failed to obtain supervisory approval.”

Solid gold, Judge Holmes.  Solid gold.

The Merits (or Lack Thereof) of the Penalties

The IRS asserted that the Estate is liable for several IRC § 6662(a) penalties: gross-valuation misstatement under IRC § 6662(h), substantial-valuation misstatement under IRC § 6662(g), and negligence or disregard of the rules under IRC § 6662(c). Because the Estate correctly valued NHT II, no penalties applied there.  This left the valuations of Jackson’s image and likeness and NHT III.

These penalties can be negated by proof that the Estate had reasonable cause and good faith for its return position. IRC § 6664(c). The Tax Court determines whether this defense applies on a case-by-case basis, after looking at all pertinent facts and circumstances. Treas. Reg. § 1.6664-4(b)(1). The most important factor is the taxpayer’s effort to assess his liability. Id.

Importantly, simply because there was an appraisal of the asset in question does not per se show reasonable cause and good faith. Id. Instead, the Tax Court examines at the appraisers’ assumptions, the appraised value, and the circumstances under which it was obtained. Id.

The Estate valued Jackson’s image and likeness at roughly $2,000 on its return. This was based on an appraisal by Moss Adams (a firm which the Tax Court specifically found to be reputable and credible). Although the Tax Court ultimately disagreed with Moss Adams’s appraisal, it did find that it was reasonable. Further, the Tax Court held that the Estate reasonably relied on it in good faith once it discovered how little revenue Jackson had been earning from use of his name and likeness. No penalties here.

The Tax Court found much the same for the valuation of NHT III. As the pages upon pages dedicated to valuation illustrate, valuing Mijac and NHT III was quite complicated. The Estate again used Moss Adams to help them estimate this value. Although the Tax Court also disagreed with this appraisal value, again it found that it was reasonable given all the facts and circumstances, and it was reasonable for the Estate to rely on it and that it did so in good faith. No penalties here either.

The Ultimate Valuations

With respect to Jackson’s image and likeness, the estate valued this asset a shade over $3 million.  The IRS valued it at over $161 million.  The Tax Court held that its value was $4.2 million.

With respect to NHT II the estate found this asset without value, while the IRS argued that it was worth $206 million.  The Tax Court agreed with the estate that this asset’s value was zero.

Finally, with respect to NHT III, the Estate valued the trust and its holdings at $2.3 million.  The IRS valued it at $114 million.  The Tax Court valued NHT III at $107 million.

Thus, the IRS was only off in its valuations by over $370 million (which, at a top marginal rate of 40%, works out to $148 million in tax).  Combined with the $200 million in penalties that the Tax Court declined to uphold, this nearly $350 million fluctuation was a rather hefty loss for the IRS.

(T.C. Memo. 2021-48) Jackson v. Commissioner

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Footnotes

[1] See United States v. Eden Mem’l Park Ass’n, 350 F.2d 933, 935 (9th Cir. 1965); Marine v. Commissioner, 92 T.C. 958, 983 (1989), aff’d without published opinion, 921 F.2d 280 (9th Cir. 1991).

[2] The Tax Court was quick to distinguish Estate of Jones as an instance where the experts agreed to take into account the form of the business entity and agreed on the entity type. The IRS argued there, as it did in Jackson, that the Tax Court shouldn’t tax affect, but in Estate of Jones, the IRS’s own experts didn’t even seem to be on board. As the Tax Court observed in Estate of Jones, “[t]hey do not offer any defense of the IRS’s proposed zero tax rate. Thus, we do not have a fight between valuation experts but a fight between lawyers.” Estate of Jones, T.C. Memo. 2019-101 at *39.

[3] Antiphrasis is the use of a word or phrase in a sense not in accord with its literal meaning, especially for ironic or humorous effect.

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