Fatal Flaw in Estate and Wealth Taxation

Chris Edwards

The Internal Revenue Service and the estate of Michael Jackson have been battling over the value of the singer’s assets since he passed more than a decade ago. The Wall Street Journal reports that the Jackson team has won a big victory over the government tax agency on an estate tax case. The battle illustrates the absurdity of broad‐​based wealth taxation, including the estate tax and the sort of annual wealth tax that Senator Elizabeth Warren and others are pushing.

Estate taxes and annual wealth taxes have many serious flaws, as I discuss here. One is the huge compliance and administrative costs they generate, partly driven by complex asset valuation issues.

The Journal describes the vastly different valuations the IRS and the U.S. Tax Court came to regarding the Jackson’s name, likeness, and part ownership of some Beatles songs. Such intellectual property can be valued by estimating the future earnings they will generate, but this can be pure guesswork.

Michael Jackson’s estate prevailed over the Internal Revenue Service on several key issues in a closely watched court case, an outcome that will push the estate’s tax burden below the government’s initial assessment.

In a ruling issued Monday, U.S. Tax Court Judge Mark Holmes found that the singer’s name and likeness were worth $4 million when he died in 2009 at the age of 50, not the $161 million the government had claimed.

… The estate initially started with some lower values, but by Monday’s decision, it had said those three assets were worth $5.3 million combined. The government had started with higher values and an estate tax bill topping $500 million, but eventually concluded those three assets were worth $481.9 million combined. Judge Holmes, in his ruling, said they were worth $111.5 million.

… Part of the difficulty in the case, which took more than seven years from its beginning to Monday’s ruling …

… The image and likeness calculations were particularly difficult, and tax lawyers had been eyeing the case as a guide on how to handle other celebrities’ estates. The questions have to do with how much of a business could be built around that image, using products such as film rights, a musical, a theme park or branded merchandise.

It took seven years in court for this one estate tax dispute. Estate tax disputes happen no more than once for each wealthy person, but they could happen every year under a Warren‐​style annual wealth tax. Taxpayers and the IRS would have to guess at constantly changing expected future values of musicians’ brands annually as artists went in and out of favor. And that is just one industry, and intellectual property is just one of many tricky aspects of valuation under estate and wealth taxes.

I discussed wealth taxation and the problems of asset valuation in this study. I pointed to an IRS analysis that compared valuations on estate tax returns to valuations of the same estates on the Forbes 400 list of wealthy Americans. The study found that estate tax valuations were, on average, only 50 percent of the valuations on the Forbes list. That is a big difference. The IRS study noted:

This research highlights the inherent difficulties of valuing assets which are not highly liquid. The portfolios of very wealthy individuals are made up of highly unique assets and often the value of assets, such as businesses, are very closely tied to the personality and skills of the owner. Determining a precise value for these assets can involve more art than science.

Another thing strikes me about the Jackson case. The IRS wanted to impose a $200 million penalty on the estate for supposedly undervaluing its assets, but the Tax Court logically denied that brutal assessment. Think about that: the IRS wanted to impose a massive penalty on a taxpayer for getting the numbers wrong, but it was the IRS itself that got the numbers vastly wrong. What penalty do the IRS employees get?

Finally, one cannot read the Wall Street Journal story without lamenting the loss to the economy from all the lawyer fees. Legal work over seven years at, say, $300 per hour or more would add up. Taxes on wealth do not help workers, but the administration of such taxes definitely helps the wealthy legal elite.