The Estate of the Musician Known as Prince
In December 2021, the estate of the musician known as Prince, The Internal Revenue Service (IRS) and the Minnesota Department of Revenue (MDR), settled the valuation of Prince’s estate. Prince’s music rights were the main point of contention –what is the day of death value of all of his songs and music rights?
It took six years of disagreeing before it settled. The estate believed the correct value was $82.3 million, whereas the IRS. thought it was worth $163.2. Technically, the estate tax (the tax on the decedent’s assets), is due 9 months after Prince died. The IRS charges interest rate equal to the federal short-term rate plus three percent and if they believe the estate has significantly under reported the value, they can impose an accuracy related penalty. Here, the IRS assessed a $6.4 million penalty. The MDR imposed a penalty as well. The estate disputed the penalties.
All sides were prepared to go to the United States Tax Court. to have the court determine the actual value of the estate, interest owed on the tax that wasn’t paid, and the validity of any penalties that may have been assessed. This would be considered a major case and the estate had hired very experienced counsel, accountants and valuation experts. The cost of trial would have been very expensive, and the result would have been uncertain (the court can rule for or against you). Over the course of the 6 years since Prince’s death, the lawyers and consultants were paid well more than $10,000,000.
The estate, the IRS, and the State of Minnesota, agreed on a $156.4 million valuation and the trial scheduled for March 2022 was avoided and the penalties (federal and state) were waived.
It’s important to note that Prince didn’t have a Will or Trust and that made his estate subject to a public state court proceeding known as a Probate (this is in addition to the Federal Tax Court that we previously discussed). The estate is represented by a person or company known as an executor (sometimes called an administrator). In this case, Comerica Bank and Trust represented Prince’s estate. The executor is allowed to charge the estate a fee for services rendered based on the size, complexity and duration of the estate administration. Here, it was $156 million, very complex, and has gone on for six years so far. Minnesota law does not say specifically how much an executor can charge, but it must be “reasonable”. The executor’s fee will be many millions of dollars in this case. The executor can determine the amount, but it is subject to the judge’s review if need be.
The estate must file a IRS form 706 within nine (9) months of the day of death and make a tax payment for the amount due, or apply for a payment plan to pay the taxes if there is not enough liquid assets to pay the tax bill. The IRS does not have to approve the request. Typically, the estate will apply for an automatic 6-month extension to file the 706 and will send in a reasonable amount for the likely owed tax amount.
In 2016 (check day of death, the amount exempted from Federal Estate tax was $5,000,000. This means that the amount over the $5,000,000 of estate value is taxed at 40%. In this case, which comes to a little over $60 million in death tax.
The State of Minnesota imposes an estate tax of 16% on the amount over $3 million dollars.
Neither the Federal Government nor the State of Minnesota has an inheritance tax.
In this case, where the estate owes estate tax to both the federal government and the State of Minnesota, the estate will receive a credit on the Federal Estate Tax Return for the estate tax paid to the State of Minnesota. The instructions for the federal 706 form say, “You may take a deduction on line 3b for estate, inheritance, legacy, or succession taxes paid on any property included in the gross estate as the result of the decedent’s death to any state or the District of Columbia.”
While Prince’s estate is being administered, income from music royalties and rent from real estate that he owned, would be considered income and the estate would need to file a federal form 1041 and a state of Minnesota form M2 . These forms would have to be filed each and every year that the estate is being administered.
Capital Gains Tax
The estate would receive a powerful tax benefit with respect to avoiding capital gains. Currently, under Internal Revenue Code Section 1014(a), the basis of the property that Prince owned at the time of death would be fully stepped-up to the day of death value. Simply put, if the asset was sold right after Prince died, there would be no capital gains tax. This would be true no matter what price he bought the asset at. Basically, a lifetime of potential capital gains tax is erased at the time of death. However, if the value appreciated after Prince’s death, there would be federal and state capital gains tax on the sales price of the asset less the day of death value.
With proper estate planning many millions of dollars of tax could have been avoided and need to go through Probate Court would have been avoided. If you are in California, Bezaire, Ledwitz and Associates can help you to avoid the mistakes that Prince made.
Samuel B. Ledwitz is a licensed California Attorney that holds the designation as a State Bar Certified Specialist in Estate Planning, Trust and Probate Law. Attorney Ledwitz also possesses an advanced law degree (LL.M. in Estate Planning) from the University of Miami School of law. Furthermore, he is a Real Estate Broker, Notary and Life Insurance Agent. He is also a former armed security officer and locksmith. In addition, he teaches an estate planning class at a local college and is a former high school substitute school teacher. He has a unique perspective on this topic. His law firm has helped three lottery winners and one Indian Reservation Slot machine winner with various aspects of their estate planning.