TAX AND ESTATE PLANNING LESSONS FROM CELEBRITIES

Presented by: Kevin N. Perkey, Esq. Woolf, McClane, Bright, Allen & Carpenter, PLLC 900 South Gay Street Knoxville, TN 37902-1810 Telephone: 865/215-1000 E-Mail: [email protected]

Presented to: Appalachia Chapter of Tennessee Society of CPA’s August 12, 2016

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Tax and Estate Planning Lessons from Celebrities

Introduction

Celebrities can provide a very public example of how tax and estate planning can be performed smoothly and competently, or how it can lead to a disaster for both the individual and their family if ignored.

Celebrities seem to constantly underestimate the importance of competent tax advice – or they often ignore the advice that they have been given. Some well-known figures, such as Mitt Romney, show us the benefits of an effective tax plan. For others, including Willie Nelson and Wesley Snipes, it seems the IRS has an uncanny ability to hunt down celebrities to pay their delinquent tax bills. In the case of former Chief Justice Warren Burger, sometimes celebrities simply do not plan well enough to pay the smallest tax burden they can.

With respect to estate planning, some celebrities such as Robin Williams and Mark Zuckerberg enlist skilled attorneys to draft documents that protect their assets at death and minimize the tax bill for their heirs and estate. While others, such Marilyn Monroe, likely did not fully comprehend the consequences of their estate planning decisions, which can create nightmares for their estate and heirs.

Ultimately there are a number of tax and estate planning lessons we can learn from the rich and the famous.

Tax Lessons

Mitt Romney

Carried Interest – Not Just For Private Equity Investors

Mitt Romney managed to avoid millions of dollars of tax by converting what might otherwise be ordinary income to capital gains. The former presidential candidate effectively used carried- interest to achieve this result.

Carried-Interest is a form of compensation often used by private-equity executives to receive a share of the firm’s future investment profits. Carried Interest is nothing more than a profits interest that is not subject to ordinary income tax upon receipt. Rather, the Carried Interest generally will avoid tax until long term capital gains are realized.

Mitt Romney’s company, Bain Capital, is a private equity firm. Typically, the fund will receive a carry percentage of around 20% as compensation to the general partner for the services provided to the fund. Allegedly, in addition to converting compensation for services to long term capital gain, Romney transferred his Carried Interests to a family trust based on the valuation at the time of grant of $0. The value of these Carried Interests later increased to more than $100 million thereby escaping significant gift and estate tax in addition to favorable capital gains rates upon exit.

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How Your Clients Can You Use Carried Interest?

If a client wants to grant an interest in a partnership or LLC to a valuable employee or service provider, the client should consider granting a profits interest in the LLC. A profits interest, compared to a capital interest, is not taxed to the recipient.

Modify the Operating Agreement

Fiduciary Duties to Members

83(b) Election

K-1s

Wesley Snipes

In 2008, Snipes was convicted of three counts of willful failure to file tax returns for 1999 to 2001. Snipes’ failure to pay taxes was not an accident. Rather, he attempted to argue he was exempt from taxation. Ultimately he lost both his tax court case and his appeal. Snipes served 28 months of a three year sentence in prison.

Yes, the “White Men Can’t Jump” star was a tax protestor who not only thought he could avoid paying income tax but actually demanded a $7 million refund from the IRS. Snipes was convinced by a group called American Rights Litigators that he could challenge the IRS’s authority to collect taxes. He made an “861 argument,” essentially arguing that domestic earnings of individual Americans do not qualify as income under 26 U.S.C. §861 because those earnings do not come from a listed “source.”

Other arguments he made included that he was a “non-resident alien” whose income came from “sources wholly outside the United States,” that the takings clause was limited to the District of Columbia and insular possessions of the United States, not including the 50 states, and that he was “a fiduciary of God, who is a nontaxpayer,” and thus he was a “foreign diplomat.”

Lessons: Never think you are bigger than the IRS. If you owe tax and there is no legal tax avoidance principal in your favor, pay them. If you get involved with a group like the American Rights Litigators, be highly cautious, or better yet, don’t get involved at all. Use your platform to protest taxes, not your tax forms.

Willie Nelson

Willie Nelson is another example of a celebrity who didn’t want to pay their taxes, and he was forced to pay dearly for his mistake. The IRS determined in 1984 that Nelson had been underpaying taxes for years due to an invalid deduction, and they won a subsequent court judgment against Nelson.

The IRS’s judgment included $16.7 million in back taxes, penalties and interest. They seized everything they could get: Nelson’s 44-acre ranch, 20 other properties in four states, and most of Nelsons instruments, recordings and memorabilia. 2

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Fortunately for Nelson, the very farmers he helped with his Farm Aid concerts stepped forward to buy most of his memorabilia and property at auction, and eventually gave it back to him when Nelson was able to raise enough money.

In an interesting twist, Nelson recorded a new album, “Who’ll Buy My Memories? (The I.R.S. Tapes),” in a deal with the IRS to pay off his debt. Fifteen percent of every record went to pay the debt. The record was purchased by calling (800) IRS-TAPE.

Lessons: As with Wesley Snipes, it’s always a good idea to pay the IRS. If there is any doubt about whether you are paying the proper tax amount, contact an attorney specializing in tax practice. They can save you a Texas-sized headache of being slapped with a delinquent tax bill like Nelson.

Richard Hatch

It is hard to hide your income when your famous for walking around naked.

Original Survivor winner, Richard Hatch, thought he could avoid hide his $1,000,000 prize from the IRS. He was convicted of tax evasion. He continues to maintain his innocence claiming that CBS was supposed to pay the taxes on the prize. Of course his contract with CBS said just the opposite.

Estate Planning Lessons

Robin Williams

Prior to his death, Robin Williams transferred many of his assets into a series of trusts. This afforded his estate plan and family some measure of privacy. Many other celebrities, like Philip Seymour Hoffman, dislike trusts, and at their death their estate becomes a public and legal mess. Williams protected his family from this public nightmare.

Among things Williams did right in planning:

Personal Residence Trust. Williams ensured his wife would get to stay in the house. He left her a residence in trust that included a fund for upkeep, insurance, taxes and mortgage payments. This way, she was not forced to pay such expenses from her own pocket, potentially resulting in her being forced to leave her home. Contrast this with Steve McNair and the impact his lack of planning had on his mother’s residence.

Charitable Giving. Williams’ publicity rights are protected from taxation. He transferred those rights into a charitable trust, thus the transfer was eligible for a 100% estate tax deduction. Furthermore his image cannot be used for 25 years after his death. Contrast this with Marilyn Monroe as we will discuss later.

Powers of Appointment. Williams provided that each of his children would eventually get equal gifts from his trusts. This includes the power for the children to modify how their share of the trust assets is distributed should they die.

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Privacy. Normally, all of this would all be private information, but litigation over administration of Williams’ trusts led to the trust instruments themselves being filed as a publicly viewable exhibit.

Lessons: Robin Williams’ estate is a good example of an estate plan done properly. Williams protected his wife from financial instability while ensuring his children would receive the largest part of his estate they possibly could. He also worked to keep his estate plan private, though in the end the terms of his trusts were revealed due to litigation

Marilyn Monroe

Marilyn Monroe seemingly had a quality estate plan. However, unforeseen consequences years down the road show how a short-sighted decision can end up causing monumental damage later.

Domicile. Monroe’s legal representatives were able to register her estate in New York, where her second home was located, and avoid a large state tax bill in California.

Publicity Rights. Unfortunately for Monroe’s heirs, New York’s image laws differ drastically from California’s laws. New York does not provide for a posthumous right of publicity, as California does. When Monroe’s estate attempted to protect Monroe’s image in 2012 from others exploiting it, Judicial Estoppel prevented Monroe’s estate from arguing that California publicity law should apply. The Ninth Circuit has removed much of the value Monroe’s estate had: her image. Now, her estate cannot pursue photo libraries, businesses and other organizations that use her image without their permission.

As the Ninth Circuit court eloquently put: “We observe that the lengthy dispute over the exploitation of Marilyn Monroe’s persona has ended in exactly the way Monroe herself predicted more than fifty years ago: ‘I knew I belonged to the Public and to the world, not because I was talented or even beautiful but because I had never belonged to anything or anyone else.

Do you know your heirs? As if this problem were not enough, all the money made by Marilyn Monroe’s image up to 2012 was collected by someone she never intended. Monroe left the bulk of her estate to her acting coach, Lee Strasberg. Lee and his first wife, Paula, were very close with Monroe. However, when Strasberg died, his second wife, Anna, a woman Marilyn Monroe had never even met, inherited the Monroe estate.

Anna hired CMG Worldwide to license Monroe products. They licensed her image to companies like Mercedes-Benz and Coca-Cola, and Anna made a fortune. She also sold many of Monroe’s personal effects in a Christie’s auction, despite Monroe’s wishes stated in her Will that those items go to close friends. Anna eventually sold Monroe’s publicity rights for $20 to $30 million, before her image was deemed to be public property.

Lessons: Marilyn Monroe’s estate leaves a lasting legacy that can teach us several lessons. First of all, be careful where you domicile your estate if you have multiple homes. The laws of the different states can result in vastly different consequences for your estate and your heirs. Also, carefully consider who will inherit your assets after your heirs pass. I doubt Marilyn Monroe intended a woman she never even knew to make millions off of her image. Vehicles like trusts offer more post-mortem control over assets and how they are passed on in the future. 4

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Steve McNair

Many recognize Steve McNair as an all-time NFL great, and possibly the greatest player to ever don a Tennessee Titans uniform. But as great as McNair was as a football player, his estate plan was equally lacking. In fact, he didn’t even have an estate plan, despite the millions of dollars he earned from his years in the NFL.

Beware the Effect of Intestacy. Steve McNair was, tragically, murdered by his paramour. Unfortunately for his family (or at least his mom), he had no estate plan. While he was alive he built his mother a house on a 45-acre tract in Mississippi. Unfortunately, McNair never had the foresight to title the house in her name. Perhaps this was strategic due to gift tax or creditor issues. Perhaps it was an oversight. Regardless, the house was still in his name at death.

McNair’s intestate heirs were his wife and children. The court automatically appointed McNair’s wife as executor to his estate. McNair’s wife demanded $3,000 a month rent from her mother-in-law! McNair’s mother couldn’t pay and was forced out of the home her son built her. To make matters worse, she tried to take her belongings with her, but McNair’s widow sued her demanding the items be returned as part of the estate.

Lessons: Steve McNair’s case is a painful example of the personal tragedies that can befall your family if you don’t have a proper estate plan. It’s hard to imagine McNair wanted his widow to oust his mother from the house he built her. Problems like this can be avoided, either by making lifetime transfers of large items like property to keep them out of probate, or properly designating beneficiaries in a Will. Unfortunately McNair did neither of these and cost his mother her house.

Chief Justice Warren Burger

Most people who know of Warren Burger will remember him as a former Chief Justice of the United States Supreme Court. Ironically, when it came to making his estate plan, Justice Burger was impossibly inept.

Justice Burger drafted his own holographic Will. The Will was a simple document, only one page in length. Among its other errors, the Will contained a typo: executor was misspelled. Additionally, Burger’s estate ended up owing the IRS more than $450,000 in tax that could have easily been avoided through trusts, gifts and other creative drafting.

Lessons: No matter how much you think you know, it is always a good idea to talk with experienced estate planning attorneys. Not only can they help you avoid problems like those Justice Burger encountered, they might be able to think of creative ways to save your heirs money that you might not have contemplated. Be extremely careful if you decide to craft a holographic will.

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Michael Jackson

Michael Jackson’s life was famously chaotic. However, he had a simple, effective estate plan that has nonetheless spawned years of litigation. Jackson’s Will was a pourover Will that left everything to the Michael Jackson Family Trust. His real problems came in when his executors attempted to undervalue his assets for IRS purposes.

Pigs Get Fat, Hogs Get Slaughtered. Jackson’s executors placed his net worth at slightly more than $7 million in documents filed with the U.S. Tax Court. On the other hand, the IRS valued his estate at $1.125 billion, obviously a drastic difference. The IRS then claimed the gross valuation misstatement penalty, doubling the usual 20% penalty for underpayment. The IRS claims Jackson’s estate owes more than $702 million in taxes and penalties.

The dispute with the IRS is based on the value of Jackson’s image and his interest in a trust that includes rights to his own songs and most of the Beatles catalog. The estate valued Jackson’s likeness at $2,105 while the IRS put it at $434 million. The estate valued the song catalogs at $0, while the IRS put it at $469 million. For reference, the estate has earned $475 million since Jackson died. He was the highest paid celebrity in 2012, dead or alive, at $160 million.

Lessons: Whatever the value of Jackson’s estate at his death, it almost certainly wasn’t as low as $2,105. When dealing with the IRS, it is better to be realistic in your valuations rather than trying to sneak an artificially low valuation by them.

Anna Nicole Smith

Anna Nicole Smith famously married billionaire J. Howard Marshall in 1994, when he was 89 years old. Marshall was careful with his estate plan, omitting her from his current estate plan and instead gifting her approximately $6 million worth of assets.

Less than a year after they were married, and while Marshall was still alive, Smith filed suit against Marshall’s son, E. Pierce Marshall, and her husband’s lawyers stating they were interfering with her right to be financially supported by her husband. This stemmed from events shortly after their marriage, in which E. Pierce Marshall helped his father amend his estate plan. J. Howard Marshall’s doctors testified he couldn’t even read the font of the documents amending his estate plan. Shortly thereafter her husband died and Smith claimed he died intestate, challenging the will on undue influence and fraud grounds.

Six years later, the Texas probate court found that Marshall’s Will was valid. Smith and her attorneys were not done. They filed a bankruptcy proceeding that eventually won her a $450 million judgment against E. Pierce Marshall and appealed the Texas probate court’s judgment to the District Court.

Eventually, her case ended up in the Supreme Court. The Supreme Court combined the bankruptcy case and appellate case and found the lesser appellate courts were precluded by the probate exception from re-addressing the issues determined at the Texas probate court level. Anna Nicole Smith lost. Of course, by the time she lost both her and E. Pierce Marshall were already deceased.

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Lessons: Again, it is wise to consider who you trust when crafting your estate plan. Furthermore, if you must make amendments to your estate plan in your senior years, be sure that the amendments are done in a way you can read and comprehend, to prevent long drawn out challenges like this one.

Philip Seymour Hoffman

Oscar-winner Philip Seymour Hoffman did not want his children to grow up as “trust-fund kids”. His estate planning strategy, which went against the advice of his advisors, was to leave his estate to his long-time girlfriend. He assumed that she would provide financially for their kids. Of course, because they were not married, the transfer to someone other than his spouse caused a significant estate tax burden. Moreover, while the mother of his children may “do the right thing”, there are no guarantees.

Lessons: Consider the use of incentive distribution clauses if you desire to avoid having a negative influence on your children.

Gary Coleman

This “Diff’rent Strokes” actor died following the divorce from his wife leaving a holographic will drafted prior to the divorce leaving everything to his wife. What ensued as a lengthy court battle over whether or not this ex-spouse was entitled to receive anything under the will.

Lesson: Update your will following divorce. See TCA Section 32-1-202, but only for divorce, not separation.

Mark Zuckerburg

While Robin Williams might have saved his children some of his money in tax avoidance, Mark Zuckerburg provided his children with a tax free fortune. Zuckerburg placed pre-IPO Facebook stock into a GRAT and completely avoided any gift tax on the transfer.

The grantor puts shares into a short-term irrevocable trust and retains the right to income, for a preset time. For the trust to work, the grantor must survive the preset time period. Provided they survive, any property left in the trust when the annuity payments end passes to family members or a trust for their benefit.

The annuity should be equal to the value of the assets transferred. Any appreciation above the annuity passes to the remainder beneficiaries with little or no gift tax. This is usually accomplished through a zeroed-out GRAT, in which the remainder is theoretically worth nothing due to the annuity payments paid out.

Zuckerburg used this vehicle to pass Facebook stock into a zeroed-out GRAT. He transferred $3,023,128 worth of stock into the GRAT, and presumably the annuity matched that value, resulting in the remainder being zeroed-out. The GRAT terminated before Facebook went public and the stock was most likely passed to another trust for the benefit of Zuckerburg’s future children or other family members. After Facebook went public, a conservative estimate by Forbes estimated Zuckerburg saved $37,315,513 in estate tax. Several other Facebook 7

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executives used the same vehicle for a total estimate of $204 million in gift-tax avoidance. A tax-free fortune indeed.

Essentially, GRAT’s allow taxpayers to transfer the appreciation on assets completely tax-free, provided they have received the original value of the asset as an annuity. This of course requires the grantor have an asset they believe is going to balloon in value. There is also the risk of the person dying before the trust terminates.

Lessons: Are you working with a serial entrepreneur who may not need to live off the dividend income or increase in value in one of his investments? Consider a GRAT.

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