The Michael Jackson Estate

Is This It?

Every generation has its icons. We have People magazine, TMZ and the Enquirer to expose our superstars and their atypical lifestyles. Some are worshipped like a deity; their every move chronicled and criticized in the tabloids – until the stardom so desperately sought – becomes a curse and the fall from grace so painful. We’ve lost many superstars, but the loss of Michael Jackson was different – it was like losing a family member. We knew as children Michael Jackson was a star. Sitting on bean bags, we watched the Jackson Five cartoons and listened to “Rockin’ Robin”, “I’ll Be There” and “Ben” over and over again on the eight track tape player. As teenagers we thought Michael having a pet chimpanzee named Bubbles was the coolest thing. Some are good dancers – but he was a dancing machine. Who didn’t look ridiculous trying to emulate his patented Moonwalk? Who didn’t buy some vinyl when “Bad” was released? As a young man, I didn’t know what MTV was, until I watched “Thriller” and “Billie Jean”. That Halloween, all you needed was one white glove, some cuffed pants and loafers. As parents, our techno savvy children – over our objections – used Napster to fill our IPODs with HISstory.

Those who loved Michael, knew weirdness was just part of Michael. Neverland, was perhaps a product of Michael trying to re-live his childhood – a little strange. A marriage to Lisa Marie Presley, and one very awkward kiss – getting stranger. Allegations of touching or sleeping with young boys, and millions paid to settle such claims –  beyond strange. The metamorphosis of his skin, nose and cheekbones; strange on whole new level. But who knows what really happened … he seemed incapable of hurting a child. Who knew what combination of illness, injury and or vanity caused his facial disfiguration. He was Michael – not like other guys.  But despite all the monkey business, all the little birdies on Jaybird Street, loved to hear the robin go tweet tweet tweet. His awe inspiring lyrics, voice, dance and dress made the girls scream and his off the wall behavior earned him the “Wacko Jacko” title – but he was our Wacko Jacko and we weren’t ready for his final curtain call. If you shed a tear when he passed, you are not alone.

Throughout his lyrics, Michael made a pact with us, he’d bring salvation, he promised joy and laughter, he reached his hand out to us, crooned he’d be there to protect us, and all we had to do was call his name and he’d be there. He reminded husbands to be there in the morning when she wakes and show her that she’s your girl. In one of the few times we saw the world unite, it was at Michael’s calling. A plea that there comes a time, when we heed a certain call, when the world must come together as one, that people are dying, and we need to lend a hand, that after all, we’re all part of God’s family and change can only happen when we stand together as one.

And as our bones began to creak in early autumn, his “Earth Song” delivered the message that we are all just conservators of our planet, stewards entrusted to protect it for our children, that should we fail, our children or our grandchildren will ask; what about the sunrise? What about rain? What about the seas and the air we breathe? What about the holy land – torn apart – by creed? Yet, he encouraged us that we can heal the world, we can make this world a better place, for you and for me, and if we really try – for the entire human race. These borrowed and altered lyrics convey only his fervent belief that with love, comes laughter, joy, and peace. He entertained us, he moved us. His words transcended generations, races and nations. We embraced him into our homes for five decades. On June 25, 2009 Michael Jackson’s brilliant fire burned out, clearly he was gone too soon. Now we read blogs, we watch his thrillers on MTV  and we know, his loss – is our loss. Though some never can say goodbye, others joined in mass to say goodbye. The world mourned his loss and the media debated his checkered life. Though Michael’s life ended abruptly, his estate was born and has a life of its own.

Few could hold backs tears when, during the funeral service, his 11-year-old daughter Paris said, “Ever since I was born, Daddy has been the best father you could ever imagine, and I just want to say … I love him so much”. The Earth was weeping, the masses mourning and the reporters digging—but that’s just human nature. The fateful 911 call was made public, and reports quickly surfaced that a private physician may have injected Michael with propofol as a sleep aid, but instead the powerful anesthetic likely caused his death –  insight from Dr. Sanjay Gupta. And so, this is it? It ends here? Hardly. His spirit will live on through his music, through his children, and through his fans. No author, no biographer or no insider could provide you with more insight into Michael’s soul, than Michael himself when he addressed Oxford University in 2001 and said,

“Love, ladies and gentlemen, is the human family’s most precious legacy, its richest bequest, its golden inheritance. And it is a treasure that is handed down from one generation to another. Previous ages may not have had the wealth we enjoy. Their houses may have lacked electricity, and they squeezed their many kids into small homes without central heating. But those homes had no darkness, nor were they cold. They were lit bright with the glow of love and they were warmed snugly by the very heat of the human heart”

The terms of Michael Joseph Jackson’s three-and-a-half page Last Will and Testament dated July 7, 2002 were as easy as ABC.

Michael was well advised to appoint his trusted advisors as Executors. His long time attorney John Branca, music executive John McClain and accountant Barry Siegel were named in the Will to so serve. But the costs of administrating his estate, defending the lawsuits, all while preserving wealth for the beneficiaries — is a dangerous undertaking, one that long time accountant Barry Seigel refused to assume. “Unlike the typical estate, the operation of Michael Jackson’s estate is more akin to the operation of a multimillion dollar business enterprise,” the administrators’ attorney Jeryll S. Cohen said in the Court filing.  With all the craziness that surrounded Jackson life, he actually created a fairly effective estate plan, there’s still plenty of litigation and intrigue. The executors, lawyers and accountants will be working day and night for years to come to administer Michael’s estate.

Typically administering an estate is a process. Once someone dies, and their Will is offered for probate, the first thing probate clerks are  required to do, is to check the Will to make sure it was signed properly, that it was not tampered with or altered, that is was in fact, the Last Will signed and to allow any interested party to object to the Will as being a product of fraud, undue influence or claims that the testator lacked mental capacity. If the Will was signed properly, and if there are no objections, the Will should be admitted to probate and the nominated executors will be authorized to administer the estate in accordance with the Last Will and Testament. Michael Jackson’s Will was admitted to probate, but not before some histrionics. His estate will likely be the largest income producing estate in the history of the United States. His relationship with his father Joe Jackson was less than ideal.  Many will try to profit off his name and likeness and somebody will wanna be startin’ something. Therefore, it should come as no surprise that litigation would mark the birth of Michael’s estate.

The Los Angeles Superior Court respected Michael’s Will and appointed his mother as the children’s guardian, and John Branca and John McClain as co-executors. No one claimed victory, no one claimed triumph and there was no bad actor. Michael’s estate will take decades to close, and will undoubtedly be in and out of the Courts for years to come.

As to who shares in the assets of Michael’s estate; the Will directs that all assets, after the payments of debts and expenses are  all payable to the Michael Jackson Family Trust. Though the terms of the Family Trust aren’t recorded in the Surrogate’s office like a probated Will is, at least one credible source reported that his Mom is to get 40% held in a trust for her benefit, the children get 40% held in a trust for their benefit and 20% will pass to charities as selected by John Branca, John McClain and Katherine Jackson. However, before all the wealth can be transferred to the beneficiaries, the executors had to be appointed to marshal the assets and liabilities, settle all claims and pay the income and estate taxes. Just weeks after Michael died, the Courts were prevailed upon like fire marshals to extinguish the brush fires.

Three weeks after Michael died, a judge ruled that Michael Jackson’s longtime attorney and a family friend should take over the pop singer’s estate, rejecting a request from Jackson’s mother to be put in charge or share control.  Los Angeles Superior Court Judge Mitchell Beckloff backed attorney John Branca and music executive John McClain, who had been designated in Jackson’s 2002 will as the Co-Executors responsible to manage Jackson’s estate. Attorneys for the Katherine Jackson repeatedly objected to their appointment, but ultimately she respected the Court appointments which were consistent with Michael’s Will. Branca and McClain assumed a difficult task. Being an executor is typically a thankless job, but they seem to be doing an outstanding job protecting Michael’s estate, settling claims and distributing monies in accordance with Michael’s intentions.

Fiduciaries are individuals or institutions who assume responsibility to protect and preserve assets for the benefit of another. The Court appointed the co-executors, and also had to appoint a guardian to care for Michael’s children until they attain age 18. Initially there was concern that Debbie Rowe, or any of Michael’s children, or his father Joe Jackson would contest the plain language of Michael’s Will which named his mother Katherine as the guardian. Ultimately Katherine Jackson, then  79-years-young was appointed as guardian. Raising children is no easy task for a young energetic parent, but is quite an undertaking for a 79-year-old grandmother. Speculation turned to the possibility that MJ’s sister Janet would raise Prince, Paris and Blanket, others suggested Janet might not actually be the aunt who eventually rears the kids, rather, Michael’s 59-year-old sister, Rebbie, might help care for the children on a day-to-day basis. Meanwhile, Katherine has never complained  and Michael’s children must know the most important thing – that they’re loved. Quite sure they can hear their father saying “I just can’t stop loving you”.

Meanwhile, back at the executors’ headquarters, protecting Michael’s intellectual property rights and image was one of their highest priorities. They petitioned United States District Court Judge Dolly M. Gee who granted their request for a preliminary injunction enjoining the “Heal the World Foundation” from further exploiting the use of Michael Jackson’s name, image and likeness and also from using any Michael Jackson-related trademarks. The injunction resulted from a  lawsuit filed on September 29, 2009 in United States District Court in Los Angeles against two related entities operated by Melissa Johnson which had been using the “Heal the World” name.  While Michael had a Heal the World Foundation, it had been inactive for many years prior to his death on June 25.  The plaintiffs in the action are Jackson Estate Executors John Branca and John McClain, along with Triumph International Inc., a Michael Jackson company now owned by his Estate. In her written order, Judge Gee wrote that the websites of Ms. Johnson’s entities “convey to consumers a false affiliation with Michael Jackson and have, in fact, misled consumers into believing that Defendants are associated with Michael Jackson or Jackson’s foundations.”  She added that the decision by Ms. Johnson’s entities to use Michael Jackson-related trademarks in its websites and on products it sells “is clearly related to Michael Jackson’s commercial success.”

Next, the Co-Executors had to defend a multimillion-dollar lawsuit filed by a concert promoter against the late Michael Jackson over a failed reunion concert.  U.S. District Judge Harold Baer, Jr., granted a motion by lawyers for Jackson’s estate to dismiss the case, citing a lack of evidence that the late King of Pop, his estate, or family were under a binding agreement to perform at a reunion concern.  AllGood Entertainment, Inc., a company started in Morristown, N.J., sued Jackson for $40 million on June 10, 2009, roughly two weeks before his death. The lawsuit claimed the Jacksons and the then manager broke a contract for a Jackson reunion show.  AllGood later filed a creditor’s claim with Jackson’s estate, claiming the potential value of the lawsuit was at least $300 million.  Baer determined that there was a letter of intent between Jackson’s then-manager, Frank DiLeo and AllGood, but the letter of intent was never a binding enforceable contract.  The Court noted that neither Jackson nor any other members of the family who were to be involved in the show,  ever signed a contract. The plaintiffs tried to enforce a weak claim, and  Michael’s executors fought back, and beat it.

Settling claims is one thing, making money is another.  The executors were hard at work doing just that. They  restructured all of Jackson’s debts, which included getting creditors to significantly lower their high interest rates.  Secondly, the executors set their sights on generating revenue, beginning with the film, “This Is It”.  According to the reports,  the movie grossed $260,000,000, the most lucrative documentary film in history.  The soundtrack sold 5,000,000 copies, making it the 3rd biggest album in 2009.  The executors also republished the “Moonwalk” book, made mega-merchandising agreements, distributed a leather-bound coffee table book on the life of the King of Pop and renegotiated the singer’s royalty agreements with the record label.

It was only a matter of time until Joe Jackson stepped in and made his voice heard. A California court rejected a bid by Michael Jackson’s father to challenge the administration of his son’s lucrative estate.  A three-justice panel of the California Second District Court of Appeal unanimously backed the  probate judge’s ruling that Joe Jackson did not have standing to intervene in his son’s estate.  Despite being excluded from his son’s 2002 Will, Mr. Jackson tried to exert some control over the Estate’s financial affairs.  Lawyer Brian Oxman, who represents Mr. Jackson, said he would ask the Court to reconsider and might appeal to the California Supreme Court.  He insisted Mr. Jackson should have some say in post-death affairs involving his son.

Even Katherine Jackson voiced her concerns. The Executors of Michael Jackson’s Estate faced a showdown with Katherine after they launched a legal battle against one of her closest friends and business partners.  The Executors sent a “cease and desist” letter to Canadian entrepreneur, Howard Mann, demanding that he stop exploiting Michael’s  image for profit.  Estate attorney, Howard Weitzman, warned:  “His day is coming.  We will be taking the appropriate legal action against him.”  The move to ban Mann from peddling Jackson memorabilia through his Vintage Pop company enraged the singer’s mother, because it turns out, she formed a partnership with him earlier that year.  Together, they’re promoting a new lavish coffee table book, “Never Can Say Goodbye”, which features previously unseen family photos, as well as a Michael Jackson calendar.  Mann even managed to get the book mentioned on Oprah Winfrey’s show. Katherine, who had sole custody of Michael’s three children, insisted she needed extra income to bolster her personal monthly cash allowance from the estate.  The estate pays money every month to cover all expenses at Katherine and husband Joe’s family home in the Los Angeles suburb of Encino.  These disbursements cover a housekeeper, two nannies and private tuition fees for Prince Michael, 13, Paris, 12, and Prince Michael II, known as Blanket, 8.  But Katherine told the Los Angeles Times in an interview:  “I think I should be getting more.  I’m not greedy like people say.  It’s need, not greed.  I wish they would leave Howard alone and I wish they would leave me alone for working with him.”  The Jackson family matriarch, despite this clash said she believed executors John Branca and John McClain are doing “a very good job” managing her son’s multimillion dollar estate.

On February 17, 2011 a report surfaced that indicated Michael Jackson’s co-executors had collected an estimated $310 million in revenue from his film, album sales and other entertainment products lawfully recognized by the estate that he owned.  Income earned after someone dies is typically called income in respect of a decedent, (I.R.D.), and the estate of Michael Jackson is the King of I.R.D.  According to the report, the staggering earnings were accounted for from the time of his death in June 2009 until December 31, 2010.  The appointed administrators have already utilized  $159,000,000 to pay down debts which totaled more than $400,000,000 at the time he died.  Although there still remains unresolved creditor claims, pending litigation and additional challenging business, tax and legal issues, the co-executors have made substantial progress in reducing the estates debts.

Though the estate will continue defending legal actions and prosecuting claims to protect Michael Jackson’s estate, his legacy is not marred by probate litigation. His estate plan did not fail him. Instead, Michael will be remembered for who he was, an imperfect superstar who, as the best singer, dancer and performer of our time, earned the name King of Pop. He’d be happy if, as a result of his words,  just one person tried to make the world a better place, maybe if you take a look at yourself … you’ll make that change.

Legacy Lesson #23: Raising Helen

There’s just no replacement for a parents. But any child who suffers the loss of his or her parents before attaining the age of majority will be raised by a guardian. In the movie, “Raising Helen”, a car accident claimed the lives of a young couple with three children. Shocked by the loss of her sister and brother-in-law,  our protagonist, Helen, is even more stunned to learn she was appointed as the children’s guardian. Sometimes it makes sense to talk with the proposed guardian and see if their even willing to assume such a role, but sometimes, its better to keep such a decision to yourself you may change your mind after any Christmas holiday, and then be phased with the prospect of either letting them know you changed your mind, or risk them being surprised to find out they’ve been removed. In choosing  the guardian of minor children consider the following factors:

  1. Age of the guardian and actuarial likelihood of being able to raise children until the minor attains the age of majority;
  2. Religion;
  3. Their willingness to assume the responsibility;
  4. The guardian’s financial status;
  5. State of residence;
  6. Whether the proposed guardian has children of their own;
  7. The health of the guardian;
  8. Who the children would be most comfortable with;
  9. The value system and moral code of the proposed guardian;
  10. Review these consideration periodically as today’s decision may be very different than tomorrow’s.

Michael Jackson named his mother as guardian of his children. The problem is, though he was probably incredibly confident of his mother’s ability and willingness to assume such a role, sometimes age is an issue. Michaels Mom was  79 at the time, and Blanket was only 7 years old. She’ll, God willing, be 90 when Blanket attains the age of majority. If she predeceased or was unable mentally or physically to raise the children, then the successor guardian would be Diana Ross. Would Diana Ross assume the responsibility? Would her appointment be in the children’s best interest? Something tells me Joe Jackson would have a comment or two. Would Aunt Remmie or Aunt Janet be good choices as successor guardian if Katherine couldn’t serve? Only Michael would know that, but, there’s a lesson here – name Guardians who actuarially are likely to survive until the last minor attains the age of majority and someone the children would be comfortable with on a day to day basis.

Legacy Lesson #24: If You Want Privacy, Use A Revocable Trust

Leona Helmsley’s Will was offered for probate and  available for all to see. So too was Jerry Garcia’s Will.  Anthony Marshall’s Will, woops, sorry, Brooke Astor’s Will, and all three Codicils are available for all to see in the Westchester County Surrogate’s Court. Any individual who seeks privacy, or who prefers to keep the terms of their Will out of public view should utilize a Pour Over Will and a Revocable Trust. Michael’s Pour Over Will simply named his family members, executors and guardians, then poured-over the assets into an existing Michael Jackson Family Trust. That Jackson Family Trust document will not be offered for probate and therefore should not be publically viewed. After a lifetime of over­exposure, the terms of his family trust should remain private.  When Elizabeth Taylor died, her assets were also transferred into a Revocable Trust and the terms of the trust are not available to the public.

The Pour  Over Will and Revocable Trust technique may also be appropriate if you own property in another state or country. The goal might be to avoid what’s called ancillary estate administration in a foreign jurisdiction. If such property is re-titled in the name of the Revocable Trust, then it avoids the necessity to file a second probate – or an ancillary estate proceeding.

Legacy Lesson #25: The Business of the Business

Could Michael have done more planning? If his net estate, after the payment of debts and administration expenses was a modest $100,000,000 less a charitable deduction of 20%, the balance ($80,000,000) less the then death time exclusion of $3,500,000 multiplied by 45%, (the then estate tax rate), the federal estate tax would be a whopping $26,775,000.  These numbers are not authenticated but are for illustrative purposes only. But the point is, should Michael have done more planning? The answer isn’t black or white –  it’s red or green.  Michael built an empire and could have done more to protect his estate from the devastation of the estate tax bite.

For those who’ve spent a lifetime growing a business, or working for the family business,  you know how emotionally charged the idea of passing the torch to the next generation could be. Just the thought of it could be paralyzing because you don’t know where to start. The fear is, you pull one thread, and the whole tent could come down. But without a business succession plan such an eventuality is likely to become a reality. Just ask the brothers Koch.

One of the largest family businesses in the United States, Koch Industries could generate  over $100,000,000,000 of revenue. Perhaps not as well known as the Mars family or the family Kardashian, but make no mistake, the Koch family is no less  scintillating.  Started in 1940 by Fred C. Koch, who once owned approximately 84% of the company stock and J. Howard Marshall II, who owned the other 16% of the stock,  these two brilliant titans built this Company into one of the largest privately owned petroleum refinement, energy and chemical  conglomerates in the United States.   But money doesn’t buy happiness, just ask the heirs of J. Howard Marshall II.

In the office, Fred C. Koch was quite the visionary, but from afar, he seemed blind when it came to nurturing his sons. He was called a monarch and a severe taskmaster who instilled the fear of God in his four children Frederick, Charles, David and William. If they failed to live up to his expectations, they’d  fear being deemed worthless in his eyes. Sadly their childhood, instead of being collectively enriched by enormous wealth was burdened with unrealistic demands and expectations.  Troubled over who was sent away to boarding school, or who was banished from the family for allegedly stealing $700.00, or who was the apple of Dad’s  eye and who was the eyesore – these siblings were not brothers in arms, but rather armed brothers destined for divisive acrimony. The writing was on the wall.

Rich or poor, it’s no curse to be part of a  dysfunctional family. Lord knows, the Koch brothers are not the only children pitted against each other by a tyrannical parent.  But to expect that after the patriarch died they’d all play well together in the Koch Industries sandbox was equivalent to pointing the oil pipeline straight up into the air and expecting the crude to fill freighters. It defies the laws of physics. The predictable result of course is a toxic mess that’s near impossible to clean up – and that’s just what they suffered after Fred C. Koch died.

In one of the longest running family feuds in the history of our country, the brothers Koch certainly didn’t universally embrace their father’s counsel, to be kind and generous with one another, as such wealth could be a blessing or a curse. The enormous wealth proved a curse as to the brother’s relationships. But once again, true to form, family relationships, sibling rivalries and favoritism are often factors that are pre-cursors to probate litigation – it’s the classic dysfunctional family syndrome. The trouble started early. Though the father, Fred C. Koch did proactively gift shares of the business to his children, his son Frederick received significantly less than the other brothers … a hangover from a $700.00 dispute and Dad’s act of frowning on that which Frederick did or didn’t do. Then after he died, though Charles was the named successor, the other brothers sought to buy up shares from others and stage a coup. The failed coup set the stage for two brothers, William and Frederick to be cashed out. Though valuation experts were hired, including Goldman Sachs, and brothers William and Frederick received $1,100,000,000 said amount would become the source of intense litigation. After the sale, the two claimed that the disclosures in the valuations weren’t complete and there was a scheme to conceal the true value of the business. The lawsuit claimed that fraudulent accounting practices resulted in their being shorted some $2,000,000,000. Their litigation odyssey brought them to the United States District Court for the Northern District of Oklahoma, United States District Court for the District of Kansas, United States District Court for the District of Utah and the United States Supreme Court. The litigation spanned two generations and the brothers were intent on crushing each other, scorched earth, in search of a result that couldn’t be judicially constructed – to be loved, trusted, accepted and praised for their respective accomplishments.

Ideally a business succession plan would have been created by Fred C. Koch before he died.  A successor should have been appointed. A valuation methodology should have been established that would be binding on all heirs. Methods to redeem shares in the company for cash should have been created so that any child could hold onto the Koch Industries shares, or redeem them over a defined period of time at an agreed upon sale price. Short of such planning in advance, and given the less harmonious family history the scorched earth mentality that fueled the Koch family litigation was pre-ordained.

Business succession planning requires the owners of their prized possession to take a step back and re-define goals for generations to come. It requires time, attention to detail and resources with a team of professionals who embrace  your goals and objectives. Children may embrace the process, avoid the process, or not even know about the process.  But somewhere down the line, someone will thank you for your efforts and appreciate that you took your precious time and resources to protect them as best as you could. The survivors may not all agree with your decisions, but should respect the fact that you did your best to balance the equities and directed the ship into calm waters.

Where to begin?

To start the process, learn about the process first. Begin with questions – lots of questions:

  1. How did the business start?
  2. What was the goal of the business at that time?
  3. Were there partners? How many and what happened to them?
  4. What’s the business model now?
  5. Who’s the leader?
  6. What’s the competition?
  7. If we looked at the tax returns for the past 10 years, what would a chart of the income look like?
  8. Is the entity an S-Corp, C-Corp, Limited Liability Company, sole proprietorship, partnership?
  9. Are there corporate books, minutes and by-laws?
  10. Is there a buy sell agreement and are shares or units properly allocated amongst the owners?
  11. Is there an exit strategy?
  12. Are any family members interested in getting involved?
  13. Are any family members qualified to one day assume control?
  14. If some children want to be involved in management of the business and others don’t, should the business be transferred to all equally? Should the successor leaders be all of the children, or just those who together will get along and forward the best interests of the company for all equity owners?
  15. Or would it be better to leave the business only to those children who are truly interested, and leave other children an equalizing bequest of cash?
  16. What’s the value of the business? When is the last time the business has been valued? What’s the cost basis?
  17. Who are the advisors: accountant, attorney, insurance professional, investment advisor and banker?
  18. If you could wave the magic wand and see this business 20 years from now – what would you like to see?
  19. What’s the best part and what’s the worst part of being involved in this business?
  20. What’s keeps you up at night? (limit the answer to business issues only please)

These questions are just a starting point, but the answers will help chart a direction which could run the gamut from, no action, to an ah ha moment, that makes it clear the time to plan is now. Before designing a business succession plan, learn the process.

A valuation of the business interest may be the next step.  The valuation of a closely held company requires a thorough understanding and analysis of all relevant facts surrounding the company, past, present and future.  There is no general formula that applies to any specific industry or type of business; rather, the approach to valuation must be tailored to fit the particular type of business and the current economic conditions.

In order to maximize the tax benefits of a business succession plan, all valuations used for estate and gift tax planning must comply with the applicable tax law provisions.  In this regard, the Internal Revenue Service guidance through at least eight fundamental factors it considers essential in providing a proper valuation of a company:

  1. The nature of the business and the history of the enterprise from its inception.
  2. The general economic outlook, as well as the specific condition and outlook of the industry engaged in by the subject company.
  3. The book value of the company’s stock and the financial condition of the business.
  4. The earning capacity of the company.
  5. The dividend-paying capacity of the company.
  6. The company’s goodwill and any other intangible assets of the business.
  7. The prior sales of the company’s stock and the size of the block of stock to be valued.
  8. The market price for stock of corporations that are engaged in the same or similar lines of business, the stock of which is actively traded on the open market (either on an exchange or over-the-counter). Typically a valuation company or an accounting firm will prepare the valuation study and then be asked to value 1% of the company’s stock, or limited liabilities company’s units.

When asked to value only a 1% interest in a company, typically a corporation or limited liability company, most valuation experts will opine that a percentage of the whole is less attractive to sell, and  there’s less of a market to sell too.  Since the percentage of the company being valued is small, it’s a minority interest, and therefore, a discount should be attached to it’s value. There are numerous types of discounts, but the following represents the discounts most typically utilized:

  • Lack of marketability discounts.
  • Minority interest discounts.
  • Information access and reliability discounts.
  • Key manager or thin management discounts.
  • Comparability discounts.
  • Investment company discounts.
  • Market absorption or blockage discounts.
  • Built-in capital gains discounts.

The amount of the discount is totally dependent upon the factors unique to the company. As a general rule of thumb however:

  • the more liquid the underlying assets is, the smaller the discount;
  • the more illiquid the company is, the more difficult it is to sell company interests;
  • the more restrictive the buy sell agreement is, the larger the applicable discount.

The range of discounts as added cumulatively could vary from 10% to 50%.  Once the value of a share has been determined and the amount of income that a share generates, the range of planning options can be considered. Conceptually, the options fall under two categories: gifts and sales.

Starting with the basics, 1% of the limited liability company (LLC) membership interest, or 1% of the issued stock in a S-Corporation,  could be gifted, or transferred outright, free of trust to an adult heir, or transferred into a trust for the benefit of an heir. If the business interest is gifted outright, a gift tax return must filed with an attachment of the business valuation and an allocation of the value of the gift against the current $5,000,000 lifetime gift tax exemption. To illustrate, utilizing a fictional entity MJ Enterprises, LLC that was valued at $7,500,000, less a discount for lack of marketability,  lack of transferability and a key person, which cumulatively equaled 33.3%, then the enterprise value for gift tax purposes would be approximately $5,000,000.  If the entity had 100 units, then each unit would be valued at  $50,000.  If each unit generates 6% the needed data is established to analyze a transaction. In this case, the units could be transferred without causing gift tax. Even if the value was $15,000,000 and the business owner was married, both husband and wife could use their lifetime exemption amount, $10,000,000 combined, and after the discounts, they could gift the entire amount outright to their children, or in trust for their benefit.

But if the value exceeded $15,000,000 then, gifts of all the LLC units would cause gift taxation over the exemption amount of $5,000,000 per spouse. Since the current gift tax rate is at a historic low of 35%, many wealthy business owners are choosing to pay the gift tax now because:   a) the valuation of the underlying assets are low given recent economic downturns; and b) gift tax rates have historically ranged from 45% to 55%.  Therefore, now may prove to be a meaningful opportunity to transfer wealth – even if it means paying gift tax. But before taking out the checkbook, consider more advanced gift transactions that reduce the value of the gift beyond just the valuation discounts.

One example is a trust affectionately known as a Grantor Retained Annuity Trust (“GRAT”). Though a possible violation of the no legalese rule, this trust can easily be broken down into plain English. The GRAT is just a trust where the owners transfer a portion of their wealth into the GRAT, and retain a benefit for a term of years. At the end of the tem, the remaining assets pass to their children or other heirs. The key is that when valuing the gift for gift tax purposes, the value is reduced by the owner’s retained interest. If an owner retains a benefit for ten years, then the current value of the gift for the children, who have to wait ten years,  is actuarially reduced. If they have to wait twenty years, the current value of the gift is reduced even more. One catch – best to live the term of the GRAT, or risk the entire trust, or a portion depending on how the trust is drafted, being pulled back into the estate at its then value. But should you cooperate and live the term of the GRAT, and your business interest grows at the rate of 10% a year, then the GRAT was a home run and allowed you and your spouse the right to transfer not $15,000,000 of LLC units, but $30,000,000 of LLC units.

Creating combinations of gifts and sales structures takes a lot of time, it’s not an inexpensive project, but when valuations are low, when interest rates are low, when the exemption is at an all time high, and your company could out perform the benchmarks – you can move the mother load. Mix in some charitable planning, and there’s no limit, a legacy is all but assured. The result of the planning can truly be thrilling … or at least very satisfying.  Could Michael Jackson have planned for a potentially huge estate tax by doing more succession planning during his lifetime – it certainly seems so.