22 Feb Prince’s Estate Planning Blunder, a Symbol of What NOT to Do – Part 2
By: Barry E. Haimo, Esq.
June 22, 2016
Prince’s Estate Planning Blunder, a Symbol of What NOT to Do – Part 2
In the first post, we discussed that Prince allegedly died owning approximately $300 million dollars in assets consisting of real estate, cash, businesses and copyright protected work in the form of music. He is survived by a sibling and some potential half-siblings and newly purported potential descendants. We learned that his estate will likely be reduced by $140 million dollars in estate taxes. The balance of his estate will be further reduced by significant attorneys’ fees and court costs, as this case will remain open for many years. This is primarily because of two reasons: 1) disputes relating to identification and validation of Prince’s heirs; and 2) difficulty in computing the present value of his estate. Ultimately, after creditors’ claims are paid or otherwise resolved, Prince’s heirs will likely share in what is left of Prince’s estate as their inheritance.
The Solution to Many of the Problems Relating to Prince’s Estate
As hinted in the prior post, Prince could have resolved if not eliminated much of the problems mentioned above that his estate will encounter. The solution was to sit down with estate and business attorneys, CPAs and financial advisers (preferably together) to formulate a plan. Working with his professionals as a team would have created a clear path towards achieving his personal and business goals. His plan would likely have consisted of a basic estate plan (last will and testament, revocable trust, power of attorney, healthcare surrogate and living will. It would also have included governing documents for each of his entities, including bylaws, operating agreements and shareholder’s agreements. It is likely his trust or trusts would own these entities.
Trusts — In General
Trusts provide the creator (often referred to as a “Grantor” or “Settlor”) with a way of owning assets while also maintaining control over their management and disposition, both during life, in the event of incapacity and after death. (Click here to learn more about trusts). In either case, a trustee is designated to manage the trust. He or she has a fiduciary duty to administer the estate for the benefit of the designated beneficiaries. A fiduciary duty is heightened standard of care that results in personal liability in the event of a breach. Typically, trusts provide the trustee with the discretion to make distributions to the beneficiaries for their health, education, maintenance and support (HEMS). It’s a broad but important standard for tax purposes. Adding protective articles, such as spendthrift provisions, making distributions subject to the trustee’s absolute discretion, and inserting additional powers for the trustee to withhold making distributions to beneficiaries under certain circumstances, such as when creditors of beneficiaries emerge or if a beneficiary has a substance abuse problem, all would protect the trust estate from creditors of the creator as well as creditors of the beneficiaries. Doing so would also protect the beneficiaries from themselves if they are financially irresponsible. All in all, properly structured and utilized trusts will help avoid probate and guardianship, enable the creator to exercise considerable control both during life and after death through the appointment of one or more trustees, and protect and preserve the trust estate from creditors of the creator and beneficiaries.
Trusts As Applied to Prince’s Estate
Prince should have at least utilized a trust to minimize the likelihood that his estate would need to be probated. He could also have used trusts to own his businesses, his music (subject to copyright issues discussed below) and other assets. All could have been neatly organized and managed with a little preparation and planning. His estate would not nearly be as public, and his estate would not be unnecessarily reduced by taxes, frivolous claims of creditors and enterprising alleged beneficiaries. Why? Because his trusts would have spelled out exactly who would inherit his estate, and when, how and in what manner they would receive assets or other distributions. A trust would have provided both him and his family and/or beneficiaries with a relatively clean, seamless and smooth transition; a benefit that ranks very highly for my clients.
Irrevocable Life Insurance Trusts (ILITs)
Prince’s estate would also likely have included one or more irrevocable trusts. At least one trust would have been created and funded so as to purchase life insurance insuring his life. Why? Because life insurance is often used to offset estate taxes. Regardless of whether the policy or policies are term or whole-life, the death benefits on these policies would have cost-effectively and productively leveraged available cash to pay off the inevitable estate taxes, which translates to more for his beneficiaries than the government. A good advisor would have put him in a whole-life policy and/or a term policy, as well as various types of immediate and/or deferred annuities to creatively fund these trusts and risk management contracts.
Two additional points affecting the impact of these strategies are worth mentioning: first, the effectiveness of this planning approach would depend heavily on Prince’s insurability; meaning that if he was sick or had a preexisting condition, the cost of achieving the foregoing results would be more expensive and less productive. Second, the use of life insurance and annuities in this context primarily aim to pay relevant estate taxes, whereas, we discuss ways of reducing the value of his estate below, which would have, in turn, reduced the amount of potential estate taxes as a result.
Gifting and Valuation Discounts
Annual Gifting Schedule
Prince also could have taken advantage of lifetime gifting. Presently, each person can gift up to $14,000 dollars per person to any number of people per year without even having to report the gifts. In isolation, gifting this amount to various people would only nominally reduce the value of his estate, but could add up over time if done systematically and continuously over time. In fact, gifting schedules are very common and can have a meaningful impact if strategically executed.
Lifetime Gifts Exclusion
In addition, Prince could have created and funded additional irrevocable trusts. These transfers may or may not have constituted gifts for gift tax purposes depending on how they would be structured. In either case, the trusts would receive cash, and, in turn, purchase assets from Prince in exchange for a promissory note. The promissory note would remain in Prince’s estate as a relatively fixed value reflecting the balance of principal outstanding on the note. Prince would effectively be gifting — estate and gift tax free — any and all appreciation on the assets that were acquired by the trust. While each person has a lifetime exemption of $5.48 million from estate and gift tax whether you plan or not, a person can significantly increase the impact of this credit with proper planning. In other words, a good plan may result in far greater savings than the value of the credit. One way is to take advantage of valuation discounts.
Prince could have either initially created his business entities with his various trusts or other people as owners of larger shares. This way he would own and strategically control a minority share. If structured properly, upon his death his estate could have enjoyed a valuation discount which would have been substantial. This is often referred to as a “minority discount”. In addition, if properly structured, his inability to sell, transfer, liquidate or otherwise monetize his businesses like it is possible on the open stock market would have resulted in another discount, which is called a “lack of marketability discount.” These discounts can sometimes reduce the values of an estate asset by 33%. Unsurprisingly, the Obama administration has been trying to eliminate these strategies for years.
Aside from unnecessarily gifting the government half of his estate instead of family or charities, one of the biggest issues with Prince’s failure to plan is that his estate consists of businesses as well as copyright protected works derived from his music and some combination thereof. Each of these issues presents considerable problems and challenges.
Prince’s various businesses will be inherited by the beneficiaries designated by Minnesota law, without regard to their qualifications or interest in managing them. That would make any business owner feel very uncomfortable.
- Copyright Protected Work
Prince’s music is subject to copyright protection. The law governing these rights is found in Title 17 of the United States Code. Prince presumably owned all or part of the copyright in the music he created. As you would expect, at various times, he probably licensed all or part of these rights to distribution companies and record labels to monetize his music. Some of these companies with whom he did business may even be his own companies.
Critically, Section 203 of the U.S. Code governs copyright protected works created after 1978. It provides the creator or his or her statutorily designated beneficiaries the unwaivable right to terminate any transfers made other than by last will and testament during the 5 year period immediately after 35 years of the transfer, provided notice is properly and timely given. Working with professionals could navigate this issue by ensuring the trusts and business entities would be consistent with this statute. Otherwise, the statutory beneficiaries who may NOT have been designated in the trusts and business documents would likely have the right to terminate nonpermitted transfers and acquire such rights for themselves. This would have rendered the trusts only a temporary solution rather than a permanent one; not to mention a likely candidate for malpractice litigation. It’s important to note that many of these corrective transfers would have been addressed in probate court.
The Bottom Line
The bottom line here is that Prince could have set aside a relatively small amount of time to sit down with his personal board of directors to formulate a plan that would have had a huge impact on his life. In particular, he could have saved his estate tens of millions of dollars in estate taxes, retained control over assets and disposition of those assets, dictated, limited and otherwise controlled how his music would be monetized after his death, ensured the proper people or charities inherit his estate, minimized public exposure of his estate and maximized the likelihood of his beneficiaries’ receiving the assets cleanly, swiftly and smoothly. Instead, Prince’s estate will likely continue to be a spectacle subject to the public scrutiny for years to come.
As I said in the initial post, it is for these reasons that the next time you hear a song by Prince, remember that he’s now a symbol of what NOT to do in estate and business planning. Think of this every time you hear Little Red Corvette from now on because Uncle Sam will be driving it rather than Prince’s beneficiaries.
Barry E. Haimo, Esq.
Strategic Planning With Purpose
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Originally posted 2016-06-22 14:21:08.