Washington Hotline – September 4, 2018


Washington Hotline

Aretha Franklin’s Estate Faces Challenges

On August 31, 2018, musicians, actors, religious leaders and politicians gathered at Detroit’s Greater Grace Temple to remember and celebrate the life of Aretha Franklin. Ms. Franklin passed away at age 76 without a will.

Los Angeles attorney Don Wilson represented Franklin throughout her music career. On several occasions, he urged her to complete a will and living trust but she did not create an estate plan.

Wilson stated, “It would have expedited things and kept them out of probate and kept things private. I just hope her estate doesn’t end up getting so hotly contested. Any time they do not leave a trust or will, there always ends up being a fight.”

Franklin’s four sons filed documents with the Oakland County probate court and indicated they were “interested persons.” One of her sons, Kecalf Cunningham, noted in the filing that Aretha Franklin “died intestate.”

The probate process is now proceeding in Oakland County, Michigan. Franklin owned three homes in Bloomfield Township, Michigan and one home in Detroit. However, the primary value of her estate is her intellectual property. This property includes many recordings, musical compositions and her likeness.

Franklin was extremely successful and was called the “Queen of Soul.” She had over 100 single recordings on the Billboard charts and received 18 Grammy Awards. Her estate property value could be in the tens, or even hundreds, of millions of dollars.

When Michael Jackson passed away, his estate executors claimed that the estate was only worth a few thousand dollars. However, IRS appraisers valued the estate at $1.1 billion. Understandably, the estate is interested in keeping the valuation low to reduce estate tax while the IRS seeks a large value in order to increase the estate tax.

Because the Franklin estate is likely valued over the 2018 exemption of $11.18 million and valuation of intellectual property is quite difficult, the four sons are likely to be in a contentious dispute over valuation with the IRS. The valuation contest with the IRS can proceed through the tax and appellate courts for a decade or longer.

Editor’s Note: Franklin’s four sons will likely receive creditor claims, contest the estate value with the IRS and negotiate multiple contracts and licenses for Franklin’s intellectual property. This process is particularly difficult because there is no will and the property will pass to heirs under Michigan law. Therefore, it may be several years before the Oakland County Probate Court determines the specific shares of ownership for the four sons or other family members. With many millions of dollars in estate value, and millions more owed to the IRS for estate taxes, the potential for intense and protracted conflict is great. A will and living trust by Ms. Franklin could have saved enormous costs and enhanced family harmony.

IRS Guidance on Separate Trade or Business UBIT

In Notice 2018-67; 2018-36 IRB 1 (21 Aug 2018), the IRS explained principles for implementing the Sec. 512(a)(6) “Separate Trade or Business” rules with respect to unrelated business income tax (UBIT). The Notice will be followed by regulations at a future date.

Until the regulations are published, CPAs must use Notice 2018-67 and a “reasonable, good-faith” interpretation of Sec. 512(a)(6) rules to complete IRS Forms 990-T. Notice 2018-67 includes ten major sections.

Section 1. Purpose — Notice 2018-67 provides interim guidance until regulations are published.

Section 2. Background — Sections 511-514 create rules for UBIT. Section 512(a)(6) requires the gains and losses of separate businesses to be reported by entities. Aggregation of the gains and losses of all entities is no longer permitted.

Section 3. Separate Trade — The standard for determining a separate trade or business is a “reasonable, good-faith” estimate of what constitutes a separate entity. Treasury and the IRS “are considering the use of the North American Industry Classification System (NAICS) codes. Prior to proposed regulations, the Treasury Department and the IRS will consider the use of the NAICS six-digit codes to be a reasonable, good-faith interpretation.”

Section 4. Income — Income includes “gross income derived by any organization from any unrelated trade or business.” In some cases, debt-financed-property income may be aggregated.

Section 5. Investments — Multiple investment funds or passive activities may generally be aggregated.

Section 6. Partnerships — Income from partnerships meeting the de minimis or controlled tests may be aggregated.

Section 7. Social Clubs — Section 512(a)(3) organizations may also be subject to the “separate trade or business” rules.

Section 8. UBTI — The fringe benefit UBTI under Sec. 512(a)(7) is not a separate trade or business.

Section 9. NOLs — Section 512(a)(6) requires net operating losses (NOLs) for separate businesses to apply to the respective entities.

Section 10. GILTI — Global intangible low-tax income (GILTI) is treated as a dividend and generally excluded from UBTI under Sec. 512(b)(1).

Editor’s Note: Notice 2018-67 is helpful, but CPAs who complete IRS Forms 990-T to calculate the unrelated business tax of multiple subsidiaries still face a daunting and complex challenge.

Lessee Denied Façade Easement Deduction

In Harbor Lofts Associates et al. v. Commissioner; No. 993-17; 151 T.C. No. 3 (27 Aug 2018), the owner of a 47-year lease and the fee owner jointly granted a façade conservation easement to a qualified nonprofit. The Tax Court denied the charitable deduction for the lessee.

Two buildings in Lynn, Massachusetts are owned by the Economic Development & Industrial Corporation of Lynn (EDC), a public corporation. The two buildings are leased to Harbor Lofts Associates (Harbor) until 2056. Both buildings are listed on the National Register of Historic Places.

On December 21, 2009, Harbor and EDC jointly granted a façade easement for the two buildings to Essex National Heritage Commission, Inc. Harbor claimed an easement charitable deduction of $4,455,515 on its 2009 tax return. The IRS audited the return and denied the deduction.

A conservation easement qualifies if “(1) the property is a qualified real property interest, (2) the property is contributed to a qualified organization, and (3) the contribution is exclusively for conservation purposes.” See Sec. 170(h)(1) and Reg. 1.170A-14(a).

Harbor claimed that the Sec. 170(h)(2)(C) provisions permitted a qualified interest even if the owner did not hold the fee interest. Because tenants in common may jointly give a façade easement and qualify for a deduction, Harbor claimed the long-term lease interest should be a sufficient level of property ownership to support the deduction.

The Court noted the Sec. 170(h)(2)(C) provisions require a “perpetual restriction.” Because the Harbor lease terminates in 2056, its grant is not perpetual.

Only the fee owner has the required property interest to grant a perpetual restriction and qualify for a deduction. Harbor granted a portion of its property rights. This gift is a nondeductible partial interest and does not qualify for a charitable deduction.

Applicable Federal Rate of 3.4% for September — Rev. Rul. 2018-23; 2018-36 IRB 1 (19 August 2018)

The IRS has announced the Applicable Federal Rate (AFR) for September of 2018. The AFR under Section 7520 for the month of September is 3.4%. The rates for August of 3.4% or July of 3.4% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2018, pooled income funds in existence less than three tax years must use a 1.4% deemed rate of return.

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