Aretha Franklin is the latest example of celebrities who have died without a will or trust, leaving heirs to deal with a potential tax fallout that could have been avoided with estate planning.
The revelation about Franklin means the proceedings involving the Queen of Soul’s estate will be public in Michigan’s Oakland County Probate Court.
While privacy will be a top non-tax concern for her heirs, “there’s going to be, I’m sure, a huge estate tax issue” as well, due to the lack of proper planning, Jeffrey E. Nusinov, managing attorney of Nusinov Smith LLP, told Bloomberg Tax. Nusinov represented the estate of Tom Clancy, the best-selling author of “Clear and Present Danger” and other military thrillers, in an $11.8 million tax liability case against the Internal Revenue Service in 2016.
The 2017 tax overhaul (Pub. L. No. 115-97) doubled the estate tax exemption for wealthy taxpayers. In 2018, estates worth less than $11.18 million for individuals and $22.36 million for married couples escape the 40 percent estate tax. Estates worth more owe tax on amounts exceeding the thresholds.
The value of Franklin’s estate isn’t yet known and it’s possible it could fall below the $11.18 million threshold, but Nusinov said he expects that won’t be the case. David J. Bennett, a shareholder at Thav Gross PC in Bingham Farms, Mich., who is the estate’s attorney according to a recent court document, didn’t return requests for comment.
Franklin’s situation is similar to that of another music icon, Prince, who died in 2016 without a will. His estate is worth about $200 million, of which approximately $80 million presumably went to the federal government in taxes.
By not having an estate plan, Franklin missed out on several opportunities that could have lowered any potential estate tax liability, said Jeffrey K. Eisen, an estate tax partner at the Los Angeles office of Mitchell Silberberg & Knupp LLP. Eisen has represented estates of celebrities such as Farrah Fawcett.
Here are some steps celebrities can take to avoid burdening their heirs with huge tax liabilities after their death.
1. Lifetime Gifting
Shifting assets that may appreciate in value over time out of a person’s estate so they won’t be subject to estate tax is a main goal for planners, said Stuart J. Kohn, an attorney with Levenfeld Pearlstein LLC in Chicago, who leads the firm’s Trusts & Estates Group.
Gifting is a common technique used to achieve that goal. Under current law, individuals can make annual gifts of up to $15,000 per recipient tax-free.
Celebrities may want to gift assets, such as memorabilia, during their lifetime to children or other heirs to lower their estate tax bill, Nusinov said.
In Franklin’s case, no one knows what memorabilia the singer had or the gifts she may have been given by other celebrities, he said. But those items likely have enormous monetary value that will increase following her death, he said.
2. Charitable Donations
Celebrities may also want to consider establishing estate plans to leave behind money for charities they supported in life.
Franklin was involved with a wide-range of charitable causes and foundations while alive, including the Barbara Davis Center for Childhood Diabetes, which funds diabetes research, Feeding America, a network of more than 200 food banks across the U.S., and the Rainforest Foundation, which is dedicated to preserving rain forests and the rights of indigenous people. But the singer didn’t have a plan in place to benefit those causes after her death.
Celebrities also have the option of donating to museums as part of an estate plan. For example, Franklin could have arranged for her wardrobe to go to Detroit’s Motown Museum, Kohn said.
There are tax benefits to charitable bequests. Assets donated to charity are excluded from a person’s taxable estate.
3. Dynasty Planning
Celebrities can take steps to shield later generations from future estate taxes.
Franklin’s lack of planning means that her entire generation-skipping tax exemption “goes to waste because whatever passes is going to pass outright to her children, and so therefore there’s no chance to do dynasty trust planning or anything like that that would prevent estate taxation at the next generation,” Eisen said.
The generation-skipping transfer (GST) tax is imposed on gifts and bequests to recipients who are two or more generations younger than the donor, such as grandchildren. The 40 percent tax applies once an $11.18 million exemption amount—the same as for the estate tax—is surpassed.
Under a common estate planning strategy, an individual can create a trust for a grandchild, transfer a certain amount of assets into the trust and apply an equivalent amount of GST tax exemption. This strategy essentially freezes the value of the assets. Any future appreciation won’t be subject to estate tax when the trust beneficiary dies. Dynasty trust planning works especially well in states such as South Dakota and Delaware that allow for trusts without expiration dates.
4. Generate Liquidity
Based on the types of assets Franklin probably has in her estate, liquidity is likely to be an issue for her heirs.
“Her estate could be in a bind on her death if most of the assets are illiquid—copyrights, royalties that are coming in,” Kohn said. Other celebrities, especially other musicians, likely face similar challenges with illiquid assets.
Once a person has died his or her estate generally has nine months to file an estate tax return and pay the taxes owed. Coming up with the cash to finance that amount can be difficult if the estate is comprised mostly of illiquid assets.
To plan for this, celebrities and other wealthy taxpayers can use a variety of techniques during their lifetime to generate a pool of funds that will be readily available at their death to cover taxes and other expenses. Many of them, for example, will take out life insurance policies for this reason.
“It becomes more difficult to create that liquidity” after the person dies, Kohn said.