Originally published on Forbes.com.
In my last post I made the case that JD Salinger may have been facing a significant estate planning problem. The IRS might have placed a very high valuation on his literary estate that was based on an assumption that it would be exploited to its full commercial potential contrary to Salinger’s wishes. This might create pressure to do the unthinkable and allow a movie based on Catcher in The Rye, a possible necessity that Salinger himself foresaw in the fifties.
I wouldn’t wish tax trouble on anybody particularly a family that values its privacy, but I have to say that I would have relished reading the opinions in which Tax Court or District Court or Court of Claims judges tried to sort it all out and the likely appellate decision and maybe, if the IRS staked out a very aggressive position, a trip to the Supremes.
There Antonin Scalia could ruminate that when he attended Xavier High School and dinosaurs roamed the earth, Catcher in The Rye was contraband. That it was required reading a mere decade and a half later would probably be viewed as part of the long moral slide that he has been decrying. That failed English major tax geeks will be denied that drama is just one more instance of the collateral damage of gridlock. Even though the law portending it was passed at the turn of the Millennium, nobody really thought that we would have a year without an estate tax, but that is the way it turned out. And the year was 2010, the year in which Salinger died.
Of course when the JD Salinger Literary Trust was created in 2008, planners would not have counted on there both being a year without an estate tax and Salinger dying in that year. What were the other options ? I was able to come up with a pretty good one, although it does have a significant drawback.
QTIPs Are Not Just For Ear Wax
If inside that Literary Trust, there was a QTIP, that would have solved the immediate estate tax problem. A QTIP is a trust that requires the distribution of its income to the surviving spouse. This allows assets that are not distributed to the surviving spouse to qualify for the unlimited marital deduction. Of course as long as the surviving spouse is alive nothing can be distributed to anybody else. In terms of protecting Salinger’s literary heritage this could work out very well. Since there is not immediate estate tax the trust would actually be advantaged by a high valuation.
There would be a depreciation or amortization deduction under either Section 167 or Section 197, so some of the cash flow would be sheltered from income tax. There is a more subtle advantage to the preservation of the trust. The “income” that is required to be distributed is not “taxable income” or cash flow from royalties. The income required to be distributed is the income that is determined under probate accounting principles. Under the Uniform Principal and Income Act, which is operative in New Hampshire, 10% of the cash flow from copyright royalties is credited to income and the balance to principal.
The Flaw In The QTIP Plan
Of course, a QTIP does not entirely solve the estate tax problem. It kicks the can down the road until the death of the surviving spouse. If Salinger’s widow is in good health though, there is a solution. Life insurance. Colleen Salinger is in her early fifties. I called my friend Keith Greenfield of the Dover Group for a little help. He got me quotes for both life pay and 10 pay on $5,000,000 of life insurance. Life pay was just over $47,000 per year standard and $41,000 preferred. Ten pay was about $100,000 standard and $88,000 preferred. In my previous post, I did a back of the envelope valuation of the royalty stream from Catcher in the Rye at $5,000,000.
Assuming that the Literary Trust is running as a business, which it does seem to be doing, it would get to amortize that over 15 years. Thus, the income tax savings from the basis step-up would more than fund enough life insurance to replace the asset, never mind just pay the estate tax on it. Presumably on higher valuations, the numbers would scale up. Of course, some fancy footwork would need to be done to keep the proceeds of the insurance out of Colleen’s estate. No it is not the future estate tax that is the flaw in the plan.
The flaw in the plan is that Salinger’s son Matthew, co-trustee of the Literary Trust is about the same age as Colleen Salinger. If everybody was on board with preserving the integrity of Salinger’s corpus being the main goal, that might not be a problem. Presumably there could be enough in the way of fees to take care of Matthew Salinger’s needs. Still, that could make for a tense situation.
The Law And Order Episode That Wasn’t
One thing that I concluded from watching the Salerno documentary, was that the people who desperately tried to hunt Salinger down to talk to him about how Catcher in The Rye had changed their life were a lot weirder than he was. The phenomenon must be a bit contagious, though, because I became convinced that there might be another Salinger mystery to uncover.
Estate planning junkies will remember that during 2010, there was intense speculation that Congress would fix the unexpected year without an estate tax retroactively. That led to further speculation on whether Congress could do that. At any rate a planner of the ghoulish variety, would probably argue that the ideal date of death would be early in 2010, but, of course not too early, since that might raise a question as to whether death had actually occurred in December of 2009.
Take those estate tax elements and combine them with a 91 year old reputedly reclusive eccentric surrounded by a community that respected his privacy. He died at home of natural causes according to the announcement. Did he decide for himself that January 27 was a good day to die ?
Even more fantastic, was there a contingency plan in place in the event that death occurred late in December ? How hard would it be to post-date a death certificate under those circumstances ? It makes a good “ripped from the headlines” plot for Law and Order, but the income tax advantages of the step-up in basis are so sweet that it would actually be stupid estate planning. If you want to pursue that story anyway, you better be young. Death certificates in New Hampshire are sealed for fifty years.
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Correction
In the initial version of this post I had the preferred and standard rates scrambled, which Keith Greenfield kindly pointed out to me.
JD Salinger – Was January 27 2010 A Good Day To Die
