This is a very significant issue for songwriters. Thought I would pass it along.


Songwriters Gain Tax Equity

By Denise Stevens and Gary Smith,

The Tax Increase Prevention and Reconciliation Act of 2005 (the “Act”), signed into law by President Bush on May 17, 2006, includes the provisions of a bill initially introduced as the Songwriters Capital Gains Tax Equity Act. The passage of the Act was celebrated by the songwriter community as the culmination of the Nashville Songwriters’ Association’s five-year effort to address the disparate tax rates historically paid by publishers versus that paid by songwriters upon the sale of a music catalog.

The Act amends Section 1221 of the federal tax code to enable the election of capital gains treatment for song catalogs when sold by the songwriter, commencing with sales that occur in taxable years beginning after the date of enactment. The change applies only to the proceeds from the sale of a copyright, whereas royalty and fee income generated from the exploitation of a musical composition will remain ordinary income. Prior to the change, the tax code required a songwriter to treat the proceeds from the sale of the self-created copyrights as ordinary income and consequently pay taxes at marginal rates currently as high as 35% (exclusive of taxes on self-employment income). However, when a music publisher (or other party who is not the creator) sold its interest in the same copyrights, capital gains treatment was available at a much lower tax rate, currently 15% for individuals, provided the one year holding period requirement was satisfied.

Under old business models from the 1920s and 1930s, songwriters typically sold their songs outright to music publishers (with no ongoing entitlement to royalty or fee income) and the income from this sale was recognized as ordinary income for tax purposes. However, music publishing evolved during the mid-1900s as markets for songs expanded and songwriters increasingly entered into co-publishing deals with music publishers or acted as their own publisher. Today, most songwriters are akin to business partners with the music publisher, with each incurring (and/or bearing the burden via recoupment) of expenses such as administration and demo production costs. Consequently, the unfairness of the disparate tax treatment upon the sale of the resulting catalog asset came into clearer focus.

The Benefit Picture
The new provision also provides a benefit to purchasers of song catalogs by adding an election to amortize acquisition costs and expenses paid or incurred after December 31, 2005 over a 5-year period, where prior law provided generally for longer amortization periods. This is likely to stimulate investment in music publishing catalogs due to the potential to write off the acquisition expense more quickly.

The Act may also aid songwriters in their succession planning by reducing barriers to the granting of lifetime gifts of copyrights since the election to obtain capital gains treatment is also made available to the recipient of a gift from a songwriter. Under prior law, such a gift recipient would have been forced to report ordinary income on any sale of such gifted property.

One issue that may require clarification relates to the determination of the holding period of a copyright recovered by a songwriter (or a songwriter’s successors) pursuant to the termination of transfer provisions of the Copyright Act. For example, under Section 203(a) of the Copyright Act, a songwriter (or the songwriter’s heirs) may, by sending notice within specified time limits and under specified conditions, elect to terminate a post-1977 grant by the songwriter of rights in a copyright, effective 35 years after the original grant. Although the right to receive the future return of the granted rights “vests” in the songwriter (or the applicable heirs) upon the sending of notice, the reversion does not become effective until after a 2-10 year period following delivery of such notice. It is unclear whether the holding period (i.e., for satisfaction of the 1-year holding requirement for eligibility for long-term capital gains) begins upon such vesting or not until ultimate recovery of the granted rights. The resolution of this issue may influence the timing of further transfers of such reverted rights.

Overall, these favorable tax changes appear likely to encourage the transfer of song catalogs, as well as investment in music publishing, during the effective term of the relevant provisions of the Act, which shall expire (unless extended) with the close of the 2010 tax year.

Denise Stevens is an attorney at Loeb & Loeb LLP who practices with the firm's national Entertainment Department. Gary Smith is the CEO of Copyright Exchange, LLC and President of Smith, Wiles & Co., PC., Certified Public Accountants and Business Managers.

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