Changes in the tax code from 2006 continue to offer significant advantages for both songwriters and music publishers. The tax breaks for songwriters were especially ground-breaking, permitting self-created musical compositions or copyrights in self-created musical works to be treated as capital assets. And gains on the sale of long-term capital assets - those held for more than 12 months - are taxed at the rate of 15%, instead of at higher income tax rates. A related law lets buyers of such works write off the purchase price over a period of five years, taking a deduction in each.
Before 2006, copyrights, literary, musical or artistic compositions, letters or memoranda were not considered "capital assets" in the hands of their creators. So a songwriter who sold his own songs, like an artist selling a painting, paid normal income tax, currently up to 35%. But the same songs were considered "capital assets" if bought by a music publisher. Not only could a publisher deduct the cost of acquiring the copyrights (as a yearly percentage of the purchase price), but the proceeds of any subsequent resale would be taxed as a capital gain (presuming the rights had been held by a non-corporate publisher for at least a year). Now, songwriters also get a capital gains break, but not automatically. Songwriters have to affirmatively elect it - a no-brainer unless they want to volunteer to reduce the national debt.
Confusingly, the tax law doesn't define a self-created "musical composition" or self-created "musical work." It seems safe to assume that these categories would cover compositions created by a lyricist and a composer. But what if an existing poem becomes the lyrics to a song by another writer? That song would probably be covered by a single copyright, and its sale should entitle the creators of both the melody and the original poem to pay the capital gains tax, even though the sale of the poem alone wouldn't qualify. The law also doesn't address what music besides self-created songs qualify as "capital assets," only stating that both self-created "musical compositions" and "copyrights in musical works" qualify for elective capital gains treatment. Accordingly, royalties and other income from musical compositions are still taxed as ordinary income. But the term "copyrights in musical works" is intuitively more expansive than "musical compositions," and could include copyrights in self-created sound recordings (which, of course, would be recordings of "musical compositions"). That means an artist could sell a library of existing recordings along with the copyrights in the underlying musical compositions to a film-TV music production house and argue that all the proceeds would qualify as capital gains. But the IRS has yet to issue an interpretive ruling.
Last year the IRS issued proposed, temporary regulations saying that each election to treat a musical composition or copyright as a capital asset must be made separately - on or before the due date of the tax return for the year of sale or exchange (including extensions). Thus, creators of musical compositions and copyrights in musical works who sold those rights in 2008 need to declare their intention to take advantage of the lower tax rates on capital gains. Buyers of eligible musical works and copyrights can also continue to get "tax bang" for their buck. Before 2006, the cost of acquiring a musical copyright generally had to be amortized and deducted over the period that the song was projected to generate income under a frequently complicated "income forecast." Since 2006, any expenses incurred creating or acquiring any "applicable musical property" can be amortized over the 5-year period beginning with the month when it was "placed in service" (for example, when a song gets exploited). Both songwriters and publishers can take advantage of this 5-year schedule. If a publisher paid a million dollars for applicable musical property on January 2, 2008 and placed it in service on January 31, 2008, by electing five-year amortization, he could deduct $200,000 for 2008 plus the following four years. But this probably does not include sound recordings.
Congress has lowered tax rates for songwriters who sell their catalogs and electively take advantage of capital gains treatment, provided such songs were held more than one year. This is in stark contrast to the higher non-capital gain tax rates paid by authors and painters who sell their literary works or paintings. In addition, music publishers buying songs can recover the purchase price over an elective 5-year period. Questions still remain as to what constitutes self-created musical works that are eligible for favorable capital gains tax rates. Does this include sound recordings and future reversion rights? Hopefully the IRS will soon provide rulings that resolve these issues favorably. In the meantime, songwriters and publishers need to take advantage of these tax incentives, which should continue to stimulate the music publishing market.
By Michael R. Morris