COPY RIGHTS AND WRONGS California CPA Education Foundation 2007 Entertainment Industry Conference June 27, 2007
Bradford S. Cohen, Esq. • Charles K. Kolstad, Esq. • Reish Luftman Reicher & Cohen • Los Angeles, CA
Overview • Copyrights, interests in literary and musical compositions, etc. • Capital gain v. ordinary income • Common owners of copyrights, etc. • Amortization and expense deductions • Income in respect of decedents • Termination of agreements • Planning opportunities
Copyrights, etc. • Copyrights • Music • Literary • Films • TV episodes • Interests in literary, musical and artistic compositions • Different from copyrights? • Sections 167, 263A, 341 (repealed), 936 (repealed), 1221, 1231, 1305(repealed) all differentiate between the two • What is an interest in a musical composition? • Writer’s Share; Publisher’s Share • Rap • Books on Tape; Soundtracks • Jingles/Ringtones
Copyrights, etc. (cont.) • Participations in films and TV series • Industry practice on withholding on participation payments • Withhold if to an individual, LLC or Partnership • No withholding if to a Corporation (C Corp or S Corp)
Capital Gains v. Ordinary Income • Self Created Works • Excluded from definition of capital asset • Section 1221(b)(3) exception to exclusion • At election of taxpayer, musical compositions or copyrights in musical works treated as capital assets • Applies to individuals, partnerships, LLCs, and S Corporations but not C Corporations • Was initially for periods after December 31, 2006 and before January 1, 2011; now permanent! • Exception does not apply to literary or artistic compositions! • Gain on sale of Property • Holding Period • Begins when work created • Ordinary income and short-term capital gains • Long-term Capital Gains
Capital Gains v. Ordinary Income • Reversion rights • Are they “interests in musical compositions”? • Ordinary income v. Capital gain • When does holding period start? • When notice is sent and rights vest, or when rights revert beginning January 1, 2013?
Common Owners • C Corporations – WRONG! • Two levels of tax • Corporate tax at 35% federal and 8.84% California • No capital gains tax rate differential for corporations • Shareholder tax at 15% federal and 10.3% California • Double tax on distribution of copyrights, etc. • Corporate tax on fair market value of copyright less tax basis • Shareholder tax on fair market value of copyright • Death of Shareholder • Basis step-up for stock of C Corporation • No basis step-up in assets of C Corporation – appreciation still taxable upon later sale • Issue regarding post-death deduction for payments to shareholder’s estate
Common Owners (cont.) • S Corporations – BETTER BUT STILL WRONG! • One level of tax - shareholder level • California tax – greater of $800 or 1.5% of net income • Limitations on eligible shareholders, classes of stock • Distributions of property - same results as C Corporation • Election for C Corporation to be taxed as an S Corporation • 10 year tax on built-in gain • Termination of election if passive income exceeds 25% of gross receipts • Death of Shareholder • Same results as C Corporation • In general, no shareholder basis for S Corporation liabilities • Ordinary income on sale of assets v. capital loss upon liquidation • Liquidation in subsequent year - no loss carryback in California • Special IRD rules apply
Common Owners (cont.) • Partnerships/LLCs – RIGHT! • One level of tax – partner level • California gross receipts tax on LLCs – up to $12,000. Constitutional? • No limitation on eligible partners; special allocations OK • Contributions of property – generally tax-free with a basis carryover • Issue of whether participations, residuals, writer’s share, and other rights constitute “property” under Section 721 • No gain on distribution of copyrights, etc. • Carryover basis • Basis for partnership liabilities; basis step-up in partnership assets upon death of partner.
Common Owners (cont.) • LLC v. Limited Partnership • Gross receipts tax on LLCs • Self-employment tax issue for LLCs • Special IRD rules may apply
Amortization and Expense Deductions • Section 167(g) • Income forecast method of amortization for films, TV series and musical compositions • Section 167(g)(8)(A) • 5 Year straight line amortization for musical compositions and copyrights • Songwriters and composers • Publishers, performers, producers and recording companies • 5 year amortization is elective, not mandatory; income forecast may give better result
Amortization and Expense Deductions (cont.) • Section 181 • Immediate deduction for costs of film and TV series • $15,000,000/$20,000,000 Cost Limitation • Must take into account participations and residuals • Qualified compensation for US based services must exceed 75% of total compensation • Payments to writers not included in test • Special rules for TV series episodes – only first 44 qualify • Section 197 • Copyrights and other intangible assets acquired as part of an acquisition of a trade or business • 15 year straight line amortization • Can write-off remaining basis if intangible asset is abandoned, etc. under Reg. 1.197-2(g)(1(i)(B)
Amortization and Expense Deductions (cont.) • Section 199 • Special deduction for domestic production activities • Applies to film and TV programming • To qualify, 50% or more of total compensation, including participations and residuals, must be for services performed in the US • Deduction for lesser of: • Applicable percentage of smaller of (i) Qualified Production Activities Income or (ii) taxable income, or • 50% of W-2 wages properly allocable to domestic production gross receipts • Applicable percentage is 6% for tax years beginning in 2007-2009, and 9% for later tax years
Amortization and Expense Deductions (cont.) • Section 263A(h) • Typically, costs that are includible in inventory are to be capitalized under Section 263A(a). • However, there is an exception for certain qualified creative expenses • Can elect to deduct expenses incurred in a trade or business of being an artist, writer or photographer that would otherwise be capitalized under Section 263A(a) • Exception applies only to artists, writers & photographers • Not to musicians, film or TV producers • Exception also applies to certain closely held, employee-owned corporations • Employee-owner • must own more than 10% of outstanding stock (Section 269A(b)(2) • Must be an artist, writer or photographer
Amortization and Expense Deductions (cont.) • Rev. Proc. 2004-36 and Rev. Rul. 2004-58 • Deal with creative properties such as screenplays, scripts, treatments, story outlines, motion picture rights to books, plays, etc. • Not creative expenses under Section 263A(h) • Permits 15 year straight line amortization starting with second half of year property is written off for financial accounting purposes under AICPA Statement of Position 00-2 (“SOP”) • SOP assumes property is abandoned if not set for production within 3 years of acquisition or first capitalization • If property is abandoned, must still amortize over remaining 15 year period
Income in Respect of Decedents • What is Income in Respect of Decedents • Individuals (Section 691) • Includes income to which the decedent had a contingent claim at the time of “his” death (Reg. 1.691(a)(-1(b)(3)) • S Corporations (Section 1367(b)(4)) • Includes income received by S Corporation that would be IRD if received by individual/estate • Partnerships (Sections 737 and 753) • IRD rules apply only to Section 737 payments to deceased partners • Not all partnerships provide for payments to deceased partners • Fair market value of future income stream included in estate; taxed at 45% estate tax rate • No basis step-up for IRD property for estate or beneficiaries • Special rule denies basis step-up for portion of S Corp stock attributable to IRD property
Income in Respect of Decedents (cont.) • When IRD income subsequently received, recipient can deduct for income tax purposes an portion of estate tax attributable to such income • Special Cases • Interests in musical compositions; copyrights • Sale v. license • Income from a sale gives rise to IRD • Income from a license does not result in IRD • PLR 8501006 • Participations, residuals, etc. in film and TV properties • Constitutes IRD
Termination of Agreements • Section 1234A • License and distribution agreements • Funding agreements • LLC and partnership agreements
Appreciated Property • Planning Opportunities • Conversion of ordinary income into capital gain • Deferral of recognition of income • Charitable Contributions
Circular 230 Disclosure • Any tax advice contained in this Article is neither intended nor written to be used, and cannot be used, to avoid penalties under the Internal Revenue Code or to promote, market or recommend to anyone a transaction or matter addressed herein.