IRS Regulations For Song Sales Tax Treatment

The Internal Revenue Service (IRS) has issued proposed and temporary regulations specifying the time and manner for electing to treat the sale or exchange of “self-created” musical compositions or copyrights as the sale or the exchange of a capital asset resulting in a potential capital gain.

The regulations reflect changes made by the Tax Increase Prevention and Reconciliation Act of 2005 (Tax Increase Act) and the Tax Relief and Health Care Act of 2006 (Tax Relief Act). The sale or exchange of musical compositions or copyrights in musical works created by the taxpayer previously resulted in ordinary income. Currently, ordinary income realized by an individual is taxed at a maximum rate of 39.6%, while capital gains realized by an individual from the sale or exchange of a capital asset are taxed at a maximum rate of 15%.

The Internal Revenue Code generally stipulates that capital assets include all property held by a taxpayer with some exclusions: copyrights, literary, musical or artistic compositions and letters, memoranda or similar property held by a taxpayer whose personal efforts created the property. Consequently, income arising from the sale of a self-created work is generally taxed at the higher ordinary
income rates.

Another exclusion applies to intangible property. For example, a painting received as a gift from the artist would not constitute a capital asset in the hands of the recipient.

Generally, self-created artistic or musical works have a zero basis for tax purposes. In determining what is self-created, the regulations provide that a work will be considered created by the taxpayer “if such taxpayer performs literary, theatrical, musical, artistic or other creative or productive work which affirmatively contributes to the creation of the property, or if such taxpayer directs or guides others in the performance of such work.”

Not included are corporate officers and executives who exercise administrative or business control over authors, artists or composers but who are not “substantially engaged in the direction and guidance of such persons in the performance of their work.”

A section added by the Tax Increase Act, and made permanent by the Tax Relief Act, provides that, at the election of a taxpayer, the exclusion from capital asset treatment will not apply to musical compositions or copyrights in works sold or exchanged by the creator. Taxpayers who create musical compositions or own a copyright in their musical works may elect to apply this provision so a gain from the sale or exchange of the composition or copyright will be treated as a capital gain.

The legislative history provides little insight as to why this exception was provided for self-created musical works, but not extended to literary works or visual artistic creations. A report by the House Ways and Means Committee merely states: “The committee believes it is appropriate to allow taxpayers to treat as capital gain the income from the sale or exchange of musical compositions or copyrights in musical works the taxpayer created.” Therefore, musical artists are provided a significant tax benefit not available to authors or visual artists.

Capital Asset Timetable

Under the proposed and temporary IRS regulations, an election to treat a musical composition or copyright as a capital asset must be made for each composition or copyright sold or exchanged during the taxable year. Elections must be made on or before the due date including extensions of the income tax return for the taxable year of the sale or exchange. An election is made by treating the sale or exchange as a sale or exchange of a capital asset on individual, partnership or corporate tax returns.

An election to treat a musical composition or copyright as a capital asset is revocable with the consent of the IRS. To obtain consent to revoke an election, the taxpayer must submit a request for a letter ruling to the IRS. Alternatively, an automatic extension of six months from the due date of the tax return excluding extensions is granted to revoke an election. This is provided that the taxpayer timely filed the return and, within the six-month extension period, the taxpayer files an amended return that treats the sale or exchange as the sale or exchange of property that is not a capital asset.

Although the sale or exchange of most self-created artistic and literary works gives rise to ordinary income, Congress has provided an exception for musical compositions or copyrights. The sale or exchange of musical property will, at the election of the taxpayer, give rise to capital gain taxed at the current 15% maximum tax rate. The regulations recently issued by the IRS provide guidance on how such an election may be made and the conditions for its revocability. [See, Internal Revenue Bulletin 2008-14, T.D. 9379.]

The Internal Revenue Service (IRS) has issued proposed and temporary regulations specifying the time and manner for electing to treat the sale or exchange of “self-created” musical compositions or copyrights as the sale or the exchange of a capital asset resulting in a potential capital gain.

The regulations reflect changes made by the Tax Increase Prevention and Reconciliation Act of 2005 (Tax Increase Act) and the Tax Relief and Health Care Act of 2006 (Tax Relief Act). The sale or exchange of musical compositions or copyrights in musical works created by the taxpayer previously resulted in ordinary income. Currently, ordinary income realized by an individual is taxed at a maximum rate of 39.6%, while capital gains realized by an individual from the sale or exchange of a capital asset are taxed at a maximum rate of 15%.

The Internal Revenue Code generally stipulates that capital assets include all property held by a taxpayer with some exclusions: copyrights, literary, musical or artistic compositions and letters, memoranda or similar property held by a taxpayer whose personal efforts created the property. Consequently, income arising from the sale of a self-created work is generally taxed at the higher ordinary
income rates.

Another exclusion applies to intangible property. For example, a painting received as a gift from the artist would not constitute a capital asset in the hands of the recipient.

Generally, self-created artistic or musical works have a zero basis for tax purposes. In determining what is self-created, the regulations provide that a work will be considered created by the taxpayer “if such taxpayer performs literary, theatrical, musical, artistic or other creative or productive work which affirmatively contributes to the creation of the property, or if such taxpayer directs or guides others in the performance of such work.”

Not included are corporate officers and executives who exercise administrative or business control over authors, artists or composers but who are not “substantially engaged in the direction and guidance of such persons in the performance of their work.”

A section added by the Tax Increase Act, and made permanent by the Tax Relief Act, provides that, at the election of a taxpayer, the exclusion from capital asset treatment will not apply to musical compositions or copyrights in works sold or exchanged by the creator. Taxpayers who create musical compositions or own a copyright in their musical works may elect to apply this provision so a gain from the sale or exchange of the composition or copyright will be treated as a capital gain.

The legislative history provides little insight as to why this exception was provided for self-created musical works, but not extended to literary works or visual artistic creations. A report by the House Ways and Means Committee merely states: “The committee believes it is appropriate to allow taxpayers to treat as capital gain the income from the sale or exchange of musical compositions or copyrights in musical works the taxpayer created.” Therefore, musical artists are provided a significant tax benefit not available to authors or visual artists.

Capital Asset Timetable

Under the proposed and temporary IRS regulations, an election to treat a musical composition or copyright as a capital asset must be made for each composition or copyright sold or exchanged during the taxable year. Elections must be made on or before the due date including extensions of the income tax return for the taxable year of the sale or exchange. An election is made by treating the sale or exchange as a sale or exchange of a capital asset on individual, partnership or corporate tax returns.

An election to treat a musical composition or copyright as a capital asset is revocable with the consent of the IRS. To obtain consent to revoke an election, the taxpayer must submit a request for a letter ruling to the IRS. Alternatively, an automatic extension of six months from the due date of the tax return excluding extensions is granted to revoke an election. This is provided that the taxpayer timely filed the return and, within the six-month extension period, the taxpayer files an amended return that treats the sale or exchange as the sale or exchange of property that is not a capital asset.

Although the sale or exchange of most self-created artistic and literary works gives rise to ordinary income, Congress has provided an exception for musical compositions or copyrights. The sale or exchange of musical property will, at the election of the taxpayer, give rise to capital gain taxed at the current 15% maximum tax rate. The regulations recently issued by the IRS provide guidance on how such an election may be made and the conditions for its revocability. [See, Internal Revenue Bulletin 2008-14, T.D. 9379.]