The following is an excerpt from the book “The Music Catalog Sales Guide”, by Silvino E. Díaz, Esq. It’s a comprehensive dealmaking guide for artists, companies, and professionals in the music industry. It discusses current trends, as well as tips on how to: organize your assets; structure your team; attract major investors; value your catalog; and prepare to sell.
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What are the tax implications of a catalog sale, for the seller?
The sale of a music catalog generally triggers taxes to be paid by the seller—on both a state and federal level—in the form of income and capital gains taxes, as well as other types. How you’ll be taxed, and at what rates, depends on factors including the length of your ownership of the catalog and your state of residency.
Up until the moment you sell, music royalties are generally treated as ordinary income, subject to tax rates potentially exceeding 37% in the U.S. if you fall into the top tax bracket. However, long-term federal capital gains rates are much lower, at up to 20% (“long term” meaning that you’ve held the asset for more than one year). The long term federal capital gain tax is graduated: you pay 0% on income up to $40,000; 15% on income from $40,000 to $441,450; and 20% on income over $441,451 (in some cases, there is an additional net investment income tax of 3.8%).
The federal U.S. tax code and regulations allow songwriters to treat the sale of musical compositions or copyrights in musical works as capital gain. This lower federal capital-gains rate isn’t available to other creators such as painters, who pay ordinary income-tax rates on sales as well as royalties.
Thus, to some music artists, the lower tax burden around selling a music catalog versus collecting yearly royalties makes moving forward with a sale more appealing. With proper structuring, profits from selling your catalog are taxed federally as capital gains, which typically amounts to a one-time tax of around 20%. However, if you do not sell, then royalties from your music catalog are taxed annually as ordinary income at rates of up to 37%.
State income taxes are another consideration. In order to calculate the full tax burden of the sale of your catalog, you need to take into account state-specific tax rates (including capital gains or ordinary income tax rates, depending on the state). States treat the sale of assets differently from each other: some states don’t tax capital gains, while others might tax them at the same rate as ordinary income.
Can you strategically change your state of residency to avoid state taxes?
To the extent you can control your state of residency, you might be able to significantly decrease the amount of money you pay in taxes.
For example, a California musician who performs in Las Vegas may become a permanent resident of Nevada prior to selling their catalog and pay a lower long-term capital gains rate. California taxes capital gains at up to 13.3%—in addition to the federal capital gains rate—but Nevada has no state income tax. The musician can establish residency in Nevada by spending the majority of her time there, switching her driver’s license and voter registration, and making Nevada her legal domicile. By doing so, when she ultimately sells her catalog, she qualifies for long-term capital gains treatment federally (up to 20%) but pays zero state income tax on the sale.
In order to change your state of residency for tax purposes, you need to establish a new legal domicile, which is your primary home. This requires both physical presence and demonstrable intent to remain in the new state. You must spend at least 183 days a year in your new state and keep detailed records to prove your presence, such as receipts, phone location data, or a calendar log.
You should establish a permanent residence in your new state by buying or leasing a home, and updating your driver’s license, vehicle registration, and voter registration to reflect your new address. You’ll need to update your mailing address with banks, the IRS, and insurance companies. Moving your personal and professional relationships, such as healthcare providers, financial advisors, and attorneys to the new state also supports your residency claim.
Are there other ways to maximize tax savings?
If your goal is to pay as little taxes as possible on the sale of your catalog, you will likely have to structure the transaction in a more unique way for those purposes, or reinvest the proceeds in a manner that takes advantage of additional tax benefits. Here are some suggestions.
First, an installment sale. Instead of receiving the full payment upfront, you receive it in installments over several years. This spreads the capital gains over multiple years, potentially keeping you in a lower tax bracket and reducing the overall tax burden. However, if the buyer defaults and is unable to pay, the seller would need to either enforce the performance or seek damages for breach.
Second, a Qualified Small Business Stock exemption (QSBS). If your catalog is held within a C corporation that qualifies as a “qualified small business” and you have held the stock for more than five years, you may be eligible to exclude up to $10 million or 10 times your investment basis, whichever is greater, from federal capital gains tax upon sale. To qualify, both the corporation and the stockholder must meet certain conditions.
For example, the company’s gross assets must not exceed $50 million, and at least 80% of the company’s assets must be used in a qualified trade or business. Importantly, this excludes performing arts where the principal asset is the reputation or skill of one or more of its employees. However, a music catalog is not an asset that relies on the reputation or skill of an employee. Thus, a music publishing company that manages music rights may qualify for a QSBS exemption, but a company primarily offering an artist’s personal services may be excluded.
Third, a Charitable Remainder Trust (CRT). A CRT is an irrevocable trust that allows you to donate assets, like music, to the trust. The trust then sells the assets and provides you (or designated beneficiaries) with income for a specified period or for life. As a tax-exempt entity, the trust does not pay immediate capital gains tax on the sale. At the end of the term, the remaining assets are transferred to qualified charities, which you get a charitable deduction for. However, distributions made by the trust to you as a beneficiary are taxable, typically as ordinary income.
Fourth, retirement account contributions. If you haven’t maxed out your contributions to tax-advantaged accounts like a 401(k) or Roth IRA, you can potentially use income from the sale of your catalog to contribute, lowering your taxable income.
Are there any tax benefits for music catalog buyers?
For investors acquiring music catalogs, the U.S. tax code offers significant benefits. IRS Section 197 allows purchasers of qualifying intangible property—such as music copyrights, publishing rights, and master recordings—to amortize the cost of the asset over a 15-year period, reducing taxable income and enhancing after-tax returns.
Under this section, intangible assets acquired in connection with the purchase of a trade or business can be amortized over 180 months. For example, if an investor acquires a music catalog for $15 million, they can deduct $1 million annually from their taxable income for 15 years. However, Section 197 does not apply to the direct purchase of copyrights or any interest in them unless they are acquired in connection with the purchase of a trade or business.
If you have questions or would like to discuss the sale or purchase of music assets, please contact EPGD Business Law in Miami, Florida, at (786) 837-6787 or email us to schedule a consultation.
EPGD Business Law is located in beautiful Coral Gables. Call us at (786) 837-6787, or contact us through the website to schedule a consultation.
