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George Saenz, the Bankrate.com Tax Talk columnist Royalties to be treated as capital gains

Dear Tax Talk,
I'm a musician and own my own recordings. When I receive royalties, I pay tax as ordinary income just as if I had received it from a job. I heard that there is a change in the law that means I can treat the income from recordings as capital gains. Does this mean that I can pay tax at 15 percent on my royalties like an investor?
-- Miles

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Dear Miles,
Musical compositions and copyrights are not capital assets. But starting in tax years that begin after May 17, 2006, you can get capital asset treatment on the sale or exchange of these assets if you elect that treatment. This is probably going to tick off some painters as they are not accorded the same treatment when they sell their paintings.

Most taxpayers file on a calendar year basis, so 2007 would be the first tax year that this would apply. However, since some folks march to the tune of a different drummer, this could have earlier implications. The law remains in effect until the end of 2010, so dust off your old records before then. At that time, music industry lawyers and accountants will be retiring.

The copyrights must be sold or exchanged. For example, an English rock band that settles a major decades-long lawsuit with an Internet music provider must sell or exchange their copyrights before 2011 so that they are accorded 15 percent capital gains treatment instead of regular income tax treatment.

Royalties from copyrights on literary, musical or artistic works and similar property, or from patents on inventions, are amounts paid to you for the right to use your work over a specified period of time. Royalties generally are based on the number of units sold, such as the number of books, tickets to a performance or machines sold. They are payments in exchange for a musical composition or copyright and, hence, would qualify as capital gain income if elected. You'd have to have some unusual circumstances not to make the election to pay lower taxes.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.

Bankrate.com's corrections policy -- Posted: March 16, 2007
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