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Taxing Creativity Across State Lines

Many Americans have moved in the past few years in search of a more affordable way of life, while others moved to be closer to family or friends due to the pandemic. Our digitally connected world made relocation possible even for those who work in creative industries, who were once tied to particular urban centers.

Working in the music industry once meant a tether to Los Angeles, Nashville or New York City. Today, digital collaboration and the rise of more prominent local music scenes can make places like Miami or Austin attractive alternatives for musical professionals at all stages of their careers. But moving is not entirely seamless. Artists who receive royalty income will need to consider state income taxes, for example. These taxes may not be something they can leave behind on moving day. Depending on the laws of the states in question and the details of a particular creator’s contract, royalty income may be sourced to the state where the artist created the work. In those cases, artists will still owe income tax to that state, even if their new home does not levy an income tax. This can create a headache from an accounting perspective, but getting it right matters.

Say a songwriter-producer used to live in Los Angeles but recently moved to Miami. While West Coast and East Coast sunshine may be interchangeable, the difference between the states’ approaches to income tax is sharp. But what does this mean for royalties generated by songs the artist created or collaborated on in LA? Can the California tax authorities demand their share even once the artist has established Florida residency?

To answer this question, it is first important to break down royalties by type. Our writer-producer will recognize several streams of revenue from her music, and the rules vary. It can also matter how the music is being used to generate a royalty payment.

California distinguishes between royalties that arise from the performance of personal services and those generated by the sale of rights to an independently developed finished product. In other words, some royalties and residuals act like copyrights or patents. These forms of intellectual property are intangible assets, and income they generate is sourced to the writer or inventor’s state of residence. In contrast, ongoing payments for “personal services” performed in the state can remain California-source income, and therefore taxable by California. To understand the difference, let’s consider a few of the types of royalties a writer-producer might receive.

Composition performance royalties are generated from a writer’s ownership interest in a composition (rather than a recording). These are royalties that performance rights organizations, often referred to as PROs, collect on writers’ and publishers’ behalf. The major U.S. PROs – ASCAP, BMI and SESAC – collect royalties from streaming services, radio and TV channels, live venues and many other sources. Any public place playing music, live or recorded, needs a license from a PRO. The organization distributes the royalties it collects back to writers and publishers. If our Floridan artist holds an ownership in one or more compositions, these royalties will be sourced to Florida. Since Florida does not levy state income tax, the artist does not owe state income tax on these payments.

(Note that proving a change of residency can be difficult when leaving a high-tax state like California. For more on this topic, see my colleague Paul Jacobs’ post “You Say Goodbye, States Say Hello.”)

Writers also often collect mechanical royalties. These result when the songwriter grants rights to the reproduction of a copyrighted work. If someone buys an album or an individual track, a mechanical royalty is how the writer gets her share. An artist who wants to release a cover (as audio, rather than video) needs a mechanical license to legally do so. Publishing administration companies, such as Songtrust, often collect both mechanical and performance royalties. Mechanical royalties, too, are sourced to the writer’s home state (in this case, Florida).

While royalties for both songwriters and producers can vary based on contractual agreements, writers’ royalties are relatively more standardized. A producer’s interest in a sound recording can differ from label to label, artist to artist, or even track to track.

Artists and producers do not always have a direct interest the master recordings they helped to create. Record labels often take ownership as part of an artist’s contract. But for independent artists, or artists who develop enough clout to regain control of their masters, interest in the master recording can be an ongoing revenue stream. They may, in turn, choose to share this income with collaborators. When working with an independent artist, a producer may expect 15% to 25% of net royalties (after any third-party costs to make and distribute the sound recording).

A distributor or a label generally collects royalties from record or album sales, and pays them out if any other parties have an ownership stake. Royalties for digital uses, such as satellite radio or webcasting, may also come from SoundExchange if a producer or artist has properly submitted a Letter of Direction. An LOD directs SoundExchange to pay some part of the artist’s royalties to a creative collaborator. Like both of the writing royalties I have described, income generated from a direct interest in a master recording would be income sourced to Florida, where our producer is a resident.

If our producer was working with a major label, she was more likely to receive a lump sum payment for her work, what is known as “work for hire.” Such arrangements will not cause any ongoing tax complications since the income is taxed based on where the work was completed. The question arises if the producer was also assigned “points” on top of the flat fee. Points are percentage points of an artist’s royalty from the label, and producers can often expect somewhere between 3 and 7 points for their work. Points do not represent any stake in the ownership of the master recording. Instead, the sound recording royalties serve as a baseline for calculating the producer’s additional compensation. Depending on the specifics of the producer’s contract, California may treat payments based on points as compensation for personal services. In that case, our producer’s royalties will be taxed in California if that is where she completed the original work. This outcome is relatively common.

What if our Floridian artist produced work in New York, rather than California? The same distinction applies in most cases. The state generally cannot tax a nonresident for an ownership interest in intellectual property, even if the artist created it in New York. However, ongoing payments for personal services performed in the state are taxable, even for nonresidents. Musical artists are not the only ones who need to bear these rules in mind. The same principles apply to actors, voice-over artists, or anyone else who may earn residuals from film or television work created in these states. It is important to fully understand the nature of your ongoing compensation to pay the tax you owe. Distinctions between types of compensation may not always be intuitive.

As this article suggests, state tax treatment of royalties can become complex, especially if artists regularly create work in states where they do not live. The most critical step is to carefully review and understand the agreement or contract that governs each collaboration. In cases where you are not confident that you understand an agreement, it is worth the investment to consult your business manager, lawyer or tax professional. If a song or album is a major success, you could be managing royalties – and the associated tax – for years to come.

Many artists now see the appeal of moving to states like Florida and Texas, with friendlier tax climates. But these artists are likely to continue collaborating with their peers in Los Angeles, New York City and elsewhere. Getting on top of the way various royalty payments are taxed will ensure you can make the most of your move while paying each state its due.

Senior Client Service Manager Melinda Kibler, who is based in our Fort Lauderdale, Florida headquarters, is among the authors of our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. Her work includes Chapter 5, “Estate Planning”; Chapter 10, “Financing Long-Term Care”; and Chapter 17, “Retiring Abroad.” She also contributed to the firm’s book The High Achiever’s Guide To Wealth.