Planned Giving
Monday May 29, 2023
Article of the Month
Donations of Intellectual Property Part I
Intellectual property refers to assets that do not have a physical form. Common types of intellectual property (IP) include copyrights, trademarks or patents. As intellectual property filings continue to rise, it is important to understand the treatment and regulations for these types of gifts.
A charitable gift of an IP asset can provide a donor with tax benefits. However, the legal complexities that surround these types of gifts necessitate a deeper understanding of these assets prior to making a charitable contribution. As such, it is crucial that advisors have a firm grasp on how these gifts operate in order to best serve their clients' needs and objectives.
This article series will provide practical information on the tax deductions available for copyright assets, their valuation and their methods for transfer. Part one of this article series will provide an overview of charitable gifts of copyrights made during life or at death. The second part of this series will review gifts of trademarks and patents. By understanding the rules that come with gifts of IP assets, advisors can be prepared to guide their clients toward a strategy that will maximize their tax benefits and fulfill their client's charitable goals.
A copyright is an intangible property right that protects original works, including literary, artistic, dramatic, pictorial, graphic, audio, sculptural, audio-visual and architectural works. The owner of the copyright has the exclusive right to reproduce the copyrighted work, prepare derivative works, distribute copies of the copyrighted work and perform or display the copyrighted work publicly.
While a copyright and the copyrighted work go hand-in-hand, a copyright is a property right that is separate from the copyrighted work. For example, one individual might own the copyright to a manuscript and another individual may own the manuscript.
For property gifts that are greater than $500, the taxpayer must fill out and include Form 8283 on his or her tax return. Donors must also fulfill the requirements for noncash gifts valued over $250, which requires the donor to obtain a contemporaneous written acknowledgement (CWA) that complies with Reg. 1.170A-13(f) and Reg. 1.170A-16(d)(1)(i). If the copyright is valued over $5,000, donors are required to obtain a qualified appraisal prepared by a qualified appraiser. Reg. 1.170A-16(d)(1)(ii).
The fair market value of a copyright is determined by a qualified appraiser and is generally based upon the income stream that the copyright is expected to generate. The U.S. Copyright Office's Circular 12, Recordation of Transfers and Other Documents includes detailed instructions for completing the process. The income stream that a copyright may generate will often depend on market demand for the copyrighted material, any restrictions on the use of or ability to transfer or license the copyright and the length of time before the copyright expires.
Copyrights are generally transferred to charity with an assignment contract that is subsequently recorded with the United States Copyright Office, ideally within one month of the transfer. Information about how to assign a copyright and record the assignment is available from the United States Copyright Office. Electronic filing is preferred and will have faster processing times than paper submissions.
Generally, a donor making a charitable contribution of his or her entire rights in an IP asset that is characterized as a capital asset is entitled to a deduction that is equal to the lesser of the donor's cost basis in the property or the property's fair market value. IP assets are subject to capital asset treatment typically when the taxpayer purchased or inherited the asset. As such, the deduction for charitable gifts of IP assets will be limited to 30% of the donor's adjusted gross income (AGI) in the year of the gift with any excess carried forward for up to five additional years.
Partial interest rules prevent charitable deductions if the gift is not of a donor's entire interest in the copyright. Sec. 170(f)(3). The donor who owns both the copyright and copyrighted material must make gifts of both interests to claim a charitable deduction.
The gift of a license to use intellectual property, for example, may not be a gift of the copyright creator-owner's entire interest in the copyright. If the donor owns the copyright and the underlying copyrighted asset, the donor is not permitted to claim a tax deduction for the value of the license. Copyrights are not considered capital assets if they are owned by the individual who created the copyrighted property or if it is received by an individual as a gift from the creator of the copyrighted property during life (i.e., an individual who has received a "carry-over basis" from the creator). Sec. 1221(a)(3). Reg. 1.1221-1(c)(1).
Copyrights received by an individual as a gift from the creator of the copyrighted property during life receive a "carry-over basis" from the creator and are not considered capital assets. Therefore, these types of copyright gifts will be subject to the 50% basis election deduction limit, rather than 30% AGI deduction limitation for appreciated assets.
This right to terminate cannot be relinquished nor can the holder of this right agree not to exercise it. For this reason, the gift of a copyright made by the creator (or the heirs of the copyright) during life is not a gift of the donor's entire interest in the copyright and thus, no deduction is allowed.
If a donor is neither the creator of the copyrighted material nor a relative who inherited the copyright from the creator, the tax consequences of the gift of the copyright will depend on their ownership and the partial interest rules. If the donor owns only the copyright, he or she may give the copyright to charity and receive an income tax deduction for the lesser of the donor's cost basis or the full fair market value of the copyright, since the donation of the copyright consists of all his or her interest. For a testamentary gift, the gift would generate a charitable estate tax deduction.
If, however, the donor owns both the copyright and the copyrighted material, he or she must give the entire interest owned to receive an estate tax deduction or an income tax deduction. If he or she gives the copyright to charity but retains ownership of the copyrighted material, the donor will receive an estate tax deduction but not an income tax deduction. This is because an inter vivos gift of the copyright without a concurrent gift of the copyrighted material is a non-deductible partial interest gift. Sec. 2055(e)(4), Sec. 2522(c)(3).
A charitable deduction is available when a donor contributes their entire interest or an undivided fractional share in the donated assets. A donor has a fractional interest in a copyright when they do not own 100% of the asset being donated. Generally, this occurs when the donor jointly owns an interest in intellectual property with another person. In this case, the entirety of the donor's interest consists solely of the fractional interest in the copyrighted property and a deduction may be available. Sec. 170(f)(3)(A).
Before June 2004, third-party purchasers of intellectual property who donated their IP to a qualified organization would receive a deduction based on the fair market value of the asset. However, the American Jobs Creation Act of 2004 amended Sec. 170(e) to state that gifts of trademarks are deductible for the lesser of the taxpayer's cost basis or the fair market value of the IP. The donor may be entitled to additional deductions for qualified donee income (QDI) stemming from the copyright in the hands of the charity. Per Sec. 170(m)(8)(B), the donor must provide written notice at the time of the donation that is to be treated as a qualified intellectual property contribution under Sec. 170(m)(8) and Sec. 6050L. Sec. 170(m)(8)(b). The charity has an obligation to report the QDI to the donor and the IRS annually on Form 8899, Notice of Income from Donated Intellectual Property.
If the recipient charity receives income relating to the contributed copyright, the donor may deduct QDI (initially reduced by the basis) for up to 10 additional years. Sec. 170(m)(5). For short tax years, a 12-year sliding scale may be used to cover a partial first and final year where the deduction is 100% of QDI in year one, 100% in year two and declines by 10% each year to 10% in years 11 and 12. Sec. 170(m)(7) and Sec.170(m)(10)(D)(i). Therefore, the percentage of income deductible will vary with each passing year. A donor is also unable to claim a deduction for any QDI accrued after the legal lifespan of the IP asset expires. Sec. 170(m)(6).
Gifts of copyrights to a qualified charity may offer attractive tax-planning advantages to donors as well as provide them with a long-lasting legacy. While there are many rules pertaining to donations of intellectual property, a donation of intellectual property can offer donors a great opportunity to fulfill their philanthropic goals and ensure that the intellectual property is enjoyed for years to come. Donors should work closely with their professional advisors to ensure that they understand the tax deduction rules and realize the full tax benefits of the gift.
A charitable gift of an IP asset can provide a donor with tax benefits. However, the legal complexities that surround these types of gifts necessitate a deeper understanding of these assets prior to making a charitable contribution. As such, it is crucial that advisors have a firm grasp on how these gifts operate in order to best serve their clients' needs and objectives.
This article series will provide practical information on the tax deductions available for copyright assets, their valuation and their methods for transfer. Part one of this article series will provide an overview of charitable gifts of copyrights made during life or at death. The second part of this series will review gifts of trademarks and patents. By understanding the rules that come with gifts of IP assets, advisors can be prepared to guide their clients toward a strategy that will maximize their tax benefits and fulfill their client's charitable goals.
Copyrights
A copyright is an intangible property right that protects original works, including literary, artistic, dramatic, pictorial, graphic, audio, sculptural, audio-visual and architectural works. The owner of the copyright has the exclusive right to reproduce the copyrighted work, prepare derivative works, distribute copies of the copyrighted work and perform or display the copyrighted work publicly.
While a copyright and the copyrighted work go hand-in-hand, a copyright is a property right that is separate from the copyrighted work. For example, one individual might own the copyright to a manuscript and another individual may own the manuscript.
Valuation of Copyrights
For property gifts that are greater than $500, the taxpayer must fill out and include Form 8283 on his or her tax return. Donors must also fulfill the requirements for noncash gifts valued over $250, which requires the donor to obtain a contemporaneous written acknowledgement (CWA) that complies with Reg. 1.170A-13(f) and Reg. 1.170A-16(d)(1)(i). If the copyright is valued over $5,000, donors are required to obtain a qualified appraisal prepared by a qualified appraiser. Reg. 1.170A-16(d)(1)(ii).
The fair market value of a copyright is determined by a qualified appraiser and is generally based upon the income stream that the copyright is expected to generate. The U.S. Copyright Office's Circular 12, Recordation of Transfers and Other Documents includes detailed instructions for completing the process. The income stream that a copyright may generate will often depend on market demand for the copyrighted material, any restrictions on the use of or ability to transfer or license the copyright and the length of time before the copyright expires.
Transfer to Charity
Copyrights are generally transferred to charity with an assignment contract that is subsequently recorded with the United States Copyright Office, ideally within one month of the transfer. Information about how to assign a copyright and record the assignment is available from the United States Copyright Office. Electronic filing is preferred and will have faster processing times than paper submissions.
Charitable Gifts of Copyrights
Generally, a donor making a charitable contribution of his or her entire rights in an IP asset that is characterized as a capital asset is entitled to a deduction that is equal to the lesser of the donor's cost basis in the property or the property's fair market value. IP assets are subject to capital asset treatment typically when the taxpayer purchased or inherited the asset. As such, the deduction for charitable gifts of IP assets will be limited to 30% of the donor's adjusted gross income (AGI) in the year of the gift with any excess carried forward for up to five additional years.
Partial interest rules prevent charitable deductions if the gift is not of a donor's entire interest in the copyright. Sec. 170(f)(3). The donor who owns both the copyright and copyrighted material must make gifts of both interests to claim a charitable deduction.
Copyright Creators
The gift of a license to use intellectual property, for example, may not be a gift of the copyright creator-owner's entire interest in the copyright. If the donor owns the copyright and the underlying copyrighted asset, the donor is not permitted to claim a tax deduction for the value of the license. Copyrights are not considered capital assets if they are owned by the individual who created the copyrighted property or if it is received by an individual as a gift from the creator of the copyrighted property during life (i.e., an individual who has received a "carry-over basis" from the creator). Sec. 1221(a)(3). Reg. 1.1221-1(c)(1).
Copyrights received by an individual as a gift from the creator of the copyrighted property during life receive a "carry-over basis" from the creator and are not considered capital assets. Therefore, these types of copyright gifts will be subject to the 50% basis election deduction limit, rather than 30% AGI deduction limitation for appreciated assets.
Example – Gift of a CopyrightIf the donor is the creator of the copyrighted material, a charitable income tax deduction will not be generated if he or she gifts the copyright to charity during their life. This is because federal law creates a non-assignable right for the creator to terminate the grant of a copyright. 17 U.S.C. 203. This limitation also applies to donors who are the creator's surviving spouse, child or grandchild who inherits the copyright.
Carleton is the author of a children's book. His copyright on the book is worth $10,000 but his cost basis in the copyright is $10, which is the cost of the pencils and paper he used to create the book. During his lifetime, Carleton gifted the copyright to his friend, Cullen. Cullen's cost basis in the copyright is the same as Carleton, $10. If Cullen donates his entire interest in the copyright to charity, he can deduct the lesser of his cost basis or the fair market value of the copyright. Therefore, Cullen can deduct only the $10 carryover cost basis.
This right to terminate cannot be relinquished nor can the holder of this right agree not to exercise it. For this reason, the gift of a copyright made by the creator (or the heirs of the copyright) during life is not a gift of the donor's entire interest in the copyright and thus, no deduction is allowed.
Example – Gift of Copyright and Copyrighted Material by Creator
Constance is the author of a book of poetry about nature. She wants to gift the book and the book's copyright to a charity that protects local open spaces. However, Constance is advised that she will not get a charitable deduction for the value of her copyright and copyrighted material if she gives them to charity during life. This is because Constance's gift is not a gift of her entire interest, since by federal law she would retain the right to revoke her transfer at any time. Even if Constance tries to give up her right to revoke, she cannot. Constance is unable to donate her entire interest in the copyright and copyrighted material to charity during her lifetime. As a result, Constance decides to leave the copyright and copyrighted material to charity in her will. Upon her passing, her estate will receive a charitable estate tax deduction for the value of the copyright and copyrighted material that goes to charity.
Third Party Owners
If a donor is neither the creator of the copyrighted material nor a relative who inherited the copyright from the creator, the tax consequences of the gift of the copyright will depend on their ownership and the partial interest rules. If the donor owns only the copyright, he or she may give the copyright to charity and receive an income tax deduction for the lesser of the donor's cost basis or the full fair market value of the copyright, since the donation of the copyright consists of all his or her interest. For a testamentary gift, the gift would generate a charitable estate tax deduction.
If, however, the donor owns both the copyright and the copyrighted material, he or she must give the entire interest owned to receive an estate tax deduction or an income tax deduction. If he or she gives the copyright to charity but retains ownership of the copyrighted material, the donor will receive an estate tax deduction but not an income tax deduction. This is because an inter vivos gift of the copyright without a concurrent gift of the copyrighted material is a non-deductible partial interest gift. Sec. 2055(e)(4), Sec. 2522(c)(3).
Example – Gift of Copyright and Copyrighted Material from Non-creator
Maria owns the rights to a popular children's song and its original recording. She did not create the song but instead purchased both the song and the original recording several years ago. Maria would like to give the song copyright to charity but wishes to retain ownership of the original recording. She learns, however, that doing so is considered a partial interest gift and she will not receive a charitable income tax deduction for the value of the copyright. As a result, Maria decides to give both the copyright of the song and the original recording of the song to charity to receive a charitable income tax deduction for her gift.
Gift of Fractional Interests
A charitable deduction is available when a donor contributes their entire interest or an undivided fractional share in the donated assets. A donor has a fractional interest in a copyright when they do not own 100% of the asset being donated. Generally, this occurs when the donor jointly owns an interest in intellectual property with another person. In this case, the entirety of the donor's interest consists solely of the fractional interest in the copyrighted property and a deduction may be available. Sec. 170(f)(3)(A).
Example – Gift of Fractional Interest in Copyright
Bill and Frank purchased a copyright for a song back in the 1970's. The song has been highly popular throughout the decades. Bill and Frank are co-owners of the copyright, each owning one-half interest in the copyright. Bill wants to give his one-half interest in the copyright to charity and Frank wants to retain his one-half interest. While Bill is giving a fractional interest of the copyright to charity, the interest constitutes his entire interest in the copyright. As such, Bill will be entitled to a charitable deduction.
Qualified Intellectual Property Donations
Before June 2004, third-party purchasers of intellectual property who donated their IP to a qualified organization would receive a deduction based on the fair market value of the asset. However, the American Jobs Creation Act of 2004 amended Sec. 170(e) to state that gifts of trademarks are deductible for the lesser of the taxpayer's cost basis or the fair market value of the IP. The donor may be entitled to additional deductions for qualified donee income (QDI) stemming from the copyright in the hands of the charity. Per Sec. 170(m)(8)(B), the donor must provide written notice at the time of the donation that is to be treated as a qualified intellectual property contribution under Sec. 170(m)(8) and Sec. 6050L. Sec. 170(m)(8)(b). The charity has an obligation to report the QDI to the donor and the IRS annually on Form 8899, Notice of Income from Donated Intellectual Property.
If the recipient charity receives income relating to the contributed copyright, the donor may deduct QDI (initially reduced by the basis) for up to 10 additional years. Sec. 170(m)(5). For short tax years, a 12-year sliding scale may be used to cover a partial first and final year where the deduction is 100% of QDI in year one, 100% in year two and declines by 10% each year to 10% in years 11 and 12. Sec. 170(m)(7) and Sec.170(m)(10)(D)(i). Therefore, the percentage of income deductible will vary with each passing year. A donor is also unable to claim a deduction for any QDI accrued after the legal lifespan of the IP asset expires. Sec. 170(m)(6).
Example – Charitable Gift of Qualified Intellectual Property - CopyrightThere are also various anti-abuse rules in place to discourage "bundling" or the creation of other entities to circumvent these rules. In addition, gifts of copyrights held by the creator (or a donor who received a carry-over basis from the creator) are not considered qualified intellectual property for purposes of additional QDI deductions under Sec. 170(m). As such, any QDI received by the charity derived from the copyright held by a creator or inheriting heir cannot be deducted by the donor in future years.
Matt held a copyright to a screenplay he purchased eight years ago. Matt donated the copyright and elected the qualified intellectual property treatment five years ago. Every year since its creation, Matt's copyright has produced an income that exceeded his cost basis by $1,000. In the year following the donation, Matt was able to deduct the full $1,000. By year five, Matt was only able to deduct $700.
Conclusion
Gifts of copyrights to a qualified charity may offer attractive tax-planning advantages to donors as well as provide them with a long-lasting legacy. While there are many rules pertaining to donations of intellectual property, a donation of intellectual property can offer donors a great opportunity to fulfill their philanthropic goals and ensure that the intellectual property is enjoyed for years to come. Donors should work closely with their professional advisors to ensure that they understand the tax deduction rules and realize the full tax benefits of the gift.
Published May 1, 2023
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