Tax and financial planning questions raised by Diddy's song rights transfer

Sean “Diddy” Combs surprised the music industry and its observers recently when he decided to transfer rights from his Bad Boy Records catalog to some of the artists and songwriters who long ago helped make him a billionaire.

Although there has been no shortage of news coverage, there aren’t many specifics about the arrangements that Combs and the record label have with the artists: Ma$e, Faith Evans, The Lox, 112 and the estate of the Notorious B.I.G., according to various reports. The transfers come amid Bad Boy Records’ 30^th anniversary, and follow offers to the tune of hundreds of millions of dollars that the label has reportedly received for its catalog.

But advisors say the news raises issues around taxes and financial planning — and there are even some parallels when it comes to business ownership between the music and the financial advice industries.

Usually, songwriters own copyrights but have agreements with publishers to collect royalties for a certain amount of time, split with artists, said Craig Manzino, partner in charge for business management and family office services at Armanino, who works with clients in sports, arts, entertainment and media.

“It’s common that these rights do revert back to the artists at a given point — what we don’t know is why they are reverting,” Manzino said. “These deals could be complicated, and it depends on how they’re worded.”

In cases where rights are transferred, both sides in such deals need to be protected, he noted. And in some cases, publishers might want tax write-offs.

Any time that rights are transferred, “it’s having the right people involved from the beginning of the transaction that’s important,” he said.That means working with CPAs and lawyers whose advice “could change the taxability of the transaction tremendously.”

In recent years, many big-name artists or their estates have sold publishing rights or recordings of songs or entire catalogs, including Bob Dylan, Whitney Houston, Bruce Springsteen, Neil Young, David Bowie and Justin Timberlake. Some of those deals reportedly amounted to hundreds of millions.

“Sometimes creative individuals retain the rights and think of it as legacy planning. It goes to the trust, it goes to the family, [or] however they set it up,” said Tiffany Soricelli, principal of Virtuoso Advising for Artists.

“If you sign away your rights … [songs] can be utilized in ways you never intended,” Soricelli said. “I would be asking [clients] what their goals are. Some people don’t want to micromanage their own catalogs.”

While income from artists has shifted to streaming services, the publishing side includes licenses for use in movie clips, TV shows and commercials, said Justin Sroka, partner at Mann Gelon Glodney Gumerove Yee.

“That’s a really large source of revenue,” Sroka said, adding that it’s also a matter of regaining authority over how and where their songs are used. “That’ a big piece of what they’re getting back.”

CAPITAL GAINS VS. ORDINARY INCOME

Decisions to sell or retain catalogs involve big tax questions for songwriters or artists, said Adam Scott, principal at WellAcre Global Wealth Advisors.

“If you’re Bob Dylan, you’re going to get hit with capital gains, which right now is relatively low compared to paying income tax at the current rate,” Scott said.

That is, of course, if the owner is in the top tax bracket. And not selling has benefits, as appreciation isn’t taxed annually, and assets of less than about $26 million for a married couple can be passed tax-free to heirs under the estate tax exemption, Scott noted.

In theory, it’s not any different than the considerations for someone who owns a plumbing company that keeps going up in value, Scott said. Or for that matter, the owner of a financial advice business. It’s often useful to limit income and put money back into the business, he said.

“If you don’t need the income from your business, you’re better off investing in your advisory business and growing it,” he said. “That’s something I do myself. Rather than taking a lot of money out of the company, I’m investing in it.”

In Diddy’s case, it’s hard to say what any tax implications are, given the lack of details on the rights transfers.

But “it seems that this deal is probably less about a tax benefit for Diddy and more about the goodwill and being able to return those copyrights and publishing rights back to the artists, which is kind of a nice thing,” Sroka said. “Clearly, he’s profited well over the years, so it was a nice thing for him to be able to provide that back.”

The decision to sell or hold onto song rights comes up frequently, Sroka said.

“We’ve had many clients who have contemplated catalog sales,” he said. “The few things that move the needle are the cash flow impact upfront versus collecting [royalties] annually.”

For someone who's in the top tax bracket in California, the 37% federal rate and 13% state income tax can make the 20% capital gains tax very attractive, Sroka noted.

However, with the cost of capital rising along with interest rates, the appetite for buying up whole catalogs appears to be diminishing, at least for now, he said.

When contemplating whether to retain or transfer rights, working with someone who is experienced with royalties is helpful, Manzino said.

“Certain songs have cycles. It’s not just the straight revenue trail. You might have an artist who has a Christmas song, and you can’t just look at the past four quarters, because you know it’s going to pop in the fourth quarter,” he said.

“However this is going, there is going to be the need for a business valuation,” Manzino said. “The tax treatment is going to be critical, because it could mean the difference in millions of dollars to each side.”