Practitioners should understand that there may be catastrophic economic consequences to their artist client, the artist’s family, the artist’s operating foundation, and therefore the artist’s advisors, for failing to understand the interplay between federal copyright laws and tax laws.
Copyright is a form of legal protection that is provided under the laws of the United States to authors of original works, including literary, dramatic, musical, artistic, and other intellectual works. The term “author” includes a wide variety of creative persons, but, for simplicity’s sake, this article will reference visual artists.
Under the 1976 Copyright Act (“Act”) copyright protection lasts for the life of the artist plus 70 years, after which there is no renewal and such copyrighted materials enter the public domain. After the protection period ends and the materials enter the public domain, the public is said to own the work and anyone can use the rights without obtaining permission.
An artist may transfer the artist’s rights to the materials by gift, by sale, or to a trust, and later the artist or the artist’s heirs may wish to regain those transferred rights. The Act provides three valuable termination provisions that artists can use to regain previously transferred copyrights, so long as the materials were not “made for hire.” Section 203 of the Act applies to grants made after January 1, 1978. Section 304(c) applies to pre-1978 transfers covered by the Act, and section 304(d) applies to grants in their renewal windows on October 27, 1998. This article focuses on transfers made after January 1, 1978.
For transfers that occurred after January 1, 1978, the artist’s right to terminate transferred copyrights exits within a narrow five-year window of time beginning 35 years after the date of the grant, or, if the transferred copyright includes the “right to publication,” then the five-year period begins on the earlier of 35 years after publication or 40 years after the execution of the grant, whichever is sooner. To terminate a transferred copyright, an artist or the artist’s statutory heirs must affirmatively notify the current copyright holder no more than 10 years before the start of the five-year termination window and not less than two years before the end of the window. Failure to give timely and adequate notice will cause the termination right to lapse and the future revenues from such grants to be lost forever.
The right to terminate a copyright grant that has been sold, gifted, or transferred through a trust vehicle has been referred to by some observers as “contract-bumping” or “estate-bumping.” Not surprisingly, many advisors are unfamiliar with the latest version of the Act because works assigned in 1978 and later would have only been available for termination starting in 2013. Because of the law’s relative novelty, the IRS has provided little guidance on the estate taxation of such rights and the resulting tax basis of reclaimed rights. For a thorough discussion of the possible gift and estate tax ramifications of termination rights under the Act, practitioners should refer to Bridget J. Crawford and Mitchell Gans’s comprehensive article, Sticky Copyrights: Discriminatory Tax Restraints on the Transfer of Intellectual Property, 67 Wash. & Lee L. Rev. 41 (2010).
The inalienable right of artists and statutorily defined heirs to claw back transferred copyrights during the statutory termination period should be carefully considered by advisors because it can create unintended windfalls to defined heirs who are not meant to be included in an artist’s estate plan, eviscerate a major source of funding for an artist’s private operating foundation, make managing an artist’s legacy by the artist’s foundation a challenge (if not an impossibility), and create unexpected gift and estate tax consequences.
Before passing the Act, Congress attempted to protect artists who sold or otherwise assigned their copyrights. The goal of such legislation was to protect artists who inevitably struck bad business deals because they were driven by inherently poor bargaining positions before knowing the true economic value of their copyright interests.
Harper Lee’s assignment of her copyright interests in To Kill a Mockingbird is a glaring example of how artists are inherently disadvantaged in the negotiation process when the potential commercial success of their works cannot be known. In 1960, Ms. Lee reportedly licensed some of her copyright interests for $2,500. At the time her editor at J.B. Lippincott and Company told her that her first book would probably sell only several thousand copies. The book was published on July 11, 1960, and became an instant American classic. At only 35 years of age, Ms. Lee won the Pulitzer Prize for her first published book. It was quickly made into an Academy Award winning movie starring Gregory Peck as the heroic lawyer Atticus Finch in 1962. Ms. Lee later recalled that when the book was released she “hoped for the book a quick and merciful death.” As history unfolded this was not to be the case. Since its 1960 launch the book has sold over 30 million copies in 40 languages with total revenues exceeding $3 billion.
The 1909 Copyright Act provided an initial 28-year protection period that was renewable for another 28 years if the artist did not also assign his or her renewal rights in the interim. This early attempt to protect artists was flawed, however, because it was common business practice for grantees to require artists like Ms. Lee to also sell their renewal rights with whatever copyright they granted thereby leaving no path to reclaim or renegotiate the economics that flowed from the copyrights they sold.
The ability to irrevocably give or sell these termination rights ended with the passage of the 1976 Act and section 203, which grants artists and certain defined statutory heirs an immutable right to terminate certain copyrights that are transferred on or after January 1, 1978.
Under the Act, artists (or their heirs as strictly defined under the statute) have an absolute right to terminate a copyright grant during a five-year window starting at the end of 35 years after the date of the grant with the caveat that if the transferred copyright includes the “right to publication,” then the termination right occurs the earlier of 35 years after publication or 40 years after the execution of the grant, whichever is sooner. Failure to exercise within the prescribed time will cause the termination right to irrevocably lapse and the artist or the artist’s heirs to lose the future revenue stream that may have been recaptured and also to lose the ability to manage the artist’s legacy.
To terminate a transferred copyright, an artist or the artist’s statutory heirs must affirmatively notify the current copyright holder no more than 10 years before the start of the five-year termination window and not less than two years before the end of the window. This means that when there is no transfer of the right to publication, an artist or his heirs have between years 25 and 38 after the initial grant to provide a notice of termination.
For example, assume a copyright was granted on January 1, 1978. Further assume that the copyright transfer documentation stated that the transfer was to be made in “perpetuity.” Despite the perpetuity language in the contract to the contrary, the artist or the artist’s heirs can terminate the transfer and regain the financial benefits of the transferred copyrights between January 1, 2013, and January 1, 2018. Notice of the upcoming January 1, 2013, termination can be sent as early as January 1, 2003, but no later than January 1, 2016.
If an artist dies before the termination window, the artist cannot bequeath the unexercised right to an heir of his or her choice. Under the forced heirship regime of the statute, the artist’s defined heirs automatically inherit the right to terminate and can exercise such rights when the termination window opens. Because the termination right is immutable, it cannot be altered by the artist or the statutory heirs by contract, disclaimer, or a promise to make a last will and testament.
But, if an artist dies after giving adequate notice during the termination window but before the termination date, the copyrights should pass under the artist’s estate plan or by intestate succession. Practitioners should note that this can cause the estate to remain open at least until the rights have reverted to the estate, which could be as long as 15 years (between years 25 and 40 after grant).
As noted above, termination rights do not apply to “works made for hire.” Section 101 of the Act defines a work made for hire as either
a work prepared by an employee within the scope of his or her employment or a work specially ordered or commissioned for use as a contribution to a collective work, as a part of a motion picture or other audiovisual work, as a translation, as a supplementary work, as a compilation, as an instructional text, as a test, as answer material for a test or as an atlas, if the parties expressly agree in a written instrument signed by them that the work shall be considered a work made for hire.
As one might imagine, current holders of copyrights often contest termination notices by asserting that the work in question was a work made for hire. The burden is on the artist to prove otherwise.
Termination rights also do not apply to copyrights that were transferred by last will and testament. It is not clear what happens if a last will and testament is silent as to copyrights. Many practitioners believe that such termination rights automatically pass under the residue of the estate, as does most intangible property under state law.
It is important to note that the statute does not make any exceptions for so-called “will-substitutes,” such as revocable trusts. Many practitioners have expressed frustration over this forced heirship regime. Some have noted that there is an inherent bias for testamentary transfers versus transfers made under contract during an artist’s lifetime despite there being a higher competency threshold to make a contract versus a last will. Others have noted that limiting the exclusion to transfers made by a last will and testament ignores the widespread use of trusts in estate planning.
Advisors should consider using a special purpose pour-over will to specifically bequeath copyrights when using revocable trusts as the cornerstone of their estate planning. Remember that if the testator intends to leave a work and its copyrights to an heir, the testator must specifically designate both the work and its copyrights to pass to said heir. If the last will is silent as to copyrights they will most likely pass under the residue of the estate, which may or may not end up in the hands of the heir who received the artwork. This nuance will generally apply only when planning for an artist’s estate because persons who buy a work of art almost never acquire the accompanying copyrights.
If an artist is deceased and has not exercised his or her right of termination, the Act provides that the artist’s termination interest is owned and may be exercised under the following forced heirship system, despite any contract or trust agreement that may provide otherwise:
- The widow or widower owns the artist’s entire termination interest unless there are any surviving children or grandchildren of the artist, in which case the widow or widower owns one-half of the artist’s interest.
- The artist’s surviving children, and the surviving children of any dead child of the artist, own the artist’s entire termination interest unless there is a widow or widower, in which case the ownership of one-half of the artist’s interest is divided among them.
- The rights of the artist’s children and grandchildren are in all cases divided among them and exercised on a per stirpes basis according to the number of such artist’s children represented; the share of the children of a dead child in a termination interest can be exercised only by the action of a majority of them.
- In the event that the artist’s widow or widower, children, and grandchildren are not living, the artist’s executor, administrator, personal representative, or trustee shall own the artist’s entire termination interest.
The term “children” includes immediate offspring, whether legitimate or born out of wedlock, and any children legally adopted.
If there are two or more artists, the majority of the granting artists or their statutory heirs must join the termination. There is no provision under section 203 of the Act that allows a joint artist to terminate just that artist’s discrete share of the transferred copyrights.
The existence of these forced heir rules raises yet unanswered questions about whether the executor and the estate’s attorney have a fiduciary duty to inform the statutory heirs of their rights, even though such rights fall outside of the probate process.
To illustrate this point, assume that an artist grants a copyright interest and then dies one year after the grant (that is, 24 years before the termination window opens). Does the executor or probate attorney have a duty to notify the statutory heirs that they will have a right to terminate starting 24 years in the future? If so, does that right exist even though none of the statutory heirs were included in the artist’s estate plan and thus will receive nothing through the probate or trust distributions?
Notices of termination must comply in form, content, and manner with the requirements as set forth in the final regulations found in 37 C.F.R. § 201.10, which were published on April 8, 2003, effective May 8, 2003. Copies of such notices are required to be recorded in the U.S. Copyright Office. As one might imagine, persons contesting a copyright notice might do so under the grounds that the notice was untimely or inadequate. Fortunately, the regulations allow for “harmless errors” in termination notices that do not materially affect the adequacy of the information required to serve the purposes of the Act.
The first known copyright law was passed in England in 1710 under the Statute of Anne, also known as Copyright Act 1710, to protect booksellers and printers. That law provided for an automatic termination right after 14 years and automatically vested copyrights back in the artist for the next 14 years. Seven decades later, Article 1, Section 8, Clause 8, of the U.S. Constitution directed Congress to make laws to promote the arts and sciences by providing, “The Congress shall have power . . . to promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.”
Today, section 302(a) of the Act automatically protects works that are fixed in a tangible medium of expression (a painting, for example) from the moment of creation until 70 years after the artist’s death. There is no need to officially record or publish works for the copyright laws to apply, although registration and publication is required to obtain certain legal recourse like attorney’s fees and statutory damages.
Copyrights are distinct from the physical work of art. Buyers and their advisors are often surprised to learn that the expensive “blue-chip” work of art they just acquired for millions of dollars does not come with any of its intrinsic copyrights and that the buyer’s use of the painting will be restricted under U.S. copyright laws.
Similar to conservation easements, copyrights are a bundle of rights granted to the creator of a work to exclusively reproduce the work, prepare derivative works, distribute copies of the work to the public, perform the work publicly, and display the copyrighted work publicly. In addition, certain artists of works of visual art also have the right of attribution and integrity as described in section 106A of the Act.
It is no longer required to file a copyright with the government for it to exist. Section 412 of the Act provides, however, that an artist who registers a copyright before the end of three months after the date of first publication (or, in the case of unpublished works, before the end of the first month after discovering a work was infringed) may be entitled to statutory damages and attorney’s fees when suing for infringement.
For a buyer to acquire the copyrights of a work of art there needs to be a properly executed writing that specifically spells out the terms of the copyright transfer, which can be in whole or in part, by territory or duration, and can be either exclusive or nonexclusive. In addition, if a decedent wishes to transfer both the work and its underlying copyrights via a last will and testament the document should expressly address the copyrights—otherwise the work of art might pass to the designated heir and the copyright to another heir under the residuary clause. Practitioners are well advised to consider the tax apportionment issues that unintended transfers under a will might create.
Charitable Contributions of Copyrighted Property
Artists who are U.S. taxpayers rarely donate their copyrights to charity during their lifetimes because IRC § 170(e)(1)(A) limits their charitable income tax deduction to their tax basis (that is, cost of materials) because the donation would be of ordinary income property and also because the donation would be considered a donation of a partial interest under IRC § 170(f)(3).
Note, however, that (1) on death the basis in the work is “stepped up” to fair market value and the artist’s estate can get a charitable deduction equal to the work’s fair market value on death and (2) the partial interest rule for copyrights does not apply for gift and estate tax purposes when a work and its copyrights are considered separate property. These are some of the reasons commercially successful artists wait until their deaths to make charitable transfers of their works and copyrights (often to their own artist-endowed foundation).
For most taxpayers the so-called “related use” rules apply only to lifetime donations of tangible personal property. But, if an artist donates his art in a testamentary transfer but transfers the associated copyrights to non-tax-exempt heirs, IRC § 2055(e)(4)(C) disallows the estate tax deduction unless the property is donated to a charity listed in IRC § 2055(e)(4)(D) (generally public charities and private operating foundations) and is put to a “related use” to obtain an estate tax deduction. It is worth emphasizing again that for the resulting artist-endowed operating foundation to own and properly manage an artist’s copyrights the artist should use a last will and testament to effectuate the transfer.
Understanding and staying on top of copyright termination rights is crucial to prevent a whole host of ills. Advisors might ask their clients the following questions to uncover looming copyright termination rights that should be considered when planning.
- Are you, your spouse, or any of your parents or grandparents an animator, architect, artist, choreographer, musician, poet, writer, video game creator, or similar professional who has created copyrighted works?
- Have any of you ever registered a copyright?
- Have any of you ever sold or assigned a copyright?
- Have you ever purchased a copyright?
- Do you have heirs that you would like to disinherit?
At a minimum, practitioners should make sure that their artist clients are aware of their termination rights and how best to plan around them. They should explain to clients that the statutory forced heirship regime can benefit a statutory heir who is not intended to be part of the artist’s estate plan. Practitioners should understand the statute’s curious preference for testamentary transfers made only by last will and testament. Planners who work with commercially successful artists who intend to leave their remaining works and copyrights to their private operating foundations need to protect the foundation by specifically identifying the bequest of copyrights to the foundation so that such rights do not pass to a noncharity by default under the residuary clause. Protecting the foundation’s copyright ownership from statutory heirs is crucial for the foundation to be able to manage the artist’s legacy through exhibits, publications, and licensing deals. Advisors who fail to educate their clients about such rights leave themselves open to potentially staggering lawsuits.