A novelist, having created valuable literary works and holding the copyrights in her name, seeks to achieve tax savings. Her proposal is to maintain legal ownership of her copyrights while directing the royalty income to her single-member LLC, which is taxed as an S corporation. This scenario presents a classic conflict between a taxpayer's desire to control their assets and the fundamental principles of income attribution.
To understand the tax implications, it is crucial to first characterize the nature of a self-created copyright. This is not a simple asset like a publicly traded bond; rather, it is a hybrid, embodying characteristics of both distinct legal property and the direct results of personal labor. This dual nature is central to the analysis. The income stream generated from this property—the royalty—is the "fruit" of the copyright "tree." A copyright owner monetizes this asset by entering into a license agreement with a publisher. This contract grants the publisher permission to use the copyrighted work in exchange for royalties, which are typically based on sales and represent a direct return on the property right.
The novelist's plan to assign the royalty income, however, is flawed under the foundational "assignment of income" doctrine established by the Supreme Court. This plan fails both the "property" test and the "services" test. It fails the property test because she is attempting to assign the "fruit" (the royalties) while retaining legal ownership of the "tree" (the copyright). Simultaneously, it fails the services test because the royalties are ultimately compensation for her personal creative labor, and she is attempting to use an "anticipatory arrangement" to deflect this earned income to another entity. This dual failure makes the proposed structure particularly vulnerable to a challenge from the IRS.
Consequently, the novelist's proposed structure is destined to fail. The assignment of income doctrine would be applied to reallocate the entirety of the royalty income from the S corporation back to the novelist personally for tax purposes, completely defeating the plan's objective. The novelist would be held personally liable for income tax on the royalties. Furthermore, because this income is derived from her trade or business as a writer, she would also be liable for self-employment tax on that income, just as if the S corporation had never been involved. The proposed structure only adds administrative complexity and cost while providing no tax benefit and creating a significant, easily detectable audit risk.
While the novelist's initial plan is impermissible, her underlying goal of using a corporate entity to manage her business and potentially reduce her FICA tax burden is achievable. The solution, however, requires adhering to the central lesson of the "fruit and the tree" metaphor: to shift the tax on the fruit, one must first transfer the tree. The correct path forward involves a formal transfer of the income-producing asset—the copyrights themselves—to the corporate entity. This ensures that the entity that owns the asset is the one that earns, and is taxed on, the income it generates.
Disclaimer: The content of the article is not based on a real case. The article is provided for general informational purposes only and is not intended to constitute legal, tax, accounting or other professional advice. You should not act or rely on any information herein without seeking the guidance of a qualified professional who is fully aware of your individual circumstances. Neither the author nor the publisher assumes any responsibility for errors or omissions or for outcomes related to the use of this information.