Streaming for Dollars

By Michael R. Morris

I recently moderated a panel for the California Copyright Conference entitled “Streaming for Dollars,” that addressed the music industry’s current evolution from an “ownership” model to an “access” model.  Instead of purchasing CDs or permanently downloading songs via iTunes, Amazon, etc., a vastly increasing share of music listeners are choosing to stream music over the Internet via services such as Pandora, Spotify, and Sirius XM.  While these streaming services still pay royalties to artists, songwriters, music publishers, and record companies, the rates can be miniscule compared to the revenue artists receive from permanent CD and download purchases.  Understandably, this seismic shift in consumer consumption of music is a hot topic in the music industry.

Key factors differentiate royalties generated by the digital streaming of music from revenues attributable to permanent purchases and the traditional "terrestrial" broadcasting of music.  This is driven by the business and legal relationship between the streaming companies, performance rights organizations (or "PROs," which are BMI, ASCAP, and SESAC in the United States) and the record labels in the streaming age.  In the "old world," permanent sales of music represented the bulk of the music business— music was sold either as physical product (CDs) or as permanent downloads.  Record labels would get a wholesale price per CD from a distributor or digital seller (like Apple iTunes) and pay a royalty to the artist (a percentage based on a wholesale or retail price, depending upon the label and type of sale).

But when a song is streamed on‑demand via Spotify or by a non‑interactive company like Pandora, there are no traditional royalty-based sales.  Royalties get paid solely from the performances of songs and master recordings.  Thus, Spotify will usually pay royalties for the performances of the songs to the PROs via "blanket" licenses of the entire catalogs.  The PROs negotiate a "blanket" catalog license fee and then divide it between the songwriters and publishers based on the number of streams.  So, hypothetically, if ASCAP received a "blanket" license fee of $1,000,000 for a particular quarter from Spotify, in which there were 5 billion streams of the ASCAP catalog, the per stream rate would be $.0002.  Spotify also pays a fee to stream the sound recordings (via direct licenses with labels), but unlike non‑interactive services such as Pandora, these deals are neither set by statute nor publicly disclosed.  Also, major companies like UMG, Sony Music, and the Warner Group have taken stakes in Spotify and other streaming services, raising the issue of whether the labels are trading equity for lower royalty rates, which are shared with artists.

Non-interactive companies like Pandora and Sirius XM also pay royalties for the performance of songs and the master recordings embodying them.  However, the rates paid by Pandora and Sirius XM to broadcast songs are based on consent decrees dating back to the 1940's.  When such rates came up for renewal, Pandora, ASCAP, and BMI couldn't agree on new terms.  Pandora then sued ASCAP and BMI for a judicial rate court determination.  To the dismay of the PROs, the District Court decision upheld the current ASCAP-Pandora rate (1.85% of income) until December 31, 2015.  In response to mounting criticism about royalty rates based on antiquated consent decrees, the Department of Justice ("DOJ") announced it will review these consent decrees.  Hopefully, the DOJ will address the argument that the changing conditions in the music industry should enable PROs to negotiate performance rates to reflect free market conditions.  As Representative Doug Collins succinctly stated:  "Should Congress promote more music creation through less regulation?"

Pandora and Sirius XM also pay royalties from digital streaming of master recordings to labels and artists under the Digital Millennium Copyright Act and the Digital Performance Right in Sound Recordings Act, whose rates are set by statute.  Such royalties are collected and distributed by Sound Exchange.  However, to the chagrin of labels and artists, Pandora and Sirius XM don't pay on pre‑1972 sound recordings, which are not protected by federal copyright.  As a result, both the major labels and "heritage" acts like Flo & Eddie (Mark Volman and Howard Kaylan, p/k/a "The Turtles") have sued Pandora and Sirius XM under various state copyright and related intellectual property rights laws.  In a decision with far reaching effects, U.S. District Court Judge Phillipe Gutierrez held that under California law, Flo & Eddie owned exclusive rights to the public performance of their pre‑1972 recordings of such classics as "Happy Together" and "She'd Rather Be With Me."  The economic consequences of this ruling cannot be overstated – companies like Pandora and Sirius XM could end up paying hundreds of millions of dollars in additional royalties.  Not surprisingly, Sirius XM has appealed.  In the meantime, Flo & Eddie have brought similar suits in other states, while a group of labels is pursuing its own action against Pandora in New York.

The legal battles over what rates should be paid for the digital performance of songs and pre‑1972 master recordings are hardly surprising, and the Flo & Eddie California case may open a floodgate of litigation.  This was predictable, given overall U.S. music revenue during 2013 was flat at $4.47 billion, down from a $14.6-billion peak in 1995. While consumer appetite for streaming music has grown exponentially and seems insatiable, digital revenues have not even remotely kept pace.

Certainly Spotify, Pandora, and similar services enable more people to experience a wider variety of music, arguably providing more access to and exposure for artists than ever before.  But present music streaming models haven't materially offset lost permanent sales revenues.  In this climate, music creators have and will continue to suffer.  Consumer habits have changed, and the economics of the music industry in a streaming world must change as well.

Gold Diggers Beware

By Lynda Chung

In the world of trust and estate litigation, claims of undue influence are nothing new. These suits usually concern a caregiver, mistress, or other interloper coercing an unfair share of an inheritance from the deceased.  However, far less common are undue influence cases brought against the wife of the deceased. That is … until a case earlier this year made it clear that marriage is not a license to steal. Indeed, all would-be “gold-diggers” should take note, as this decision is a potential game changer.

In this case, the deceased took the defendant as his third wife in 1999. After divorcing six months later, the couple remarried in 2005. The deceased was a retired real estate magnate worth millions, and had multiple children and grand children from previous marriages, while the defendant had two children of her own. Needless to say, this type of blended-family can be a powder keg when it comes to inheritance.

At the time of his marriage, most of the decedent’s real estate holdings were kept in a trust, which provided for his children and grand children. However, in mid-2005 (after remarrying Wife No. 3), he began introducing a series of amendments to the trust, providing his wife with more and more of his inheritance, and finally giving her the power to disinherit his own children altogether after his death.

Upon his death, his eldest children brought a suit alleging the defendant unduly influenced the deceased into modifying his trust, and that the way in which she freely spent her husband’s money constituted a breach of fiduciary duty. The court found that the deceased “did not know the extent of [defendant’s] spending,” and that “while it is not uncommon for a spouse to spend money or purchase items of which the other is unaware, and the line between such conduct and financial abuse is not always clear, what [defendant] did in this case went well beyond the line of reasonable conduct and constituted financial abuse.”

Widespread financial conflict in blended families is already quite common, but the result of this decision could have far reaching implications for future situations in which a new spouse attempts to disinherit the rest of the family. 

Non-Profit Corporations Must Operate Pursuant to the Rules

By Arlen R. Gunner

I was recently asked to serve as an expert witness in a case that demonstrates the abuse that occurs when people form a non-profit for the sole purpose of personal gain.

As an experienced attorney representing non-profits, I was hired by the plaintiff’s attorney to testify as an expert witness against the founders of a non-profit organization. Rather than using the money raised for the mission of the organization, they were using the entity as their personal piggy bank and had already pocketed large amounts of cash.

They had no interest in running a charitable organization for the public benefit; they were out to milk the business for themselves. Ignoring even the most basic rules, they controlled everything and hired “front men” to run the charity. These individuals were highly paid and were used to front the organization.  Although they were officers of the entity, they were never allowed to review financial statements, attend board meetings, or run the business.

Over the course of my preparation to be deposed, I discovered that this wasn’t the first time they had carried out this scheme. The founders had a history of using a non-profit corporation as a vehicle to line their own pockets.  This is a serious offense, and violates both California and IRS rules for tax-exempt organizations. Finally the IRS pulled the plug on them and revoked their 501(c)(3) status.

As part of the suit against the founders for the recovery of lost funds, I was deposed by the defendants' counsel. When the nitty-gritty details were laid bare, the defendants’ legal team eventually determined they were fighting a lost cause and offered to settle.

The lesson to be learned is that there are very specific rules and requirements to operate a non-profit corporation. Non-profits are not a vehicle for personal enrichment. Business must be conducted in accordance with the mission for which the non-profit was formed.

To obtain tax-exempt status, the corporation must file an application with the IRS and, if granted, it must also obtain exemption from state taxes as well. Once a non-profit entity is formed, a trust is legally impressed upon its assets, which are held for the benefit of the public. The attorney general is responsible for preserving those assets. If you violate non-profit rules, the attorney general and/or the IRS have broad enforcement power to pursue the entity and those who violated the law, in addition, you will likely face the repercussions from those whose funds have been collected under false pretenses.

More Recent Tax Developments That May Affect You

By Michael R. Morris

The following is a summary of the most important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. If any of these tax developments apply to you, please call me or one of the other attorneys in our Tax and Wealth Planning Group for more information on how to take advantage of or minimize the impact of these developments.

No bankruptcy exemption for inherited IRAs
A unanimous Supreme Court has held that inherited IRAs do not qualify for a bankruptcy exemption, i.e., they are not protected from creditors in bankruptcy. Under the Bankruptcy Code, a debtor may exempt amounts that are both (1) “retirement funds,” and (2) exempt from income tax under one of several Internal Revenue Code provisions, including the one that provides a tax exemption for IRAs. Resolving a conflict between the Circuit Courts of Appeal, the Supreme Court has held that this exemption does not extend to inherited IRAs because funds held in them are not retirement funds. For this purpose, the term “inherited IRA” doesn't include amounts inherited by the spouse of the decedent. This decision should be taken into account when selecting IRA beneficiaries. If a potential beneficiary is under financial distress, the IRA owner should consider naming a trust as beneficiary instead. The individual could be named as beneficiary of the trust without jeopardizing the full IRA funds if he or she personally goes bankrupt.


Purchase of underlying property didn't prevent deduction for lease termination payment.

The Court of Appeals for the Sixth Circuit has allowed a party that exercised an option to buy property that it was leasing, to deduct a portion of the amount tendered in the transaction as a lease termination payment. In so doing, it rejected the IRS's argument that the full amount tendered had to be capitalized as part of the purchase price. The dispute centered on an obscure tax law. It states that where property is acquired subject to a lease, no basis is allocated to the leasehold interest. The IRS said that this provision precluded a deduction, but the Sixth Circuit disagreed. It held that because the lease terminated when the taxpayer acquired the property, the property was not acquired subject to a lease, and the law at issue did not apply to bar the deduction. Years earlier, the Tax Court reached the opposite result in a case with similar facts.


Employer health insurance tactic may backfire.

The IRS has warned of costly consequences to an employer that doesn't establish a health insurance plan for its employees, but reimburses them for premiums they pay for health insurance (either through a qualified health plan in the Marketplace or outside the Marketplace). According to the IRS, these arrangements, which are called employer payment plans, are considered to be group health plans subject to the market reforms of the Affordable Care Act. These reforms include the prohibition on annual limits for essential health benefits and the requirement to provide certain preventive care without cost sharing. Such arrangements cannot be integrated with individual policies to satisfy the market reforms. Consequently, such an arrangement fails to satisfy the market reforms and may be subject to a $100/day excise tax per applicable employee.


Qualified retirement plans and IRAs may permit purchases of “longevity” annuities.

The IRS has issued regulations that allow purchases of deferred “longevity” annuities under various tax-favored retirement vehicles including 401(k) plans and IRAs. Under the regulations, retirees may use a limited portion of their retirement savings to purchase guaranteed income for life starting at an advanced age, such as 80 or 85, to address the risk of outliving their assets.


More enforcement of responsible person penalty likely.

If an employer fails to properly pay over its payroll taxes, the IRS can seek to collect a trust fund recovery penalty equal to 100% of the unpaid taxes from a person who is responsible for collecting and paying over payroll taxes and who willfully fails to do so. A recent report issued by the Treasury Inspector General for Tax Administration has found the IRS has often not taken adequate and timely actions in assessing and collecting the responsible person penalty. The report also makes recommendations for improvements. The IRS has agreed to implement the recommendations making greater enforcement of the penalty more likely.


Big tax for sellers who got home back from defaulting buyer.

In a recent case, a married couple sold their home at a big gain for installment payments and a balloon payment down the road. In the process, they permissibly excluded $500,000 of their gain under the special exclusion for gain on sale of a principal residence. The buyers ultimately defaulted and the sellers got the home back. The IRS said that they had to report the previously excluded $500,000 gain on the reacquisition. The dispute wound up in the Tax Court, which sided with the IRS.

More trust/estate expenses escape deduction limit.

Miscellaneous itemized deductions are allowed only to the extent they exceed 2% of adjusted gross income (AGI). For this purpose, the AGI of an estate or trust is computed the same way as for an individual, subject to certain exceptions. Under one exception, costs paid or incurred in connection with the administration of an estate or trust that wouldn't have been incurred if the property weren't held in the estate or trust are allowed as deductions in arriving at AGI. For a number of years, the IRS provided guidance on which costs qualified for the exception including proposed regulations issued in 2011. Recently, the IRS has issued final regulations, which list more trust/estate expenses that are deductible in computing an estate or trust's AGI than were included in the earlier guidance.


Next year's inflation adjustments for health savings accounts.

The IRS has provided the annual inflation-adjusted contribution, deductible, and out-of-pocket expense limits for 2015 for health savings accounts (HSAs). Eligible individuals may, subject to statutory limits, make deductible contributions to an HSA. Employers as well as other persons (e.g., family members) also may contribute on behalf of an eligible individual. Employer contributions generally are treated as employer-provided coverage for medical expenses under an accident or health plan and are excludable from income. In general, a person is an “eligible individual” if he is covered under a high deductible health plan (HDHP) and is not covered under any other health plan that is not a high deductible plan, unless the other coverage is permitted insurance (e.g., for worker's compensation, a specified disease or illness, or providing a fixed payment for hospitalization). For calendar year 2015, the limitation on deductions is $3,350 (up from $3,300 for 2014) for an individual with self-only coverage. It's $6,650 (up from $6,550 for 2014) for an individual with family coverage under a HDHP. Each of these amounts is increased by $1,000 if the eligible individual is age 55 or older. For calendar year 2015, a “high deductible health plan” is a health plan with an annual deductible that is not less than $1,300 (up from $1,250 for 2014) for self-only coverage or $2,600 (up from $2,500 for 2014) for family coverage, and with respect to which the annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $6,450 (up from $6,350 for 2014) for self-only coverage or $12,900 for family coverage (up from $12,700 for 2014).


Taxpayer Bill of Rights.

The IRS recently adopted a “Taxpayer Bill of Rights” to help taxpayers better understand their rights. While taxpayers already had these rights, they were scattered in various provisions of the Internal Revenue Code and were unknown to many taxpayers. They are now prominently displayed on the IRS's web site and fall into these 10 broad categories: (1) the right to be informed; (2) the right to quality service; (3) the right to pay no more than the correct amount of tax; (4) the right to challenge the IRS's position and be heard; (5) the right to appeal an IRS decision in an independent forum; (6) the right to finality; (7) the right to privacy; (8) the right to confidentiality; (9) the right to retain representation; and (10) the right to a fair and just tax system.

When is a Property Owner also an Employer?

By Laurie Murphy

If a tree falls in the forest, and no one is around to hear it, does it still make a sound? What if an unlicensed tree trimmer falls out of the tree, and the forest is your property? Are you liable?

If you’re not careful, a $200 tree-trimming job can turn into a five-figure plus lawsuit. When landscapers, plumbers, handymen, etc., are injured while working in your home or on your commercial property, your liability depends on whether the law recognizes them as an employee or an independent contractor. Section 2750.5 of the California Labor Code states that any unlicensed worker performing a job for which a contractor’s license would be required is viewed by the law as an employee of the hirer, rather than an independent contractor.

In short, any unlicensed and uninsured worker you pay to work on your home can be legally viewed as your employee, thus obligating you to provide worker’s compensation benefits.  And most homeowners' insurance policies will cover such claims.

Luckily, the Labor Code carries a few exemptions that may protect the average homeowner in these cases. Section 3352 (subsection h), includes an exclusion for “casual residential employees.” This is defined as any employee that has worked for the employer for less than 52 hours, or earned less than $100, in the 90 days preceding the accident.

Though many rulings have found this exemption to trump Section 2750.5, the best way to avoid a potential legal battle is to hire licensed and bonded contractors in the first place.  Paying a handyman or landscaper “under the table” might save money, but the liability implications really aren’t worth it.  It certainly is not for owners of commercial property and apartment buildings whose insurance policies generally exclude claims by unlicensed workers because they simply don't provide workers' compensation insurance.  The property owner in such a case can be hit with a double whammy – getting penalized for not carrying workers' compensation insurance and having to defend himself and pay the injured worker.

Unusual Facts Lead to Unprecedented Victory for Lender

By Gary Torrell

I’d like to discuss a recent case where unusual facts and aggressive actions, led to an almost unheard-of victory for one of our lender clients.

Many homeowners miss a monthly mortgage payment or two, then make it up. But when three to five consecutive payments are missed, the lender often attempts to collect or reach a loan modification with the borrower and, if that process is unsuccessful, the lender begins to foreclose.

California and federal laws (including bankruptcy) protect homeowners and can delay a foreclosure for six months to over a year. During this time the borrower often stays in the house without making any mortgage payments. Sometimes (but rarely) the lender tries to have a state court receiver appointed to take possession during the foreclosure, but many courts won't force a borrower out until after the foreclosure. All in all, it is often a long and arduous ordeal before the lender can take possession of the property. And that’s what makes this particular case so unusual.

In this case, the owner of a luxury estate didn’t pay the loan, refused to allow the lender to inspect the property and delayed the foreclosure by filing a lawsuit and personal bankruptcy. After getting bankruptcy court relief, the lender obtained a court order forcing the homeowner to allow a property inspection, but he refused and went so far as to feign an injury to postpone the inspection. When we requested proof of the injury, the borrower couldn’t deliver.

Meanwhile, the lender caused a trustee to be appointed in the bankruptcy case to investigate and possibly care for the home. Thinking he may be able to sell it for more than the liens, the trustee inspected the property. Imagine the trustee’s surprise when he discovered the borrower no longer lived there and, presumably out of spite, had removed all appliances and stripped the fixtures, sinks, etc.

Following this discovery, the trustee agreed to cooperate with the lender. We filed an ex parte application in state court and presented this sequence of events as evidence the lender should be allowed to take possession immediately, without appointing a receiver and before finishing the foreclosure. While the case was strong, decisions of this kind are practically unheard of, but in this case the court agreed.

In 30 years, this is the first time I’ve seen a court award possession of a home to the lender before completing the foreclosure. This just goes to show how creative and aggressive legal tactics can make the difference.

IRS Offers Clean Slate for Undeclared Foreign Accounts

By Mayer Nazarian

If the tax status of your undeclared overseas accounts is keeping you up at night, effective July 1st Uncle Sam may have just issued you a “Get Out of Jail Free Card.” The IRS has announced a big change to their Offshore Voluntary DisclosureProgram (OVDP), making it easier than ever for those with undeclared offshore accounts to reach tax compliance.

Over the past seven to eight years, the IRS has stepped up their enforcement of auditing individuals with over $10,000 in accounts overseas. Under previous programs, even voluntarily coming forward and declaring the overseas accounts could carry a penalty of 27.5% the highest value of the undeclared accounts. But in an effort to encourage more Americans to come clean, the new program drastically reduces the penalty to 5% for domestic taxpayers, and even 0% for those living abroad.

The IRS explains that these new procedures are intended for U.S. taxpayers whose failure to disclose their offshore assets was clearly non-willful. “This opens a new pathway for people with offshore assets to come into tax compliance,” said IRS Commissioner John Koskinen. “The new versions of our offshore programs reflect a carefully balanced approach to ensure everyone pays their fair share of taxes owed. Through the changes we are announcing today, we provide additional flexibility in key respects while maintaining the central components of our voluntary programs.”

Some examples may include those who have been on or recently returned from an assignment overseas for an extended period of time, those who have recently immigrated to the United States and still have accounts overseas, first or second-generation citizens who may have accounts set up by their parents, and perhaps older citizens who may have forgotten about overseas assets. Thanks to these new procedures, individuals in these situations will have a much easier time coming forward and clearing the record, rather than being lumped in with those intentionally hiding their overseas accounts.

For more information on the changes to the new OVDP, click here or contact me at Valensi Rose, PLC.