## Facts

- David Stern III created the fictional character “Francis,” a talking Army mule, during World War II and later developed the character through stories and two published novels.
- In 1950, Stern entered a contract with Universal Pictures Company, Inc. transferring “all his rights, title, and interest” in the Francis character and in the two novels featuring Francis.
- The contract provided Stern a lump-sum payment and continuing payments measured by Universal’s motion-picture exploitation of the Francis property.
- The IRS recharacterized the Universal receipts as ordinary income, asserting the transaction was a license rather than a sale and that a 1950 statutory amendment excluded self-created copyrights and similar compositions from capital-asset status.
- Stern and his wife paid the assessed deficiencies and sued for a refund in federal district court.

## Issues

1. Whether the 1950 agreement transferred Stern’s entire interest in the Francis property (a sale) or granted exploitation rights while Stern retained significant ownership (a license), for federal income-tax characterization.
2. Whether the 1950 statutory exclusion for certain self-created copyrights or literary/artistic compositions prevented capital-gain treatment even if the transaction was a sale.

## Decision

- The court entered judgment for the taxpayers and awarded a refund.
- The court held the Universal agreement was a sale of Stern’s entire property interest in the Francis character and related literary rights.
- The court held the payments received under the agreement qualified as long-term capital gain rather than ordinary income.
- The court rejected the government’s reliance on the 1950 statutory exclusion as applied to this complete disposition of the Francis property.

## Legal Principles

- For federal income-tax purposes, a transaction is treated as a sale of intangible property when the transferor conveys all substantial rights (the full bundle of economically significant rights) and retains only a contractual right to receive consideration.
- Payment terms resembling royalties do not, by themselves, convert a complete transfer of rights into a license; the controlling question is whether the transferor retained substantive ownership interests.
- Statutory exclusions from “capital asset” status for certain self-created copyrights or literary/artistic compositions are construed in light of their purpose and scope and do not necessarily reach a one-time transfer of an entire developed property interest.
- Property is not excluded from capital-asset treatment as “held primarily for sale to customers in the ordinary course of business” where the creator’s activities do not amount to dealing in such properties as inventory.

## Conclusion

The court held that Stern’s comprehensive transfer to Universal of all rights in the Francis character and related works constituted a sale of a capital asset and that the resulting receipts were taxable as long-term capital gains, entitling the taxpayers to a refund.


Stern v. United States, 164 F. Supp. 847 (E.D. La. 1958)