What are the Tax Implications for Royalties?

What are Royalties

Royalties are payments for the use of your property. That property can be intellectual, such as music, movies, writing, etc. or physical property such as oil from wells, gas wells, or mineral rights. The payments are made to the owner of the property, and there are laws that specify the term and rights of the owner.

Royalties can be negotiated in different ways. You can sell your work to someone or a company and receive percentage payments on their income from the use of your property. An example would be a percentage of each showing of a movie or each book sold. You can also receive royalties in the form of a license fee for licensing to use your property. You will find this in terms of use of a lot of your software agreements. You’re licensed to use it according to the terms of the license, and you pay for that in most cases.

How are Royalties Taxed?

Calculating tax liability for royalties received can be tricky, and you should consult a tax professional. However, some general statements often apply:

  • The timing and type of income you receive.
  • Ownership, whether individual or corporate.
  • Whether the property or work is a business or trade.

There are, however, a few taxation examples that can shed some light on how you may be taxed on royalties you receive.

Self-employment Tax

Depending on the situation, you may be liable for Social Security and Medicare taxes on your royalties. Generally, that is determined by whether you regularly engage in business or activities to earn those royalties.

An example could be if you are a freelance writer regularly writing for income. If part of that income is from book royalties, then you’ll probably be subject to self-employment tax. However, if you’re a lawyer or accountant and you write a book and don’t normally engage in publishing, you would probably not be liable for self-employment taxes.

Income Tax

You’ll generally, independent of whether you’re liable for self-employment taxes, be taxed on your royalties at your personal income tax rate. So, how would our freelance writer and lawyer/accountant examples report the royalty income on their tax returns?

The freelance writer is in the business of writing for money, so any book they also published in their name would normally make them subject to self-employment tax. They would then report the income for taxes on a Schedule C with their tax return.

The accountant or lawyer who wrote one book and isn’t considered in business for those royalties would report them on Schedule E with their return.
One other wrinkle would be if an advanced royalty is involved. A book writer or songwriter may be paid an advance royalty, say $5,000 to write a book or some music. If that book or music never makes money to further create royalty payments, the IRS would generally consider the $5,000 as payment for services and reported on Form 1099-Misc.

Royalties are nice, as they’re like ongoing payments for a one-time effort. You aren’t doing anything, but you’re banking the money. If you think you’ll be in a situation to receive royalty payments, consult a tax professional as to how you’ll be taxed.

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