If you've ever created anything -- like music, art or literature -- and someone else profits from its use, you may be entitled to royalty income. In other words, if others use your work to make money, you get money. Royalties are payments for use of intangible works (not services). You can also receive royalty income through investment in a mineral operation, like gas or oil.
You can negotiate your royalties in different ways. For example, you can sell your work (also called property) to an investor in return for a constant percentage of royalties on the revenue the investor makes. Or you can simply receive a royalty any time anyone uses your property to make money (called licensing.) No matter how or why you receive royalties, the federal government sees them as income, and expects you to report that income on your taxes [source: Adkins].
Taxes paid on royalty income depend on many factors, including the following:
- Whether the creative work is a trade or a business
- The timing and kind of income received
- Who owns the property (an individual or a corporation, for example)
Although there is no blanket equation for royalty taxes, typically royalties received from your work are reported as self-employment income, and are taxed at a higher rate. You report these on Schedule C of IRS form 1040. If you earn more than $400 through self-employment, including royalties, you must report that income on your tax return.
Royalties from one-time earnings (a gig that isn't your primary job), or mineral interests, are reported on Schedule E of IRS Form 1040. Let's look at a few real-life examples.
Say you write and publish a book outside of your regular job. You never revise it. In the eyes of the government, you're not self-employed as a writer, so your royalties wouldn't be reported as self-employment under Schedule C. Instead, report them under Schedule E, Supplemental Income. However, if you're a full-time writer, or you regularly revise your book, the government considers you self-employed as a writer and you would report your royalties under Schedule C, Profit or Loss from Business [source: Saenz].
Of course, it's not always so cut and dried. Often, artists receive advance royalties before a work is completed. For example, a record company might pay a songwriter advance royalties of $10,000 for the rights to 10 songs, plus a percentage of proceeds of the songs' sales. But if the songs end up not making any money, the songwriter still gets to keep the $10,000. So even though that money is called advance "royalties," the taxman actually sees that $10,000 as money for services rendered, reported on IRS Form 1099-Misc, Non-Employee Compensation [source: Kelley].
If you sell your royalty interest, it no longer applies as royalties and likely turns into capital gains. This can vary, however, on your circumstances and the asset you sell.
If you need more guidance, a tax adviser can point you in the right direction.
- Adkins, W.D. "Royalties Subject to Self-Employment Tax." Houston Chronicle. 2014. (Sept. 26, 2014) http://smallbusiness.chron.com/royalties-subject-selfemployment-tax-12596.html
- Financial Web. "Reporting Royalties In Your Federal Income Tax Schedule." 2014. (Sept. 25, 2014) http://www.finweb.com/taxes/reporting-royalties-in-your-federal-income-tax-schedule.html#axzz3ETO7CD00
- Investopedia. "Royalty." 2014. (Sept. 26, 2014) http://www.investopedia.com/terms/r/royalty.asp
- Kelley, Claudia L., Ph.D., CPA, and Kowalczyk, Tamara, Ph.D., CPA. "Tax Issues for Individuals Who Create Intellectual Property." American Institute of CPAs. Dec. 1, 2014. (Sept. 25, 2014) http://www.aicpa.org/publications/taxadviser/2013/december/pages/kelley_dec2013.aspx
- Saenz, George. "Royalties deemed ordinary income." Bankrate. Oct. 11, 2007. (Sept. 26, 2014) http://www.bankrate.com/brm/itax/tax_adviser/20071011_royalties_tax_a1.asp