Are Royalties Considered Investment Income?

Posted by Colton Hoisager on Sep 18, 2022

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Royalties are fees that one person or company pays to another for the use of their work, usually their intellectual property. Royalties are frequently used for licensing agreements, such as when a product manufacturer wants to use a popular song to advertise their product. In addition, writers may receive royalties when their book sells copies, and artists earn royalties when radio stations play their music, for example.

Similarly, computer manufacturers pay royalties to Microsoft to be allowed to install the Windows operating system on their computers. In fashion, designers receive royalties for their work, but a sports star or other celebrity can also earn royalties for licensing the use of their name or likeness even without creating the actual clothing design.

Aside from intellectual property and individual endorsements, royalties are associated with mineral and oil rights. These leases and contracts may entitle the landowner to a share of the value of produced oil or other output.

Royalties are taxed as ordinary income.

The IRS typically considers royalties as ordinary income. It may be reported on Schedule E in most cases or Schedule C if you are self-employed. Royalties are sometimes part of a category called unearned income, which means the taxpayer was not actively involved in the income source. Unearned (or passive) income also includes interest and dividends from stocks, bonds, and inheritances.

What is included in investment income?

In a discussion of Net Investment Income, the IRS stated that “…investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer…”

For this purpose, taxpayers must pay a net investment income tax of 3.8 percent if they have investment income and a modified adjusted gross income above these qualifying thresholds:

 

Filing Status

Threshold Amount

Married filing jointly

$250,000

Married filing separately

$125,000

Single

$200,000

Head of household (with qualifying person)

$200,000

Qualifying widow(er) with dependent child

$250,000

 

How are royalties evaluated as income?

Since royalties are part of the investment income category, this income stream is part of the calculation lenders and others may use when assessing an investor’s ability to manage payments or risk. It may be up to the individual to demonstrate that the income is likely to be stable and reliable, at least by showing a history of payments. For example, an oil lease may be more reliable than royalties for a singer with their first successful song, but a chart-topper could be more lucrative overall. It’s challenging to evaluate the potential without reviewing the record.

 

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

Examples are hypothetical and for illustrative purposes only. Withdrawal strategies should take into account the investment objectives, financial situation and particular needs of the individual.

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