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What's Your Number? An Accounting Blog
Royalties — Why Do They Cause Confusion On Your Income Taxes?
Dianne Graham
As more and more Americans pursue a second or passive income stream, more taxpayers run into challenges preparing tax returns for that income. One of the most confusing of these tax challenges involves royalties. Royalties — income received when you allow someone to use your property for business purposes — is often taxable income. However, it can be taxed in different ways.
Here's what you need to know about this unique situation.
Where Do You Report Most Royalties?
Schedule E (Supplemental Income and Loss) is a catch-all form that serves to report a variety of income earned outside one's regular business or employer. Perhaps you took a great photograph and offered it for licensed use through an online platform. However, you're not a photographer by trade. In this case, royalties by people using that photo are reported on Schedule E.
Schedule E can be difficult to complete. You may need to list all your supplemental income sources separately, including each property producing royalties and/or each rental asset you report as well. You can, though, deduct related expenses such as a fee paid to the online platform you advertise on. These deductions reduce the amount which is taxable.
What About Business Royalties?
As mentioned, some royalties may be reported elsewhere on your taxes. These are royalties earned through a regular business enterprise. Say you're trying to grow your photography business as a side hustle and put some photos for licensing on that online platform. Now the royalties are not supplemental income but, rather, business income.
Business income is reported on Schedule C (Profit or Loss from Business). This form captures all income generated from one business venture, whatever form that comes in. As with Schedule E, you can deduct expenses related to that business. Pursuing more than one side business? You may need to complete separate Schedules C for each.
Why Does It Matter?
If this sounds confusing, you may wonder if it really matters how you report royalties. In fact, it does. One major reason is that business income is often subject to self-employment taxes, whereas supplemental income may not be. In addition, there are limitations as to how you can deduct losses in years in which you don't make a profit on any venture. Schedules C and E losses have different effects.
Finally, of course, there is the possibility of IRS and state tax agency audits. Misreporting income can land you in more auditing trouble and result in fines and penalties for errors.
Where Can You Get Help?
Because it's important to get this reporting correct, it's best to work with an accountant who specializes in tax preparation in your state. Make an appointment today to learn how your royalties will affect your personal taxes.
To learn more about tax preparation, contact a local professional.
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