If you receive royalties from creative works, intellectual property or natural resources in the US, it is important to understand the tax implications. The Internal Revenue Service (IRS) treats royalties as ordinary income and requires the payment of taxes on this income.

In this article, we will provide an overview of the US taxation of royalties and the key considerations for taxpayers.

What are royalties?

Royalties are payments made to a person or entity who holds the rights to a particular asset, such as a patent, trademark, or creative work. These payments are made by another party who has been granted the right to use that asset. Royalties can also be paid for the use of natural resources, such as oil, gas, or timber.

US taxation of royalties

Royalties are considered ordinary income by the IRS, which means they are subject to the same tax rates as other types of income. The amount of tax owed on royalties depends on the taxpayer’s marginal tax bracket and other factors such as deductions and credits.

It is important to note that royalties earned by foreign individuals or entities may also be subject to US withholding tax. This means that a percentage of the royalty payment is withheld by the payer and sent to the IRS as a prepayment of the tax that will be owed by the foreign taxpayer.

Tax planning considerations for royalties

Tax planning is an important consideration for those receiving royalties. One strategy is to take advantage of deductions that may be available, such as expenses related to the production of creative works or intellectual property.

Another important consideration is the tax implications of structuring the payment of royalties through a business entity. Depending on the circumstances, it may be advantageous to receive royalties through a limited liability company (LLC) or S corporation, which may provide tax benefits and liability protection.

Additionally, it is important to consider the impact of state taxes on royalties. Some states may have different tax rules regarding royalties and may require separate tax filings or payments.

Seeking professional tax advice

The US taxation of royalties can be complex, and it is important to seek professional tax advice to ensure compliance and maximize tax savings. A qualified tax accountant can help identify deductions, structure royalty payments for tax efficiency, and ensure compliance with federal and state tax laws.

If you need assistance with US tax accounting, JTT Accounting, a Toronto-based accounting team, offers a range of tax services for individuals and businesses. Contact us today to learn more about how we can help you with your US tax needs.

In conclusion, understanding the US taxation of royalties is important for those receiving this type of income. Royalties are considered ordinary income and are subject to federal and possibly state taxes. By working with a qualified tax professional, taxpayers can ensure compliance and potentially reduce their tax burden.