Is Royalty Income Subject to Social Security Tax?

Royalty income often comes from copyrights and patents but can also come from other property, including timber and mineral rights.

In addition to being subject to federal and state income taxes, your royalty income may also be subject to Social Security taxes. Whether or not you must also pay into the Social Security system depends on both the source of the royalties and the amount (if any) of your self-employment income. Royalty income generated by your trade or business that nets more than $400 a year does require payment into Social Security.

Self-Employment and Social Security

Most people who work as employees for others should have Social Security and Medicare taxes withheld from their pay. Self-employed people, including independent contractors and sole proprietors, do not have an employer deducting these taxes. These taxes are still owed, however. The full amount owed is ultimately calculated on the taxpayer's Form 1040 federal income tax return, Schedule SE, as self-employment tax. The amount owed in self-employment tax is added into the regular income tax liability and is due at the same time.

Royalties Generated by Your Trade or Business

If you are engaged in a trade or business that generates income in the form of royalties, these royalties are subject to self-employment tax. This could be the case if, for example, you are working as an independent inventor and hold patents that generate royalties.

These royalties should be reported as income on Form 1040, Schedule C, which reports business income and expenses. If the taxpayer has over $400 in net income (i.e., income reduced by expenses) on Schedule C, the taxpayer must continue onto Schedule SE, on which the amount of self-employment tax owed is figured. In other words, if your royalties are business income, and if your business has over $400 in profits for the year, you will owe Social Security taxes on those royalties.

Deduction for One Half Self-Employment Tax

If you are required to pay self-employment tax, make sure you take the allowed deduction for one half of the self-employment tax owed. The deduction is taken as an adjustment to income on the first page of your 1040 tax return, so you can take the standard deduction rather than itemizing and still take advantage of this deduction.

Non-Business Royalties

Royalty income that is not generated by a trade or business you are currently engaged in is not subject to self-employment tax. For example, this could occur if you had written a book in the past that was still selling but you no longer work as a writer. Rather than being reported on Schedule C (and ultimately Schedule SE), these royalties are reported on Schedule E, Supplemental Income and Loss. Unlike with Schedule C income, Schedule E income does not carry to Schedule SE.

References

• IRS.gov; Publication 17 -- Tax Guide 2010; 2010
• IRS.gov; Publication 334 -- Tax Guide for Small Businesses; 2010
• IRS.gov; Schedule C -- Profit or Loss From Business; 2010
• IRS.gov; Schedule SE -- Self Employment Tax; 2010
• IRS.gov; Schedule E -- Supplemental Income and Loss; 2010
• IRS.gov; Form 1040; 2010