June 27, 2019

Royalty Income is Subject to Self-Employment Tax

Section 1401 of the Internal Revenue Code imposes a separate tax on income resulting from personal services performed in a trade or business.

In Slaughter v. Commissioner, TC MEMO 2019-65, the taxpayer argued that royalty income from taxpayer’s “brand” was distinct and unrelated to the personal services she performed in producing manuscripts, and therefore was not properly subject to self-employment tax. The taxpayer considered the royalty income as investment income relating to the value of her brand. The IRS took the position that the taxpayer’s activities in promoting herself, including speaking engagements and social media activities, were personal services designed to increase the value of her business (of being an author) and the royalty payments were the result of the taxpayer’s combined efforts to be a successful author.

The taxpayer relied on Revenue Ruling 69-499 in which receipt of payments under a license agreement (separate from a related employment agreement) were not wages for FICA withholding purposes.  The taxpayer argued that her position was analogous to the employees in the ruling: if income from licensing agreements was separate from wages and not subject to FICA, royalty payments from activities other than writing should not be considered income derived from taxpayer’s trade or business for self-employment tax purposes.

The Tax Court rejected taxpayer’s argument stating that wages are conceptually distinct from income from a trade or business. Wages result from services as an employee. For the self-employed, the term trade or business is interpreted broadly (a continuous and regular activity for the purpose of making money). The royalties paid to the employees described in the Revenue Ruling was unrelated to the services performed and would have been paid to the license holders irrespective of their services as employees. In Slaughter, the taxpayer’s efforts to promote herself related and furthered her trade or business of being an author. The Tax Court said that it did not matter how taxpayer’s publishing contract characterized the payments because the payments and the taxpayer’s promotional activities both related back to the taxpayer’s trade or business.

The lesson for the self employed is that care should be taken when characterizing income derived from personal services as something other than self-employment income. If income from a business is the result of the taxpayer’s efforts, skill or reputation, it is probably subject to self-employment tax.

For more information on the impact of this ruling, contact Liam K. Healy at (313) 961-0200 or lhealy@kerr-russell.com.