Where to report royalty income on individual form 1040 tax returns for performers and writers of music is not always clear. Are the payments to artists for personal service of the artist, or payments for the rental, license, use, or sale of their work?
The choices are form 1040, Schedule C and E. Schedule C is subject not only to income tax, but also to the self-employment tax, and is where you report net profit or loss from business or profession.
Schedule E is where you report rent and royalty income. But just because the title of schedule E has the word “royalty” in it does not mean you can use that form to avoid the self-employment tax on your royalty income.
Royalties paid to most musical artists should be reported as business income on form 1040 schedule C, subject to self-employment tax. Artist royalties (including advance royalties) paid to a recording artist by a record label, performance royalties, and royalties paid to a song writer from a publishing company, both generally get reported on schedule C for most musical performers.
It is a rare case for even an occasional or part-time writer and/or performer to be able to exclude royalty income from self-employment tax. That person would have to prove to the IRS that they are not engaged in an occupation or profession for profit. If they are in the trade or business of being a performer or writer, then royalties, net of deductible business expenses, are subject to self-employment and income tax and are reported on form 1040 schedule C.
At the heart of the matter is what the IRS rules and court cases say about royalty income. Royalties earned by the creator of intellectual property are either classified as business or non-business income. Individuals engaged full or part-time in the trade or business of writing and/or performing music, report royalties as business income, which includes most musical performers.
Business income is included on form 1040 schedule C and subject to the self-employment tax, while non-business income is reported on schedule E. Even if you’re retired from the music business, you still report royalties as business income on schedule C, subject to self-employment tax, if you were engaged in a schedule C business at the time you created the property that is still currently generating royalties.
You would like to report royalties on Schedule E, because it would save you the self-employment tax. But rarely can you report net royalty income from music on schedule E unless you can prove that you are more of a non-business, passive investor type, that doesn’t provide significant services.
A note of caution though about schedule E. If your royalty income is reported to you on a 1099 in the royalty box, the IRS computer will look for it on schedule E – the IRS computer and the IRS can’t tell that you reported it on schedule C or D – and will send you a letter from its matching program telling you that you left it off of your tax return. You can either wait for the letter and mail them back the reason, or report it both on the income and other expense lines on Schedule E.