What Are Royalties?

A musician holds an instrument.
Photo:

MoMo Productions / Getty Images

Definition

Royalties are payments to owners of property for use of that property. Royalties often deal with payments for the right to use intellectual property (IP), such as copyrights, patents, and trademarks.

Key Takeaways

  • Royalties are payments that buy the right to use someone else's property.
  • Licensing agreements outline the details of royalty payments.
  • Royalty payments may cover many different types of property, including patented inventions, the use of artwork, or the mining of resources.
  • Royalties may be reported as business income or expenses.
  • Typically, you have to report royalties on Schedule E when you file your taxes.

How Royalties Work

Royalties are payments that buy the right to use someone else's property. Royalties stem from licensing, which is the process of giving or getting permission to have, produce, or use something that someone else has created or owns.

In other words, when you keep the ownership of the property and get royalties from someone for use of that property, that is licensing. Licensing your business's intellectual property and getting royalties from these licenses is a common way to increase your business income. Royalties also protect the buyer from claims by the owner for improper use.

Royalty fees and payment amounts can be set in a variety of ways. For example, in a franchise situation, fees can be set as a fixed or variable percentage of gross sales. In many cases, there is a minimum royalty. Some common forms of royalty payments include:

  • Royalties for specific products (like a book, a piece of music, a patented product, or a concert) are generally based on the number of units sold.
  • Royalties for oil, gas, and mineral properties may be based on either revenue or on units, such as barrels of oil or tons of coal.

A variable percentage is often used for newly created IP. In this case, the royalty percentage might be small in the beginning as sales are low. Then, as the sales increase, the royalty percentage might increase to a maximum amount.

Some royalties are paid for public licenses. The Copyright Office collects royalty fees in several scenarios, including:

  • Cable operators retransmitting TV and radio broadcasts
  • Satellite carriers retransmitting network and non-network signals
  • Distribution of digital audio recording devices and media

Contracts

Each type of royalty payment has benefits and drawbacks for each party. The owner of the property will negotiate the specifics of royalty payments with potential buyers as they create a contract.

While royalty contracts differ depending on the type of royalty, there are some common features in royalty contracts.

The contract will include a detailed description of the subject matter (the property) and who owns it. For example, if you are selling the right to use a group of your images to an online image company like Getty Images, you would describe your images in detail (maybe with a listing), and then the following references to the photos could simply call them "the Images." 

The contract will detail the scope and limits of the use of the property. For example, you might allow someone just one-time use, or you might allow perpetual use of your images.

The contract will also include the payments (the royalties themselves). The section covering payments should include:

  • When the payments are to be made
  • How the amount of payments is determined
  • How records are to be kept
  • Any advance payments

The contract could also establish an "earn-out" arrangement that bases royalty payments on the performance of the property being licensed. In an author contract, for example, there may be an advance. When the author's portion of royalties from book sales exceeds the amount of the advance, the author will begin receiving additional royalty payments.

Note

Like other legal business contracts, licensing and royalty contracts may vary based on state laws. Check with an attorney who practices in your state to get more details.

Taxes

Like other forms of payment in a business, royalties are taxable income and also a business expense.

If you receive royalties from someone for use of your property, you must claim these payments as business income, usually on Schedule E (Form 1040). Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income. In general, any royalties you receive are considered as income in the year when you receive them.

If you are paying royalties or licensing fees, these payments might fall under legitimate business expenses. If the payments are for the purchase of property, the property becomes an asset on your business balance sheet, and the payments might need to be amortized. If you pay more than $10 in royalties in a year, you must give the payee a 1099-MISC form to show the total of your payments for the year.

Note

The question of how this expense is entered on your business tax return depends on the specifics of your situation. Before you attempt to include any of these royalties or licensing fees as expenses, check with your tax professional.

Types of Royalties

In music, royalties are paid to owners of copyrighted music. These are called performance royalties. You may pay this royalty if you want to play a song on your radio station or use the song in your movie.

Note

A musician may register a trademark or copyright with a private performing rights organization (PRO) like ASCAP or BMI. The PRO assumes responsibility for collecting royalties, and then it distributes the royalties to the owner.

Royalties may be paid for the use of images, such as when you want to add stock photography to your website. Another type of royalty is a book royalty, which publishers pay to authors for every book they sell.

If someone wants to make or use a patented product, like a new invention, they will have to pay a royalty to the person who owns the patent. 

In franchised businesses, such as 7-Eleven convenience stores, the franchise holder pays franchise royalties to the main company for the use of the name and other assets. 

Royalties may also be paid in the context of rights to take minerals from the property of someone else. These are often called mineral rights, rather than royalties, but they work the same way. For example, oil and gas producers in the U.S. pay a royalty of 12.5% of production value for onshore operations.

Frequently Asked Questions (FAQs)

What are examples of royalties?

Royalties can be paid out to an author for books sales, a songwriter for a song, or to a musician for an album.

How are royalties paid?

Royalties can be paid at a flat percentage of sales, for example, or via a variable percentage rate that starts out lower and increases as sales of the property increase.

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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. IRS. "Publication 525: Taxable and Nontaxable Income," Page 17.

  2. Royalty Rates. "Intellectual Property Royalties—Everything You Need To Know."

  3. Copyright Office. "Circular 75: The Licensing Division of the Copyright Office," Page 1.

  4. The Steve Laube Agency. "The Myth of the Unearned Advance."

  5. Contracts Counsel. "Royalty Agreement."

  6. CCH AnswerConnect. "Business Expense Deductions for Rents and Royalties."

  7. IRS. "Instructions for Form 1099-MISC and 1099-NEC."

  8. Department of the Interior. "Revenues."

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