What expense category is Royalties Paid ?

Businesses often pay royalties for the right to use someone else's intellectual property. This can include payments for the use of a patent in a manufacturing process, a copyright for a piece of music or software, or a trade name for a product. These royalty payments are a common cost of doing business.

For accountants and business owners, it's important to know that these payments are a fully deductible business expense. This guide will clarify how to categorize royalties you pay, the important tax rules to follow, and how to track these expenses for accurate compliance.

Royalties (Paid) Category

The royalties you pay for the use of intellectual property in your business are an ordinary and necessary business expense. These costs are not a specific line item on the tax return; instead, they are reported under Other expenses.

On a company's books, these costs should be tracked in a specific account, such as Royalty Expense, to distinguish them from other types of fees and commissions.

Important Considerations While Classifying Royalties (Paid)

The key to handling royalties correctly is to distinguish them from payments for franchises or natural resources, which have different tax treatments.

Royalties for Intellectual Property

The rules discussed here apply to payments for the right to use assets, such as patents, copyrights, and trade names. These are generally deductible in the year they are paid or incurred.

Distinction from Franchise Fees

It is important not to confuse a simple royalty payment with payments made under a franchise agreement. As detailed in IRS Publication 535, the large upfront fee to acquire a franchise must be capitalized and amortized over 15 years. Ongoing royalty payments made as part of that franchise agreement, however, are typically deductible as a current expense.

Distinction from Natural Resource Royalties

Payments made to a property owner for the right to extract natural resources, such as oil, gas, or minerals, are also referred to as royalties. However, these payments are handled under the specific tax rules for depletion, as outlined in IRS Publication 535, and are not treated as a standard royalty expense.

Information Reporting on Form 1099-MISC

If you pay $10 or more in royalties to an individual, partnership, or LLC (that is not taxed as a corporation) during the year, you are required to report these payments by filing Form 1099-MISC, Miscellaneous Information.

Tax Implications and Recordkeeping

To deduct royalty payments, you must report them correctly and maintain the required documentation.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), royalty payments are deducted under Part II, Line 27a, Other expenses. List them with a clear description, such as Royalty Payments.

What Records to Keep

You must have documentary evidence to substantiate all royalty payments. Your records should include:

• The licensing agreement or contract that outlines the terms of the royalty payments.
• Statements or invoices from the property owner detailing the amount owed.
• Proof of payment, such as canceled checks or credit card statements.

How Fyle Can Automate Tracking for Royalty Payments

Fyle helps you manage and document recurring royalty payments, ensuring every cost is captured, coded, and ready for tax and 1099 reporting.

• Centralize Invoices and Agreements: Attach the licensing agreement and all royalty statements directly to the expense records in Fyle.
• Track Recurring Payments: Fyle’s real-time credit card feeds can instantly capture royalty payments made via a business credit card.
• Create a Clear Audit Trail: Fyle maintains a time-stamped, unalterable record of all payments and documents for easy substantiation.
• Automate Your Accounting: Sync the categorized royalty expense directly to the correct GL account in QuickBooks, Xero, NetSuite, or Sage Intacct.