Can income from royalties be used to fund a qualified plan?

[Guest arlene]

Is income from royalties deemed to be earned income and can said income be used to fund a retirement plan?

[JAY21]

Hopefully you'll get a more definitive answer than mine, but I would think if the person is in the business that generated the royalties that the royalties would flow through the business and therefore likely be considered earned income.

[Blinky the 3-eyed Fish]

To qualify as income you need it to come from a situation where "...personal services of the taxpayer are a material income-producing factor." 401©(2)(A)(i). So, are the royalties from the person's personal services?

[Guest merlin]

I just had the same question come up yesterday. CPA has a client who is a theatrical producer with about $500,000 in royalties this year. I made pretty much the same observations as Blinky and JAY21. His answer was yes, she wrote the book, play, graffiti,whatever, and therefore her royalty payments should be considered as EI.

Are royalties subject to SE tax? If so, is that determinative?

[Guest merlin]

I put the question to the Technical Answer Group. Their response referred me to IRS Publication 54, which says that royalties from the leasing of oil and mineral lands and patents are a form of rent or dividends and are unearned income.

Royalties received by a writer are EI if they are rec'd:

1. For the transfer of property rights of the writer in the writer's product, or

2.Under contract to write a book or a series of articles.

[Blinky the 3-eyed Fish]

What if the royalites are generated through a series of interpretive dances on a street corner?

[Lame Duck]

I was unable to use the royalties from the sale of my book to set up a qualified plan, but that's only because I couldn't find a provider who would set up a plan with annual contributions of $7.

[Lori Friedman]

You have to look at the underlying activity and turn to common law for an answer. Royalties are usually considered to be passive income, and not SE income, but a number of court decisions have treated certain royalties as earned income.

In general, royalties are subject to SE tax if the recipient is actively engaged in a trade or business. Someone who writes a book and works to promote it is probably self-employed. On the other hand, the Tax Court held that royalties received more than 5 years after completion of work on a textbook, which had required no later revisions or updating, weren't self-employment income.

Blinky, just how much time do you spend on street corners, and just what sort of dancing are we talking about?