Do Royalties Qualify for the QBI Deduction?
Explore how different types of royalty income may meet QBI deduction rules based on activity level, income source, and tax classification.
The Qualified Business Income (QBI) deduction, established by the Tax Cuts and Jobs Act of 2017, offers a potential tax break of up to 20% on certain business income.1Internal Revenue Service. Qualified Business Income Deduction While often linked to traditional small businesses, taxpayers receiving royalty income may wonder if they too can benefit.
Whether royalties qualify depends on specific factors beyond just receiving the payments. The nature of the royalty and the activities involved in generating it are key considerations. Let’s examine the requirements.
Types of Royalties That May Qualify
Royalty income stems from payments received for the use of property. Common sources include intellectual property, such as copyrights, patents, and trademarks, as well as natural resources like oil, gas, and minerals.
Payments for intellectual property often depend on usage—for instance, the number of books sold under a copyright or items produced using a patent, as noted in IRS Publication 525.2Internal Revenue Service. Publication 525, Taxable and Nontaxable Income Royalties can also arise from the extraction of natural resources from property you own, typically based on production volume or revenue.
The source of royalty income is generally where the property is used. Royalties from a copyrighted play produced in the United States, for example, are considered U.S.-sourced. This matters because the QBI deduction typically applies to income connected with a U.S. trade or business. While various royalty types exist, eligibility hinges less on the category and more on how the income is generated.
Passive vs. Active Royalties Criteria
A central factor in determining QBI eligibility for royalties is whether the activities generating them constitute a “trade or business” under the Internal Revenue Code. Tax law generally defines a trade or business, based on guidance like the Supreme Court’s decision in Commissioner v. Groetzinger, as an activity conducted with continuity, regularity, and the primary purpose of earning income or profit. This standard comes from Section 162, which governs the deduction of business expenses.3Cornell Law School Legal Information Institute. 26 U.S. Code § 162 – Trade or Business Expenses
Applying this to royalties involves looking at the taxpayer’s involvement. If you are actively and consistently engaged in efforts related to the property generating the royalty, it suggests an active trade or business. An author who regularly writes, publishes, and promotes their books, receiving royalties, likely meets this standard. An inventor actively managing patents and seeking licensing opportunities would also probably qualify. Income from such activities could be eligible for the QBI deduction if other requirements are met.
Conversely, royalties from activities lacking regular and continuous involvement are typically viewed as passive investment income and do not qualify. An individual who inherits mineral rights and merely receives checks from an energy company, without participating in management, usually does not meet the trade or business threshold. Similarly, holding a copyright from a past project with no ongoing effort to manage or market it generally yields passive income. Income must stem from a trade or business to be considered QBI under Section 199A rules.4Internal Revenue Service. Section 199A Qualified Business Income Deduction FAQs
Important QBI Eligibility Factors
Even if royalty activities constitute a trade or business, other requirements under Section 199A affect QBI deduction eligibility. A taxpayer’s overall taxable income before the QBI deduction is one consideration. For the 2024 tax year, Revenue Procedure 2023-34 sets income thresholds at $383,900 for married couples filing jointly and $191,950 for other filing statuses.5Internal Revenue Service. Revenue Procedure 2023-34 (Inflation Adjustments for Tax Year 2024) Below these thresholds, the deduction is generally the lesser of 20% of QBI or 20% of taxable income minus net capital gain, subject to other potential limits.
When taxable income exceeds these thresholds, the calculation can become more complex, and the type of trade or business matters. Tax law distinguishes between general businesses and “Specified Service Trades or Businesses” (SSTBs).6Cornell Law School Legal Information Institute. 26 U.S. Code § 199A – Qualified Business Income SSTBs involve services in fields like health, law, accounting, performing arts, consulting, athletics, financial services, or where the main asset is the reputation or skill of employees or owners. Royalties earned by a performing artist or an author heavily reliant on personal reputation could be classified as SSTB income.
This classification impacts taxpayers above the income thresholds. For 2024, if taxable income is above the initial threshold but below $483,900 (married filing jointly) or $241,950 (others), the QBI deduction for SSTB income is phased out. Above these upper limits, the deduction for SSTB income is disallowed entirely.
For royalty income from a non-SSTB trade or business, taxpayers with income above the 2024 thresholds face a different potential limitation. The deduction may be restricted based on W-2 wages paid by the business and the unadjusted basis immediately after acquisition (UBIA) of qualified property.7Internal Revenue Service. Instructions for Form 8995-A, Qualified Business Income Deduction Royalty activities, especially involving intellectual property or passively managed mineral rights, might have minimal W-2 wages or UBIA. In these cases, even for non-SSTB income, this limitation could reduce or eliminate the QBI deduction for higher-income taxpayers.
Filing Steps for the Deduction
Claiming the QBI deduction for qualifying royalty income involves specific steps on your federal tax return. First, report the royalty income, typically on Schedule E (Form 1040), Supplemental Income and Loss.8Internal Revenue Service. Instructions for Schedule E (Form 1040), Supplemental Income and Loss List each royalty property, report the gross income, and deduct related expenses to determine the net income or loss.
This net royalty income figure contributes to the QBI calculation on either Form 8995 (Simplified Computation) or Form 8995-A.9Internal Revenue Service. About Form 8995, Qualified Business Income Deduction Simplified Computation The choice depends mainly on your taxable income. Taxpayers generally use Form 8995 if their taxable income before the QBI deduction is below the annual thresholds ($191,950 single/other, $383,900 joint for 2024) and they meet other criteria outlined in the form instructions. Those exceeding the thresholds or facing more complex situations use Form 8995-A.10Internal Revenue Service. About Form 8995-A, Qualified Business Income Deduction
Both forms require aggregating QBI from all qualified trades or businesses, including qualifying royalty activities. Form 8995 involves a straightforward calculation leading to the deduction amount. Form 8995-A is more detailed and may require completing additional schedules, especially if dealing with SSTBs or multiple businesses.
The final QBI deduction calculated on Form 8995 or Form 8995-A is then entered on your main tax return, Form 1040 or Form 1040-SR (typically line 13). You must attach the completed Form 8995 or 8995-A (and any associated schedules) to your return. Maintaining clear records of royalty income, expenses, and activities supporting the trade or business classification is important for substantiating the deduction.