Passive income is usually what royalty payments are considered. Passive income is earnings that are not derived from an employer or contractor. Royalties fall under this category because they are created by activities like owning intellectual property (like books, music, patents, or trademarks) without the need for ongoing active involvement.
Royalties can be considered active income in certain circumstances. If you are actively involved in the process of generating royalties, such as through continuous effort in promoting your work, maintaining a business, or providing ongoing services related to the royalties, it can be classified as active income. For example:
- An author who consistently advertises their books and makes appearances at book signings.
- A musician who is active in marketing their music and performs live concerts.
- A franchise owner who actively takes charge of their business.
In these circumstances, the constant effort and involvement in generating and maintaining the income stream can make it active instead of passive.
The S Corporation Revocation Rule:
An S corporation's status is not revoked by the IRS because of the percentage of royalty income alone. In order to maintain its status, an S corporation must meet certain eligibility requirements and restrictions. An S corporation must ensure that it doesn't accumulate too much passive income, as an example. The S corporation may become a C corporation if passive income (including royalties) surpasses 25% of the corporation's gross receipts for three consecutive years.
