8168 / Are royalty payments made to an employee for the creation of intellectual property considered “wages” for purposes of the Federal Insurance Contributions Act (FICA) and Federal Unemployment (FUTA) taxes?
No. In Revenue Ruling 68-499,1 the IRS analyzed a situation where a company paid royalties to five individuals for licenses to manufacture certain articles to which the individuals held the patent. Three of the individuals were employees of the company. The licensing contracts were separate and distinct from the employment contracts governing the employment relationships with these individuals. The royalties were not paid for services performed for the company by any of the five individuals.
Under Sections 3121(a) and 3306(b) of the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA), the term “wages” means all compensation for employment, including the cash value of any property paid as compensation to the employee. The term employment generally means any service performed by an employee for his employer.2
Based on the definition of wages, the IRS found that the royalties were paid for licenses to manufacture certain articles, rather than as compensation for services rendered in the course of an employment relationship. Thus, the IRS held that the royalty payments were not wages for FICA and FUTA tax purposes (so that the payments were not subject to general employment tax withholding that applies to wages).3