What are Royalties & How do Royalty Payments Work?

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Royalty payments are what encourage and protect creativity and inventions around the world. From the photograph hanging on your wall, the song playing from your radio–even the fuel powering your car (which started as crude oil extracted from someone’s land). Royalty payments ensure that the creators and owners of these properties are appropriately compensated.

Essentially, royalty payments are payments received through license agreements or royalty agreements that compensate owners for the use of their intellectual property, creative works, or mineral rights for natural resources like oil and gas extracted from their land. 

Royalties provide cash flow to owners through a legal contract for a royalty-based license that pays a percentage of gross revenue, net sales, or another negotiated rate during the license term. 

This article defines royalties, royalty payments, royalty income, and royalty fees. It provides insights into types of royalties and typical royalty percentages.

What are Royalties?

Royalties are payments that purchase the rights to use, have or make changes to someone else’s property, whether it’s intellectual property or other creative works. The royalty rate is usually negotiated and determined between the licensor and licensee

What Works Can be Copyrighted to Receive Royalties?

The U.S. Copyright Office is used to register and copyright these types of works before publication:

  • Literary works
  • Performing arts
  • Visual arts
  • Other digital content
  • Motion pictures, and 
  • Photographs. 

Types of Royalties

Types of royalties include:

  • Song or music royalties
    • Songwriters, composers, and their publishers owning the copyright
  • Book publishing royalties
  • Digital content and social media influencers
  • Oil & gas and mining royalties
    •  paid to mineral rights owners with a royalty interest
  • Franchise fees in franchising businesses
  • Patent royalties

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Royalty Income vs. Royalty Payments vs. Royalty Fees

Royalty payments, royalty income, and royalty fees differ based on the license agreement and the type of royalty.

What is Royalty Income?

Royalty income is the amount received through a licensing or rights agreement for the use of copyrighted works, influencer endorsements, intellectual property like patents, or natural resources like oil and gas properties, often including an upfront payment and ongoing earnings and payments. 

What are Royalty Payments?

Royalty payments are funds paid to owners through a royalty agreement for rights to publish or use copyrighted writing, music, movies, other intellectual property like patents or types of tangible property like oil & gas land for drilling rights. 

What are Royalty Fees?

Royalty fees are amounts earned upfront and subsequently upon making product sales from their licensers or publishers of copyrighted works of literature, music, or other types of property like patents or oil & gas land. In the franchising industry, the franchisee pays the franchise company ongoing franchise royalty fees as a percentage of revenues to remain in the franchise. 

Average franchising royalty fees are 6%, according to franchise industry software provider, FranConnect. 

Royalty Payments and Royalty Income Examples

What are Royalties in Music?

According to Songtrust, music industry royalties include Composition Royalties, which are performance royalties and mechanical royalties related to physically reproducing, digitally streaming, or downloading musical compositions. Music royalties also include Master Recording royalties for digital performance royalties and master recording revenues. 

Performance royalties are royalty fees paid by public broadcasters and users of copyrighted performance royalties. Triggers include radio stations playing songs or music, movies, television shows, advertisements, and public events with theme songs or music used at political campaign rallies.

ASCAP is the organization for songwriters, composers, and music publishers that helps them register their music and see royalty statements online to collect royalties. BMI is the largest U.S.  non-profit music rights organization that connects songwriters and music owners to the companies and organizations that want to play their music publicly.

Distributors in the music industry, like CD Baby, structure agreements to receive either fixed fees or percentage distribution royalties from the artist’s master recording royalties. 

Book Publishing Royalties

Book publishing companies pay royalties to an author for their copyrighted work when they purchase the rights to publish their book. Published authors receive both advances and future royalties income based on book sales. Once books are sold, the book royalties are payable, then paid once or twice a year, according to the publisher, Penguin books. 

Digital and video content

Companies are turning to online content creators—bloggers, vloggers, dancers, music artists, and more—for a new take on digital marketing. From web videos to blogs, creative partners run the gamut of content specialties and niches. Consider YouTube: creators are producing comedy skits, DIY, daily vloggers, gaming streams, pranks, challenges, cooking videos—and that’s just one video platform! 

The diverse content specialties demonstrate that every collaboration is its own production, which means a standard royalty rate doesn’t exist. In a Collaborator Academy course, YouTube shared a list of various costs to keep in mind when collaborating with a content partner:

Talent: paying for the on-air talent and whether that contract is exclusive, non-commit, or just a talent fee.

Production: the work behind the scenes, such as special effects or on-location fees.

Intellectual property: the rights and terms to use the video for commercial use.

Distribution: placing the content on the websites.

Media amplification: promoting the video collaboration through social channels.

These pricing considerations can also apply to other partnerships with other creators like lifestyle bloggers or songwriters. Understanding the various aspects of producing content will help you develop a productive partnership with creative content creators domestically and abroad.

Under U.S. copyright law, original works receive “copyright protection the moment it is created and fixed in a tangible form that it is perceptible either directly or with the aid of a machine or device.” In other words, any original work produced by a content creator is automatically copyrighted, which gives the creator the right to license the asset and charge royalties for ongoing use of it. The royalty rate is calculated according to specific terms defined in a licensing agreement; the terms include restrictions on geographic distribution, time period, or the number of uses of the licensed asset. A typical calculation for a royalty rate is paying a specific percentage of the sales generated from the asset.

Franchisee to Franchisor Royalties

According to the Small Business Administration (SBA), in franchising, franchisees pay monthly franchise royalties (franchise fees) to a franchisor as 4% to 12%+ of gross sales to “own and operate the business.”

Oil and Gas Royalties to Mineral Rights Owners

Oil & gas producers pay royalties to land mineral rights owners monthly based on their royalty interest for production. The royalty payment is the negotiated percentage of gross revenue from production, based on the oil & gas lease. 

Patent Royalties

A patent licensee pays the patent owner for the rights to use the invention based on a negotiated agreement. The patent license may either be a fixed-rate contract or a royalties-based license fee. The arrangement may be exclusive or non-exclusive use of the patent’s intellectual property, providing the know-how to become a licensed product and legal protection. The length of the patent license is determined in the license agreement. 

What is Royalty Payments Tax Treatment in the U.S.?

In the U.S., businesses can generally take a tax deduction for royalty payments as expenses. 

The IRS treats royalty income received as ordinary income reportable either on Schedule E for Supplemental Income and Loss or Schedule C for self-employed individuals. IRS Publication 525 has more detailed information about Taxable and Nontaxable Income. 

Payers report royalties of $10 or more paid to recipients in Box 2 of the information return, Form 1099- MISC. Payers send or file a copy of each form with the IRS, any applicable state, and the recipients to prepare their income tax returns. 

How Do Royalty Payments Work?

Royalty payments are negotiated once through a legal agreement and paid on a continuing basis by licensees to owners granting a license to use their intellectual property or assets over the term of the license period. Royalty payments are often structured as a percentage of gross or net revenues. 

What is a Royalty Deal?

A royalty deal is when an investor gives funds to a company–not the individual–in exchange for a certain percentage of total sales. For example, let’s say an investor invests in a clothing company and receives 5% of gross sales. This means the investor earns $2.50 on every $50 shirt sold. 

Example of Automated Royalty Payment Processing

Because royalty payments are made to many payees at once, using a system for mass payment automation is essential to streamline the process. 

Lean operations are the ideal in many industries, but it’s critical for companies that deal with digital creative services.

Izo, Digital Media Firm, Automates Tax Identification Process

Izo, the parent company of Dance On, is well aware of the challenge. The Los Angeles-based digital media firm partners with thousands of dance groups around the world to produce videos aimed at Millennial and Gen-Z audiences. Izo’s influence network is best known for creating dance music videos to Silentó’s “Watch Me (Whip/Nae Nae),” helping propel it as the top trending song in 2015.

That’s the heart of its business—collaborating and distributing content—but Izo knew that cumbersome back-end processes would distract the company from its focus.

“For a lot of early-stage digital media entertainment companies, in order for them to become cashflow positive, it behooves them to run very lean,” Izo Chief Finance Officer Dan Steinberg told Tipalti. “Digital media involves much more guerrilla approaches to production. You’re filming a lot more with lower budgets, and ideally employing data-driven approaches to extend the value of content.”

With the help of the Tipalti mass payment platform, Izo improved its royalties payment workflow by automating tasks related to tax identification. Previously, Izo had to request, collect, and validate the tax identification of its growing community of content creators. But after implementing the Tipalti platform, new artists and partners were able to complete digital IRS W-9 and W-8 documents through Tipalti’s onboarding portal. The streamlined workflow reduced the paperwork for partners and Izo management, enabling the company to run a lean finance operation.

“From our partners’ standpoint, the process is smooth and transparent,” Steinberg said. “We don’t hear complaints. That’s the golden indicator that nothing is going wrong, and that’s the payment experience you want.”

Use Automation to Create a Lean Finance Operation

Simply put, automation is the key to unlocking the secret behind global creator and royalty payments. A lean finance operation enables Izo to put its business growth efforts where it matters most: growing its influencer network, creating exciting new content, and connecting with new audiences.

Why put geographic limits on creative collaboration and marketing reach? Automation is the key to unlocking the secret behind growing your global creator network while scaling your royalty payment capabilities. A mass payment platform like Tipalti takes on the manual tasks, such as verifying country-specific tax compliance, and keeps you focused on partnering with influencers and other creatives without geographic limitations.

That Germany-based video creator you’ve been dying to partner with? You can now reach out in confidence, knowing your business operations will support global partners.

Creative partners are the driving force of change, continually serving up new ways to share information or tell stories. Lean business operations using automation enable media producers to focus on where it matters: producing innovative content with the growing community of creatives around the world.

Conclusion – Royalties and How Royalty Payment Works

Businesses and organizations pay royalties to owners to use their creative works and pay owners for their intellectual property or ownership interests like mineral rights. Users pay royalties based on the terms of a legal license agreement. A royalty payment received by licensees is royalty income to the recipient, subject to U.S. ordinary income taxation. 

Streamlining the royalty payment process with AP automation software significantly increases business efficiency. If your business pays royalties, refer to this link to find out how to make royalty payments efficiently to attract and retain creative talent. 

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