# US citizen in UK; receiving royalties from US?



## NotanAccountant (Apr 6, 2014)

Royalties, as in payments or compensation for use or purchase of intellectual property, seem to be complicated. At least there seem to be a bewildering number of ways of treating them.

I am a US citizen resident in the UK and I have sold the rights to a design I created to a US company in exchange for an agreed percentage of the price they get from their distributors. If the product doesn't sell I don't get anything, but it has been selling slowly but probably not enough to go to a second run, I estimate I might get $4k spread over two years. First payment was at the end of 2015, so needs to go on my IRS return. 


The US company has provided Form 1099-MISC showing the payment as "Royalties". Nothing has been withheld. Since UK tax filing for 2015 isn't due yet this income hasn't shown up on the HMRC radar yet. 

This is the first time I have done this sort of design work and been paid, I have an unrelated full time (PAYE) job and earn no other income. Basic rate 20%.

I have read a lot of pages across the internet, but can't decide which information matches my situation. *Can anyone here give their opinion on how I should be reporting these payments?* :confused2:


The chap here seems pretty close to my situation.
www_DOT_expatforum.com/expats/expat-tax/473498-looking-structure-prevent-double-taxation-book-royalties_DOT_html (sorry not enough posts to post link )
Where its suggested that even though the income is not earned from a "foreign" source, it can be counted into the FEIE Form 2555. 

The other stated option involves tax credits, but whether this means paying the US, then claiming the credit with the UK, or the other way around, I don't know. :frusty:

Thanks

Chris

PS. Thanks to all the folk who share their knowledge and expertise!:clap2:


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## BBCWatcher (Dec 28, 2012)

U.S. source royalties, especially of the sort you describe, do not count as foreign earned income for Form 2555 or 2555-EZ. That's simply not an option.

Unless the U.K.-U.S. tax treaty says otherwise (doubtful), you pay U.S. income tax on that royalty income first then take a foreign tax credit as/if/when allowed on the HMRC side.


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## Bevdeforges (Nov 16, 2007)

Do check Publication 54, though. I know that for royalties stemming from a published work (like a book or magazine article) or a work of art, the royalties are considered "earned income" as long that you were located overseas while doing the work (i.e. writing or creating the work). It's where you were located while working on the original work, not where the royalties are coming from.

Not sure if that applies to designs, but I would definitely check pub 54 before just assuming it's not earned income.
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

OK, let's check Publication 54. Here's what I was thinking of as the showstopper:

"Foreign earned income does not include the following amounts.... Payments you receive after the end of the tax year following the tax year in which you performed the services that earned the income."

Setting aside every other hurdle, is this a showstopper?


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## Bevdeforges (Nov 16, 2007)

No, there is (or used to be, when it was relevant to me) something in pub 54 specifically about royalties. Obviously, an author writes a book, but is paid royalties in subsequent years after it is published (based on sales). It may depend on whether the royalties are an "advance" against sales in the future or just a toting up of sales over a given period - but you report the royalties when they are received.

Now, as I said, I'm not sure if that is specific to written works and/or works of art, but it would be worthwhile to check. (I can't right now as I have some family matters I have to attend to today and tomorrow and am "otherwise occupied"). 
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

Well, there isn't such text now, and we have to deal with 2015.

....I'm also thinking a couple steps ahead here (Self-Employment Tax), so "be careful what you wish for" in terms of royalties as earned income.  We'll get to that potential issue in due course.


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## Bevdeforges (Nov 16, 2007)

OK, found it - from pub 54 (I'm going from the HTML version so I don't have a page number or anything):



> Royalties received by a writer are earned income if they are received:
> 
> For the transfer of property rights of the writer in the writer's product, or
> 
> ...


Unfortunately, they don't mention other types of royalties, but I'd take the position that the first one could be used to cover property rights of a designer in the designer's product.
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

What's the exception to the next tax year rule? I don't see one.


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## ForeignBody (Oct 20, 2011)

The US-UK Tax Treaty should be your starting point: https://www.treasury.gov/resource-center/tax-policy/treaties/Documents/uktreaty.pdf

Article 12 is all about royalties.


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## BBCWatcher (Dec 28, 2012)

OK, but the treaty doesn't offer any help (or harm for that matter). Royalties (whether earned income or not) aren't covered in Article 1 section 5. So we can safely ignore the treaty.


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## NotanAccountant (Apr 6, 2014)

A simple answer would have been nice for my filing, but I am a little glad that the answer isn't totally straight forward since it allows me to feel slightly less of an idiot for not having found the answer myself!

It looks to me that if I was 100% British, rather than dual national, Article 12 would cover the situation. Its the pesky US citizenship taxation clause in Article 1, para 5 that invalidates Article 12 in my case.


> "4. Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship *may tax its citizens, as if this Convention had not come into effect*."




Article 12 does go into greater depth about what royalties can be paid for and goes so far as to list 


> "... any patent, trade mark, design or model, plan, secret formula or process, or other like right or property,..."


I look at it that I have created something and sold the rights to reproduce and sell it, in return for a percentage of the sales income. That's pretty much what authors and musicians do and that's the pigeon hole that this income seems most comfortable in. Bev's find makes it sound like royalties can be firmly considered as earned income.

I looked into the self employment angle and am confident that it does not apply to me.

I am still struggling a bit to bend my head around the definition of "Foreign Earned Income". I had always thought that it meant "income from foreign sources while you are outside the US" but P54 seems to describe it more simply:


> Foreign earned income generally is income you receive for services you perform during a period in which you meet both of the following requirements.
> 
> Your tax home is in a foreign country.
> You meet either the bona fide residence test or the physical presence test.


It makes no mention of where the income is coming from, just where you are when you earn it, In which case all income I receive can be counted against the FEIE...which is good...I am just suspicious of things which sound that good!

Is that too good to be true?


BBCWatcher, 

I have read that line about "Payments you receive after the end of the tax year..." a bunch of times and think that it means that income is only counted in the tax year it is received, not in the tax year in which the work was done. If this was not the case, everyone who is paid on any day other than the last day of the month would have a problem with some percentage of their January pay packet not being eligible for FEIE. If you get paid on the 20th of each month, January's pay packet includes about 9 days' worth where the work was done in December

Does that make sense? 

If someone was self employed and finished one big contract in Nov/Dec but were not paid until January, just before starting another big job due to finish in September, they could find that they exceed the FEIE limit with both payments in the same year. Filing before June they might wish to count the payment for the first job in the year that the job was completed. 

That's just my inexpert take on it.


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## BBCWatcher (Dec 28, 2012)

OK, a couple points:

1. Ignore the tax treaty. That's a red herring/dead end. Article 1 section 5 obliterates most of the treaty, including any part of the treaty that deals with this type of income.

2. You're eager to try to do something that might not be in your self-interest. If this royalty income is "conventional" royalty income then it cannot be subject to the Self-Employment Tax. Do you want it to be subject to the SE Tax?  If you do, keep struggling to try to classify it as earned income. 

3. What's your marginal U.S. tax bracket on this income, and how does it compare to the marginal U.K. tax bracket? If the U.S. tax bracket is similar or lower, then you _really_ don't have to worry about it. Just pay the U.S. tax first then take a foreign tax credit against your U.K. tax return. But even if the U.S. marginal tax rate on this income is higher you might still be able to take a full foreign tax credit on your U.K. tax return. You just have to take a look at how the foreign tax credit works on the U.K. side, that's all.

Check that path first. If that path works, great, everything is nice and tidy. Trying to shoehorn this royalty income into a strange definitional bucket isn't where you'd start, in my view.


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## Bevdeforges (Nov 16, 2007)

OK, a responsible alternate opinion here. I think your take on things is spot on.

I would contend that royalties such as the ones you're getting are earned income of the same sort as authors and artists. (They only seem to make the distinction with oil and gas "royalties" which are payments for mineral extraction - obviously something you didn't "create" just because you own a piece of land with valuable minerals on it.)

And yes, the pub 54 definition of foreign earned income doesn't say a thing about the source of the income. Just where you were when the work was done. (This would complicate matters if, for example, you were receiving royalties for a book or other work you actually created while living in the US. But I take it that's not your case.) And yes, income is counted in the year in which it is paid - so I have no idea what that "next tax year" thing is. (There's a science devoted to whether or not you defer your December paycheck into January to smooth your tax income.)

I don't know much about UK taxes, but you should be aware that not all jurisdictions allow you to simply offset taxes paid to another country (i.e. the US) against what you pay locally. (That's not at all how it works here in France, for instance.) I would check out the UK's treatment of foreign taxes before committing to one plan or another. 
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

I'm hard pressed to figure out why you'd _want_ to pay the U.S. Self-Employment Tax in this case, which would seem to logically follow if this income is treated as earned income. Versus just taking the 1099-MISC that says "royalties" and treating them as, well, royalties -- with a tax credit against U.K. taxes.

Before doing something _exotic_, calculate the total tax impact of just bog standard treatment of this income, at face value. It says "royalties" on the 1099-MISC, so what does standard royalty income treatment mean? Figure that out first, then decide whether you even need to try to get clever or cute. (Which doesn't seem so clever or cute to me.)


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## NotanAccountant (Apr 6, 2014)

I don't know how to be any clearer than I have been that I don't want to pay self employment tax because I am not self employed. I am obviously missing some important cue because I don't understand why treating the payments as income will mean I have to pay self employment tax. My understanding was that income from one off or very infrequent exercising of a hobby did not make one self employed in that activity. I'll try to find where I saw that, but if anyone and pull up a reference faster, I am keen to see it.

As for being cute or exotic, I am not looking to be either. I wanted to handle this in as straight forward a way as possible and have searched high and low for how I am meant to treat royalty payments, and other than treating them as earned income I have found no other advice. It was that very lack of clear information on how to treat "standard royalty" income that brought me here.

Perhaps you can tell me how it is meant to work over time if I do go for paying tax in the US, then claiming tax credit in the UK? 

Payments are made quarterly. The tax years are different for the US and UK, US runs from January and UK runs from April, so for US-2015 return I would declare and pay tax on the first payment which I banked before the end of 2015. Then for the the UK-2015 return I would have to declare the payment made at the end of 2015 which I would have paid US tax on, and the one from the start of 2016 that I have not yet paid US tax on. Then for the US 2016 return I would be declaring four payments, one of which has had tax paid in the UK. That sounds far from straight forward. paying a bit of tax here and a bit there and having tax credits from both countries.

I will look up what the UK will charge in tax and how they handle overseas royalties.

Thanks for all the advice so far!


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## Bevdeforges (Nov 16, 2007)

No, there is no question of you paying "self employment" tax on royalties. As long as you are enrolled somehow in the UK social insurance scheme, you're most definitely not subject to the US self employment tax - even on side activities like this. (And frankly, for all they yap about the "certificate" to prove this, I've never heard of anyone in a social security treaty country being asked to actually produce one.)

I agree with you that lapping tax credits back and forth sounds more complicated than it is worth - IF that is even an option. Normally speaking, if you are resident in the UK, your "primary" tax obligation is to the UK. They should have some method of adjusting or crediting any taxes you wind up paying to the US (where the income tax system is about as intricate as they come) but it's usually not based on a straight-forward tax credit.
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

Bevdeforges said:


> No, there is no question of you paying "self employment" tax on royalties.


Hang on a second. There is actually a _question_ about that.

So run the calculation when this royalty income is treated as, well, royalty income. It's what's marked on the 1099-MISC, so start with that. You calculate the U.S. tax owed on that income, then calculate how much of that U.S. tax owed you can take as a credit on your U.K. tax return. Start with that and see where you end up. That's the bog standard method here, completely uncontroversial. Everything else is at least somewhat controversial -- and perhaps also less attractive from a tax point of view.

I would also add that the FEIE has a time limit. I've already described it upthread. The IRS doesn't allow you to defer foreign earned income too far ahead. (For hopefully obvious reasons. It'd be a gigantic loophole otherwise.) Yes, you can receive payment in January -- or in December, for that matter -- of the year following when you performed the service. But the IRS doesn't let you go past that, and you already said this royalty income will stretch for at least two years. So the FEIE isn't going to work very effectively here anyway.


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## Bevdeforges (Nov 16, 2007)

Royalty income is, by definition, paid over an extended period of time. Say, if you wrote a best seller and managed to flog it to an American publisher. You wrote the book in Year 1, and it can take until Year 2 or 3 before it's published. Then you get royalty payments in years 4, 5, and 6 as the book sells. That's not actually deferred income. Obviously we don't know the exact terms of the royalty agreement here, but generally speaking royalties are paid based on the use or sales of the item or works.
Cheers,
Bev


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## ForeignBody (Oct 20, 2011)

You guys are making this far too complicated.

In the US royalty payments are "taxable as ordinary income" (publication 17). Enter it in Schedule E of 1040.

In the UK "Overseas pension, social security benefits and royalties, etc." (FN10) are lumped together. Fill in the Foreign Pages of the UK tax return and claim Foreign Tax Relief for any US tax paid.

Yes, there is a timing issue, but that is no different from any other US/UK income because of the different tax years.


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## Bevdeforges (Nov 16, 2007)

Yes but - royalty income can fall under the FEIE if you choose to go that route. (As long as you were located outside the US when you created the object of the royalty payments.) Sure, report it on Schedule E, but include it with "earned income" on the 2555, too, to exclude it from taxation.
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

Where is there an exception to the next year time limit even for FEIE-qualified royalty income (which I'm not convinced this is)?

I quite agree with you, ForeignBody.


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## Bevdeforges (Nov 16, 2007)

BBCWatcher said:


> Where is there an exception to the next year time limit even for FEIE-qualified royalty income (which I'm not convinced this is)?
> 
> I quite agree with you, ForeignBody.


It has nothing to do with the FEIE. That's how royalties are paid and reported for taxes.
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

Bevdeforges said:


> It has nothing to do with the FEIE. That's how royalties are paid and reported for taxes.


Bev, I described the problem upthread. Go take a look again at the FEIE's instructions (and Publication 54). There's a next tax year time limit associated with all FEIE qualified income (which this income may not be). Unless you can find an exception that isn't actually written there. I've looked and haven't been successful. Yes, I know royalties can stretch over more than one or two years. As written, the FEIE's instructions say that's perfectly fine -- you can receive such income, of course -- but you cannot treat N+2 year income as excludable.

Contrast that with taking the 1099-MISC at face value, reporting the income as exactly what it is described as (royalty income), not trying to shoehorn it into the FEIE, paying U.S. tax at ordinary rates on that income, and then taking a foreign tax credit on your U.K. tax return. That's all straightforward and easy, there's zero risk of any IRS or HMRC questions, and the overall tax impact is likely to be _at least as favorable_ as any other approach (primarily due to social insurance taxes owed on either side of the Atlantic -- you can't choose one "earned income" aspect without the other). And yes, work done "as a hobby" is self-employment, of course. (What else is it?)

There are at least three seriously difficult hurdles here to try to squeeze this particular income into the FEIE, and for what, why? I don't get it. I agree with ForeignBody on this one. "Keep it simple."


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## NotanAccountant (Apr 6, 2014)

BBCWatcher,

Okay, I think I am following what you are saying better now. Can you confirm I am understanding you right: Royalties paid in the year that you sell the rights and the following year can be considered for FEIE, but beyond that returns would have to be considered like interest or other non-exclude-able income? 

In general, when categorising a new income, does one have to start as one will continue?

In the UK I believe that the only way to pay tax on income not from an employer is to register as self employed. However I don't think that there is a separate tax levied for being self employed. The additional charge for National Insurance (social security) depends on profits from self employment being in excess of £5,965 per year. I am a long way short of that point so should be able to claim relief from additional payments.

I am going to try to get in touch with HMRC today and see if they can advise on how they expect such payments to be handled for someone in my situation. I expect that they will be taxed at 20%. Its how the alternating US/UK tax credit thing works that I am unclear on.

Thanks for all the advice!


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## ForeignBody (Oct 20, 2011)

NotanAccountant said:


> BBCWatcher,
> 
> Okay, I think I am following what you are saying better now. Can you confirm I am understanding you right: Royalties paid in the year that you sell the rights and the following year can be considered for FEIE, but beyond that returns would have to be considered like interest or other non-exclude-able income?
> 
> ...


No, in the UK it is covered in the Foreign Pages of the tax return as per the reference I gave. You don't have to go through any self employment process. 

Check out these guidance notes for the UK return and you will see that claiming the US tax and declaring royalties are both covered:

https://www.gov.uk/government/uploa...achment_data/file/420047/sa106-notes-2015.pdf


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