7727.06 / What are the tax consequences with respect to any royalties created by the NFT?
Many NFTs have embedded contracts that give the seller or creator the right to a royalty any time the NFT is sold in subsequent transactions. Royalty payments are generally taxed as ordinary income to the seller under the basic gross income principles contained in IRC
Section 61.
If the creator of an NFT was an employee and was granted royalty payments by their employer for use of the NFT, the amounts likely will not be subject to FICA and FUTA taxes based on otherwise applicable tax principles that apply in the context of intellectual property in employment relationships. The IRS has provided guidance on a situation where a company paid royalties to five individuals for licenses to manufacture certain articles to which the individuals held the patent. 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.
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.1
Planning Point: Note that the tax issues vary depending on whether a transaction involving an NFT is treated as a license or a sale of the actual NFT. The IRS has cautioned that the treatment as either a sale or a license must be consistent across all parties to the transaction.2
1. See Rev. Rul. 68-499.