FICA tax. “Royalties are not taxable wages unless paid to an employee for remuneration for employment. If an employee receives such payments pursuant to an agreement apart from an employment contract, royalties are not considered remuneration for employment.” (Rev. Rul. 68-499, 1968-2 C.B. 421)
Federal unemployment tax. Same rules as FICA tax.
Federal income tax withholding. “While royalty payments are not specifically exempted by regulations, they appear to be exempt by the implication of other rulings excluding payments for use of property. Note: Be sure to separate payments under employment contracts from payments for the right to employees’ inventions. Reason: Only the payments for services are subject to employment taxes.” (Fingertip Guide to Benefits: A-71)
Royalty payments are reported on Form 1099-MISC.
To process a royalty payment, a Direct Pay Form will need to be completed. Be sure to indicate “Royalty Payment” in the “Description and Special Instructions” area on the Direct Pay form.