IRS Revenue Ruling 2004-86 is a comprehensive ruling issued by the Internal Revenue Service (IRS) that discusses how to handle royalties and licensing fees. This article will summarize the main points of IRS Revenue Ruling 2004-86, so you can understand what it means for your business.
The IRS defines “royalties” as payments received from the sale or use of a product or service, including copyrights, patents, trademarks, and licenses to use intangible property. Payments made in exchange for technical information are also considered royalties.
Royalties are taxed at ordinary rates as income if they have an established tax basis such as cash method accounting or specific identification method accounting under IRC section 482. If the royalties are not taxed as income, they are usually subject to withholding tax at a rate of 14% or 30%, depending on which country the recipient is located in and whether the payment was for certain services.
The lower withholding tax rates will apply if an international agreement exists between your home country and the recipient. Since the royalties are paid for intangible assets, they would be subject to a US withholding tax rate of 30%. If such an international agreement exists, you can apply for a reduced withholding tax rate. The standard treaty uses either 14% or 0%, depending on the country where the recipient is located.
To summarize, the IRS revenue ruling 2004-86 states a reduced withholding tax rate is granted to recipients who are not residents in the US (and thus, do not have an SSN or EIN) and reside in certain countries where treaties exist.