Becoming a contributor in the stock media market can be an appealing proposition. The relative ease of breaking into the industry and the allure of a source of passive income can make it a worthwhile endeavor. But even with minimal sales, it is important to understand that selling stock media may draw you into a whole new world of tax implications.
Those that already operate a freelance or self-employed business will likely take these tax implications in stride, but for the hobbyist contributor, unexpectedly receiving a 1099-MISC in the mail for the first time can lead to a daunting learning curve.
This guide will not cover all of the basics to running a self-employed business, though I will be posting links to further resources that will aid you if you are unfamiliar with the US tax process. This guide is specifically geared toward the stock media contributor. Be it photos, music and sound effects, or code and software, it is my hope that this guide will help you understand how your stock media sales are viewed in the eyes of the Internal Revenue Service (IRS), and how to properly prepare your taxes to prevent a letter or an audit down the road.
Disclaimer: This article is intended for US based contributors only, and will not cover aspects of VAT. Furthermore, it will not cover tax law at the state or local level. Tax laws change regularly, therefore the accuracy of this article is based on the publication date, and may not reflect all current changes. I am a trained professional tax preparer and offer this information accurately to the best of my knowledge, but you are advised to visit with your local tax professional.
Business vs. Hobby
Many of us do not consider sales from stock material to be our primary source of income. I personally make the majority of my living as an audio mixer, and only a fraction of my income comes from royalties on stock audio sales. In my case, audio mixing and selling stock audio are certainly in the same vein, so to consider my royalties as business income is an obvious choice. But what if your primary business is unrelated? Perhaps you are a chef at a restaurant, but you make some income selling stock photos. Would you consider your income to be from business or hobby?
Short Answer: Stock media sales are considered a business activity, not a hobby. Read below for a more detailed response.
The IRS provides 9 factors to assist in determining whether your income is considered business or hobby, and they are as follows:
- Whether you carry on the activity in a businesslike manner
- Whether the time and effort you put into the activity indicate that you intend to make it profitable
- Whether you depend on income from the activity for your livelihood
- Whether your losses are due to circumstances beyond your control, or are normal in the startup phase of your type of business
- Whether you adjust your methods of operation in an attempt to improve profitability
- Whether you (or your advisors) have the knowledge needed to carry on the activity as a successful business
- Whether you were successful in making a profit in similar activities in the past
- Whether the activity makes a profit in some years, and how much profit it makes
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity
There is no strict determination based on the number of factors that apply to you (for example, if 3 or more factors apply than it is considered a business).
To further clarify, we must dig deeper by examining court rulings on the subject of hobby vs. business. In Revenue Ruling 77-4356, the court determined that a member of Congress who made 10 private speaking engagements with cumulative earnings of $1500 in a single year, showed “a degree of recurrence, continuity and availability” consistent with the factors of self-employment.
http://www.bradfordtaxinstitute.com/Endnotes/Rev_Rul_77-356.pdf
Any stock media website (Envato, Pond5, iStock, etc.) places your media for sale in a marketplace that is available 24/7. Thus, I would argue that participation as a contributor would show at minimum the same degree of recurrence, continuity and availability as in Revenue Ruling 77-356 to constitute businesslike activity.
A Caveat
The IRS states in specific rulings (58-112, 55-431, 55-258) that income from an occasional act or transaction, absent proof of ongoing activity to continue or increase earning that income, is not enough to substantiate business activity. In Langford v. Commissioner, the ruling states that an assistant professor who coauthored a book without any obligation to later work on revisions, did not have adequate proof to substantiate business activity. The fact that she did revise the textbook five years later was not sufficient to substantiate regularity.
https://www.leagle.com/decision/1988132255jitcm126711054
Had the coauthor made multiple revisions to her work or published additional writings, her activity would have been deemed a business. Considering that most stock media contributors have multiple items for sale and/or regularly upload new material, I believe you would be hard pressed to substantiate stock media sales as anything other than business activity.
The 1099-MISC: Royalties Vs. Non-Employee Compensation
A 1099-MISC is most commonly associated with a dollar amount listed Box 7, or non-employee compensation, and is typically issued as a result of payment for a contracted service performed. For example, a musician who was hired for a gig should receive a 1099-MISC if the total amount earned at the venue throughout the year was $600 or more.
However, stock media contributors are likely to receive a 1099-MISC even if their sales did not exceed $600. This is because income earned from stock media sales is not calculated as non-employee compensation, but rather as royalty income, or the amount listed in Box 2 of the 1099-MISC. The threshold for reporting royalty income is considerably lower. As of 2016, a company is required to report and issue a 1099-MISC for royalties paid of $10 or more.
Royalties: Schedule C Vs. Schedule E
Inevitably, receiving a 1099-MISC for selling stock media means that you will have to claim that income on your taxes. There is some confusion regarding which schedule to file your royalty income under. After all, royalty income can be filed on both, and filing it on a Schedule E allows the payer to bypass paying Self-Employment tax.
However:
Royalty income earned from stock media sales should be reported on a Schedule C.
Why? Self-employment is defined as an individual who earns income through conducting profitable operations from a business or trade that he operates directly. An individual with direct control over his business activity earns what the IRS refers to as active income. Active income is filed on a Schedule C. An individual without direct control over the business activity earns what is referred to as passive income. There is a substantial disconnect between his daily operations and the income received, hence it is passively earned. This income is claimed by filing a Schedule E.
While I have referred to my stock media business as passive income in other articles, I create my own stock material, and have direct control over its distribution. By IRS definition, it is active income, and therefore filed on a Schedule C.
Practice
Here are a few examples of business income. Try to determine how the person would file in each of the situations:
Schedule C or Schedule E?
John wrote a couple books and receives royalty payments from the publishing company for units sold. John wrote the books, or actively participated in the production of the income, and he maintains the copyrights.
Answer: Schedule C
John actively participated in his business, so he files his royalties on a Schedule C.
Schedule C or Schedule E?
Bill, a history professor, is interviewed for a documentary. He receives royalties from the producer for his participation.
Answer: Schedule E
Even though Bill participated in the documentary, he does not have direct control of the business, so his activity is deemed passive. Bill would file his royalties on a Schedule E.
Schedule C or Schedule E?
Bill decided he liked the spotlight, so he decides to film his history lectures. He makes them available for sale on eLectures.com, from which he receives royalties.
Answer: Schedule C
Bill has direct control over his business, and is therefore an active participant in the production of the income. He must file his royalties on a Schedule C.
Schedule C or Schedule E?
Bill has since retired from teaching, but still occasionally receives royalties from his online lectures.
Answer: Schedule C
Even though Bill no longer teaches, he still maintains the copyrights and has direct control of its distribution. Bill must file his royalties on a Schedule C.
Schedule C or Schedule E?
Joe works as a bank teller, but he likes to take pictures in his spare time. Joe decided to upload his photos to PhotoDune, and much to his surprise, has earned enough from royalties to receive a 1099-MISC.
Answer: Schedule C
Because he took the pictures, and he controls the distribution rights, the amount he earns is considered to be active income. The fact that he is not a professional photographer does not matter. Joe must file his royalties on a Schedule C.
Recapping the Facts
To recap these concepts in a few bullet points:
- The presence of your stock media in an online marketplace gives your business activity a degree of recurrence, continuity and availability. It cannot be hobby income.
- By agreeing to the terms of stock media libraries, you maintain direct control over the distribution of the stock media. This, by definition, is active income.
- Active income must be filed on a Schedule C, and is subject to Self-Employment Tax.
I’ve devised a new checklist to determine if your stock media contributions are considered business income on a Schedule C:
- Do you maintain the copyrights to your stock media material?
- Do you have direct control over the distribution of the stock media?
- Is your stock media available for sale with a degree of recurrence and continuity?
- Do you regularly maintain, edit or add to your stock media library?
Further Reading
SE Tax and Sporadic Activity
http://www.journalofaccountancy.com/issues/2011/oct/20114408.html
Self-Employment or Other Income?http://www.journalofaccountancy.com/issues/2009/jul/20091639.html
Tax Issues for Individuals Who Create Intellectual Property
http://www.thetaxadviser.com/issues/2013/dec/kelley-dec2013.html
Market Segment Specialization Program (MSSP) Guide
http://www.unclefed.com/SurviveIRS/MSSP/entertainment.pdf
Royalty Income Received by Musical Performers and Songwriters
https://musiccpa.com/royalty-income-received-by-musical-performers-and-songwriters/
