Sony-USA Records had not signed a new recording artist for several months. Currently, an international media frenzy was underway regarding the highly-acclaimed recording artist known as Holt. His music had a distinct sound that was ethereal, bold, and haunting.
After logging countless hours of research on Holt, his music, and his fan base, Sony-USA Records decides to contract with Holt to produce records. The contract specifies that Sony-USA Records will retain all intellectual property rights, but that Holt will receive payments or “royalties” on future sales of recordings.
A treaty between the United States (U.S.) and Holt’s home country exempts royalties from being taxed in the U.S. However, his home country tax treaty, does not define “royalties” or “compensation for personal services.” The Internal Revenue Service (IRS) has told Holt, his contract with Sony-USA Records generates personal service income in the U.S.
Prepare a tax research memo advising Holt on the appropriate tax treatment, given his situation, and with his type of income.