Patent Holders: Do Not Forget Taxes
JMBM attorney Stan Gibson discusses…
What patent holders and inventors need to know before licensing, acquiring, or settling a lawsuit involving intellectual property
There are complex tax issues surrounding the licensing of intellectual property and the settlement of lawsuits regarding intellectual property. Therefore, the tax issues impacting a particular situation should be thoroughly analyzed before a patent owner goes too far down the road in licensing or settling a dispute over intellectual property. There are even more specialized rules for inventors of patents who may be able to achieve capital gains treatment for the sale of their patents, provided that the proper guidelines are followed.
The main purpose of this note is to advise that inventors and patent holders should consult their tax professionals early in the process and certainly before a license or a settlement agreement is consummated. In particular, for inventors, section 1235 of the Internal Revenue Code should be analyzed to determine if a patent sale can be structured in a way that provides capital gains tax treatment. Section 1235, pertaining to the sale or exchange of patents, provides a safe-harbor for capital gains tax treatment. It states: General. A transfer (other than by gift, inheritance, or devise) of property consisting of all substantial rights to a patent, or an undivided interest therein which includes a part of all such rights, by any holder shall be considered the sale or exchange of a capital asset held for more than 1 year, regardless of whether or not payments in consideration of such transfer are—
- payable periodically over a period generally coterminous with the transferee’s use of the patent, or
- contingent on the productivity, use, or disposition of the property transferred.
“Holder” defined. For purposes of this section, the term “holder” means—
- any individual whose efforts created such property, or
- any other individual who has acquired his interest in such property in exchange for consideration in money or money’s worth paid to such creator prior to actual reduction to practice of the invention covered by the patent, if such individual is neither—
- the employer of such creator, nor
- related to such creator (within the meaning of subsection (d) of Section 1235).
Thus, for inventors it is particularly important to analyze their tax options before they make any transfer or assignment of patents.
For a company, there may be many different ways to treat a license, acquisition or settlement of an intellectual property dispute, each of which may have different tax consequences. For example, even though a company may receive a settlement that provides for an upfront payment for a perpetual license to compensate for both past and future use, the taxes may be due for the year in which the payment is made depending on the terms of the settlement agreement. A company expecting to defer its tax payments over a number of years may face an unpleasant surprise if it fails to structure its settlement agreement to make the deferment possible.
The point here is to emphasize that patent owners in any intellectual property license, acquisition or settlement involving intellectual property, should consult their accounting and tax professionals early and often. If you wait until the ink is already dry on the agreement, it will be too late and the tax consequence may be severe and detrimental.