Wednesday April 24, 2024
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4.9.1 Patents
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Patents
Definition: A patent is an intangible property right that protects an invention.
Tax Deduction: The owner of a patent who gives his entire interest, or an undivided percentage of his entire interest, in a patent to a qualified charity is allowed to claim an income tax deduction for the contribution.
Amount Deductible: Patents that are appreciated capital assets may be gifted to charity and qualify for a deduction for the lesser of the cost basis or fair market value plus a percentage of qualified donee income (QDI).
Valuation: The fair market value of a patent is determined by a qualified appraiser and is generally based upon the income stream that the patent is expected to generate.
Transfer Methods: Patents are generally transferred by way of an assignment contract, will or deed of gift that is subsequently recorded with the USPTO.
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Definition
A patent is an intangible property right that protects an invention. A patent gives its owner the right to exclude others from making, using, distributing or selling a product that includes the patented invention or concept.
Intangible property differs from tangible property. Tangible property refers to physical property - something that can be touched or felt such as real estate, vehicles, money, furniture and works of physical art. Intangible property is property that has value but the property cannot be seen or touched. Patents are one kind of intangible property. Other kinds of intangible property include copyrights, trademarks, goodwill and brand recognition.
A patent gives its owner the right to exclude others from making, using, selling, offering for sale or selling an invention that includes the patented invention. The United States Patent and Trademark Office is the federal agency that grants U.S. patents to inventors. While utility and plant patents are valid for a term of up to 20 years, design patents have a shorter 15-year term. Patent terms are generally not renewable.
There are three types of patents: utility, design and plant patents. Individuals have to apply for a patent through the USPTO. A utility patent, the most common type, is granted to an individual who discovers or invents "any new and useful process, machine, article of manufacture or composition of matter, or any new and useful improvement thereof." 35 U.S.C. Sec. 101. Design patents are granted to an individual who invents "a new, original and ornamental design for an article of manufacture." 35 U.S.C. Sec. 171. Plant patents may be granted to an individual who "invents or discovers and asexually reproduces a distinct and new variety of plant." 35 U.S.C. Sec.161.
The protection of a patent is rooted in the United States Constitution and is among the enumerated powers granted to Congress:
To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.
Article I, Section 8, United States Constitution
Tax Deduction
The owner of a patent who gives his entire interest, or an undivided percentage of his entire interest, in a patent to a qualified charity is allowed to claim an income tax deduction for the contribution. Rev. Rul. 58-260.
Due to the partial interest rule in Sec. 170(f)(3), an owner who gives less than his entire interest in a patent is not allowed to claim any tax deduction. A donor gives less than their entire interest in a patent if the owner retains the right to license the patent to others, manufactures or uses any product that is covered by the patent or places conditions on the gift, which, if triggered, may result in ownership of the patent reverting to the donor. Rev. Rul. 2003-28.
The owner of a capital asset patent who gives his entire interest, or an undivided percentage that represents the owner's entire interest in a patent, to a qualified charity is not barred by the partial interest rules to claim an income tax deduction. Rev. Rul. 58-260. The appreciated patent gift qualifies for a deduction for cost basis plus a percentage of QDI. Sec. 170(m)(3).
Example 4.9.1A
Tommy Edison has developed several inventions, including a product that reduces the heat emitted from stage lights. The invention is popular in theatres and playhouses because actors like the way the product reduces heat generated by the lights on stage. Eddie has patented the invention but has not yet found a company willing to manufacture it.
Tommy is a patron of the arts and really enjoys attending performances at the local community musical theatre, a qualified charity. Tommy grants the theatre a non-exclusive license to use his invention. Tommy's grant of a license is not deductible because Tommy retained a substantial right in the patent. Tommy retained ownership in the patent, the right to grant further licenses and a right to any future income from the patent.
Amount Deductible
Patents that are appreciated capital assets may be gifted to charity and qualify for a deduction for the lesser of the cost basis or fair market value plus a percentage of qualified donee income (QDI). Sec. 170(m)(3).
If the donor informs the nonprofit of the intent to take a QDI deduction, the income produced by the charity's use of the intellectual property will produce QDI. Notice 2005-41. Per Sec. 170(m)(8)(B), the donor must provide written notice at the time of the donation electing treatment as a qualified intellectual property contribution under Sec. 170(m)(8) and Sec. 6050L. Qualified intellectual property includes copyrights, trademarks and patents. Sec. 170(m)(9), Sec. 170(e)(1)(B)(iii).
The net income from the intellectual property is then reported by the nonprofit on IRS Form 8899 each year. The donor may deduct QDI (initially reduced by the basis) amounts for up to 10 years. Sec. 170(m)(5). For short tax years, a 12-year sliding scale may be used to cover a partial first and final year where the deduction is 100% of QDI in year one, 100% in year two and declines by 10% each year to 10% in years 11 and 12. Sec. 170(m)(7), Sec.170(m)(10)(D)(i). A donor is unable to claim a deduction for any QDI accrued after the legal lifespan of the intellectual property asset expires. Sec. 170(m)(6). The following table illustrates the number of years since the gift and the corresponding deduction percentage.
| Tax Year | Deductible Percentage |
| 1/gift year | 100% |
| 2 | 100% |
| 3 | 90% |
| 4 | 80% |
| 5 | 70% |
| 6 | 60% |
| 7 | 50% |
| 8 | 40% |
| 9 | 30% |
| 10 | 20% |
| 11 | 10% |
| 12 | 10% |
Example 4.9.1B
Two years ago, Kate purchased a patent for $400,000 for a device used to polish gems and other valuable stones. The utility patent has 16 years left of its legal life. Kate is so appreciative of the education that she received at her local college that she wants to share the benefits of her patent with the college. She gifts her entire interest in the patent (including the right to all royalties the patent will generate) to the college. Because she gave her entire interest in the patent, Kate is entitled to a deduction for her cost basis plus QDI.
As soon as Kate's patented gem polishing machine went into production, it was in great demand from jewelers around the world. Experts are predicting continued demand for the device and are projecting that Kate's patent could be worth more than $5 million.
Kate's initial deduction for the patent is limited to the lesser of her cost basis or its fair market value. Based upon a qualified appraisal, she is allowed to take a deduction of $400,000, which is her total cost basis. She notifies her local college at the time of the contribution that she is electing treatment as a qualified intellectual property and plans to deduct any QDI. Her local college licenses the patent, receives QDI and files IRS Form 8899. Since Kate will be filing a return for a short taxable year, Kate's deductions are qualified over 12 years, to account for a partial first and final year. She reports no deductions after 12 years.
Date of
Contribution | Applicable
Percentage | QDI | Kate's
Deduction |
| 1st | 100 | $0 | $400,000 (basis) |
| 2nd | 100 | $200,000 | $0 (Not over basis) |
| 3rd | 90 | $200,000 | $0 (Not over basis) |
| 4th | 80 | $250,000 | $200,000 |
| 5th | 70 | $250,000 | $175,000 |
| 6th | 60 | $300,000 | $180,000 |
| 7th | 50 | $300,000 | $150,000 |
| 8th | 40 | $350,000 | $140,000 |
| 9th | 30 | $435,000 | $105,000 |
| 10th | 20 | $400,000 | $80,000 |
| 11th | 10 | $400,000 | $40,000 |
| 12th | 10 | $400,000 | $40,000 |
| | Total Deduction | | $1,510,000 |
While patents are considered capital assets if acquired by purchase or inheritance, they are not capital assets if the taxpayer created the patent, or it is received by an individual as a gift from the patent creator. Sec. 170(e)(1)(B). A donor who makes a charitable gift of an ordinary income asset is entitled to a deduction that is equal to the lesser of the property's cost basis or fair market value. Sec. 170(e)(1). Intellectual property that is given as a gift from the intellectual property creator will carry over the basis and character from the donor. Sec. 1221(a)(3).
Valuation
The fair market value of a patent is determined by a qualified appraiser and is generally based upon the income stream that the patent is expected to generate. The income stream that a patent will generate often relates to whether the patent is current or obsolete, the kind of patent, restrictions on the use or transferability and the remaining duration of the patent.
Example 4.9.1C
Mary developed and patented a bird-protection device for wind turbines. Her cost basis is $100,000 and the value is $1,000,000. She gave the patent to her local food bank. Because she created the patent through her personal efforts and the fair market value is greater than the basis, under Sec. 1221(a)(3) Mary qualifies for a charitable deduction for her basis of $100,000. For gifts of IP that are greater than $500, donors must fill out and include Form 8283 on his or her tax return. Donors must also fulfill the requirements for noncash gifts valued over $250, which require the donor to obtain a contemporaneous written acknowledgement (CWA) that complies with Reg. 1.170A-13(f) and Reg. 1.170A-16(d)(1)(i). Because the IP is valued over $5,000, Mary must obtain a qualified appraisal prepared by a qualified appraiser. Reg. 1.170A-16(d)(1)(ii).
Transfer Methods
Patents are generally transferred by an assignment contract recorded with the USPTO. There are specific rules applicable to the transfer of patents and more information about transfer can be found in Chapter 300 of the Manual of Patent Examining Procedure.
The document that transfers a patent should be notarized and include, among other things, the patent number, the date the document is executed and the names of the parties giving and receiving the interest. If a patent assignment is not recorded within three months, it will not protect the transferee against a subsequent purchase of the patent unless the assignment document is recorded prior to the subsequent purchase.
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Case Studies on Patents
Ducky Don and the Wobble Ducks Patent:
Donald Holden Ducksworth III (Ducky Don to friends) was a lifelong outdoorsman. He loved to hunt and fish. Each fall, Ducky Don and his friends would gather for the opening of duck hunting season.
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