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 ąd@  .@ ffffffÖæffffffÖæffffffÖæX9“Čv¾æ?X9“Čv¾æ?333333Ćæ333333Ćæš™™™™™¹æC@C@ffffffÖ?333333Ć?333333Ć?)\Āõ(¬?$’’359=AEIMQ4""""""""H •’’4heading 4heading 4Ō&  ŌÓ  ÓŌ‡ĀĀĀŌŌW‡,ō\  `*Times New RomanTTWŌŌ  ŌŌ  Ōņ ņó óŌ  ŌŌ  ŌŌ‡ōōōŌŌW‡,ō\  `*Times New RomanTTWŌŌ'  Ō# e37=CIQYag­­1.a.i.(1)(a)(i)1)a)8”‰’’,TitleTitleÓ  ÓŌ‡XXXŌŌW‡,ō\  `*Times New RomanTTWŌŌ  ŌŌ  Ōņ ņó óŌ  ŌŌ  ŌŌ‡ōōōŌŌW‡,ō\  `*Times New RomanTTWŌō\  `*Times New RomanTTHŻ ƒ¤U!ŻÓ  ÓŻ  Ż›Ņ,°ŅŃŠ°ŃŃŠ°ŃŅ,°ŅŌ€¼F ¼XXŌÓfęÓÓ  ÓŃ7€XXdédČ7ŃŌ‡ ¼F ¼¼¼F ŌŌ‡ x×x¼ ¼F Ōą@RR,ģąINTELLECTUAL€PROPERTY€ą@@777ģąTAXATIONŌ#† ¼F ¼x x×ó#ŌŌ#†¼F ¼¼ ¼F Ō#ԈŠ Š ŠĢą@==:ģąņņbyóóˆŠ ¦Ö Šą@w w 1ģąņņCurtis€L.€HarringtonˆŠ > ŠĢą@¶¶0ģąHARRINGTON€&€HARRINGTONˆĢĢą@m m (ģąóóą@@q q (ģąņņ6300€State€University€Drive,€Suite€250ˆŠ –Ę  Šą@½½1ģąLong€Beach,€CA€90815óóˆŠ ¶ę  Šą@¶ ¶ *ģąņņ(562)€594„9784,€Fax:€(562)€594„4414óóˆŠ Ö  Šą@}}ģąhttp:/www.patentax.com€€€€E„mail:€curt@patentax.com€€€€€€€PATENTAXņņņņššóóóóˆŠ ö&  ŠĢĢĢĢŌ‡x×x¼¼F Ōņņą@œœ;ģąAˆŠ ŗź Šóóą@7 7 6ģąņņPATENTAXņņšš€óóˆŠ Æ Šą@``5ģąPRESENTATIONóóˆŠ Dt ŠĢŌ#†¼F ¼xx×Į#ŌŌ‡XW:X¼¼F ŌDisclaimer:€Educational€Only:€This€outline€is€Educational€Only€and€no€part€of€this€presentation€can€be€considered€asŠ ė#! Šfederal€or€state€tax€advice,€opinion,€or€position€and€is€not€intended€or€written€to€be€used,€and€may€not€be€used,€for€theĻpurpose€of€(I)€avoiding€tax„related€penalties€under€the€internal€revenue€Code€or€(ii)€promoting,€marketing€orĻrecommending€to€another€party€any€tax„related€matters€addressed€herein,€nor€(iii)€constituting€guidance€on€any€tax€orĻintellectual€property€matter.ĢŌ#†¼F ¼XXW:Ø#ŌŌ‡x×x¼¼F ŌĢĢŠ Ä+ō( ŠŌ#†¼F ¼xx×ļ#ŌŌ‡čØŠ č¼¼F ŌŌ#†¼F ¼ ččØŠH#ŌņņŌ‡XW:X¼F ŌI.ą „ ąUnderstanding€the€Negative€Nature€of€IPŠ Š ŠĢóóą „ ąA.ą Ü ąCommon€MisconceptionsŠ <l Šą „ ąą Ü ą1.€PatentsĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąš šIf€I€have€a€patent€I€have€the€right€to€manufacturešš€„€NOŠŽŒ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(b)ą0 Œ ąš šI€have€to€do€a€search€so€I€can€know€all€thatššs€out€thereššŠÆßŒ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(c)ą Œ ąš šCan€I€get€an€š šINTERNATIONAL€PATENTšš?Š €° ŠĢą „ ąą Ü ą2.ą 4 ąTrademarksŠ " R Šą „ ąą Ü ąą 4 ą(a)ą0 Œ ąš šBut€if€the€name€people€donššt€know€what€the€product€is€by€reading€the€trademark,€whatŠ ó #  Šgood€is€it?ššŠ Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(b)ą0 Œ ąš šHey,€lets€use€the€same€trademark€that€ššbig€corpšš€has€but€we€can€change€one€letter€andŠ • Å  Šthey€canššt€touch€usššŠ Œ ¬&Œ ¬& ŠĢą „ ąą Ü ą3.ą 4 ąCopyrightŠ 8  Šą „ ąą Ü ąą 4 ą(a)ą0 Œ ąš šI€made€this€clothing€by€hand,€I€want€to€copyright€itššŠŁ Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(b)ą0 Œ ąš šWill€you€take€my€case€on€contingency,€I€donššt€believe€in€my€copyright€THAT€much€andŠ ŖŚ  ŠI€donššt€want€to€pay€anything€if€I€loseššŠ Œ ¬&Œ ¬& ŠĢą „ ąą Ü ą4.ą 4 ąGeneralŠ M Šą „ ąą Ü ąą 4 ą(a)ą0 Œ ąš šSend€them€a€really€nasty€infringement€letter,€if€they€donššt€like€it,€they€can€lump€itššŠīŒ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(b)ą0 Œ ąš šWe€just€received€a€letter€accusing€us€of€infringement,€but€they€are€not€serious€until€theyŠ æļ Šbring€a€lawsuit.ššŠ Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(c)ą0 Œ ąI€just€won€this€big€judgment€for€6€years€worth€of€infringement,€the€money€is€capitalŠ a‘ Šgains,€right?Š Œ ¬&Œ ¬& ŠĢĢņņII.ą „ ąOverview€of€Intellectual€Property€CategoriesŠ „Õ ŠóóĢą „ ąA.ą0 Ü ąCOPYRIGHTЬÜܬ&ܬ& ŠĢą „ ąą Ü ą1.ą0 4 ąCopyright,€like€all€other€forms€of€intellectual€property,€is€based€on€negative€rights.€€A€copyrightŠ N~ Šregistrant€may€exclude€others€from€reproducing€a€given€copyrighted€work,€composing€aĻderivative€work,€performing€the€work€publicly,€distributing€the€work€(including€sale,€lease,€orĻrental€of€the€work),€or€displaying€the€work.€€Works€that€may€be€protected€by€copyright€includeĻliterary€works;€musical€works€and€accompanying€words;€audiovisual€works,€including€motionĻpictures;€sculptural€works;€pictorial,€graphic€and€architectural€works;€sound€recordings;€and,Ļpantomimes€and€audiovisual€works.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąThe€power€of€copyright€is€especially€effective€in€preventing€the€rote€copying€of€a€work.€€A€workŠ Ö#!' Šis€a€fixed,€complete€form€of€authorship.€€To€be€complete,€a€work€must€have€all€of€its€componentĻparts.€€A€computer€program€which€does€not€run€and€has€no€utility€is€a€good€example€of€anĻincomplete€project€that€is€not€a€work.€€Direct€copying€is€the€easiest€form€of€copyrightĻinfringement€activity€to€prevent.€However,€the€test€in€copyright€is€one€of€substantial€similarity.€ĻWhether€a€copied€work€is€substantially€similar€to€the€copyrighted€work€is€a€question€of€fact€to€beĻdecided€by€a€jury.€Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąRights€conferred€to€a€copyright€registrant€can€be€retained€or€licensed€as€the€copyright€registrantŠ ^*Ž'/ Šsees€fit.€€For€example,€a€license€agreement€may€be€crafted€based€on€the€registrantššs€rights.€ĻLicense€agreements€can€be€as€broad€and€open€as€any€contract€and€can€require€a€licensee€to€payĻmoney€or€perform€other€duties€in€exchange€for€the€license.€€The€ability€to€exclusively€performĻthe€work€is€especially€important€for€playwrights€who€receive€royalties,€not€only€from€theŠ ¢-Ņ*3 Špublication€of€their€plays,€but€also€from€the€performance€of€their€plays.Š 4¬&4¬& Š€€€€€Ģą „ ąą Ü ą4.ą0 4 ąCertain€areas€of€copyright€law€are€rife€with€traps€for€the€unwary€copyright€registrant.€€First,€aŠ r¢ Šwork€must€rise€to€a€minimum€level€of€originality€to€be€considered€copyrightable.€€For€example,Ļdata€works€such€as€columns€of€raw€information€may€be€so€lacking€in€authorship€as€to€beĻconsidered€›unregistrable.€€Similarly,€designs€which€only€include€basic€geometric€forms€may€alsoĻbe€held€unoriginal.€€Generally€speaking,€the€more€complex€a€work€is,€the€more€likely€it€is€to€beĻconsidered€original€in€terms€of€authorship.€€Š 4¬&4¬& Š€€€€€Ģą „ ąą Ü ą5.ą0 4 ąAnother€area€of€copyright€that€may€present€problems€is€that€of€works€for€hire.€Works€for€hireŠ ) Y  Šinclude€works€done€as€a€non-contract€employee€and€contributions€to€a€larger€collective€work,Ļsuch€as€a€movie.€€Where€a€party€pays€to€have€a€work€performed€but€neglects€to€clearly€specifyĻwho€the€owner€of€the€completed€work€will€be,€problems€are€certain€to€arise.€€We€strongly€adviseĻthat€those€seeking€to€hire€authors,€designers,€and€the€like,€should€not€only€contract€for€the€workĻto€be€done,€but€should€ensure€that€the€contract€explicitly€sets€forth€who€the€owner€of€theĻcompleted€work€will€be.€€Collective€works€present€another€set€of€problems€because€allĻcontributing€authors€must€give€their€permission€for€use€of€their€constituent€parts.€€The€creativityĻwhich€is€applied€to€organize€the€parts€making€up€the€whole€is€also€protectable€by€copyright.Š 4¬&4¬& Š€€€€€Ģą „ ąą Ü ą6.ą0 4 ąJoint€works€also€create€potential€problems€for€copyright€registrants.€€Where€a€work€is€preparedŠ Sƒ Šby€two€or€more€authors€who€intend€to€merge€their€contribution€into€an€inseparable€whole,€the€USĻCopyright€Office€will€treat€each€of€the€authors€as€having€equal€rights€to€register€and€enforce€theĻcopyright,€and€this€holds€true€whether€or€not€there€are€other€agreements€to€the€contrary€betweenĻthe€registrants.Š 4¬&4¬& Š€€€€€Ģą „ ąą Ü ą7.ą0 4 ąThe€duration€of€a€copyright€varies€depending€on€the€type€of€work€for€which€protection€is€sought.€Š 9i ŠIn€general,€a€work€is€protected€for€the€life€of€the€author€plus€70€years€(Sony€Bono€CopyrightĻTerm€Extension€Act).€€The€exceptions€to€the€rule€include€works€for€hire,€anonymous€works,€andĻpseudo€anonymous€works,€which€are€protected€for€95€years€from€the€first€publication€or€120Ļyears€from€the€year€of€creation.Š 4¬&4¬& ŠĢą „ ąą Ü ą8.ą0 4 ąCopyright€notice€can€be€communicated€in€a€number€of€different€ways.€€The€most€common€formsŠ O Šof€notice€include€the€š šcircle€Cšš€symbol€or€the€word€š šcopyrightšš€in€full€or€abbreviated€form,€asĻwell€as€the€first€year€of€publication€and€name€of€the€copyright€registrant.€€After€March€1,€1989,Ļlack€of€copyright€notice€is€not€fatal,€but€including€a€copyright€notice€is€advisable€because€(1)€itĻlets€others€know€that€a€work€is€protected€by€copyright,€(2)€it€directs€would-be€users€to€theĻcopyright€registrant€for€permission€to€use€the€work,€and€(3)€it€precludes€a€defendant€in€aĻcopyright€infringement€case€from€using€the€defense€of€š šinnocent€infringeršš€because€it€serves€asĻconstructive€notice€of€copyright,€i.e.,€the€defendant€is€considered€to€be€aware€of€the€copyrightĻwhether€or€not€he€actually€saw€the€notice.Š 4¬&4¬& ŠĢą „ ąB.ą Ü ąTRADEMARKŠ I$y!) ŠĢą „ ąą Ü ą1.ą0 4 ąA€trademark€is€any€word,€name,€symbol,€device,€or€any€combination€thereof€which€is€used€inŠ ė%#+ Šconnection€with€goods€or€services€to€help€consumers€identify€the€source€of€those€goods€andĻservices€for€the€purpose€of€differentiating€the€goods€and€services€from€those€of€competitors.€€Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąTrademark€rights€accrue€as€to€a€given€set€of€goods€or€services€based€upon€the€theory€thatŠ /)_&/ Šsuccessful€name€recognition€will€follow€increasing€quality€and€excellence.€Trademark€rightsĻbegin€with€the€use€of€the€trademark.€€For€this€reason,€later€users€of€a€trademark€can€potentially€beĻforeclosed€from€using€a€name.€€The€scope€of€rights€in€a€trademark€depends€upon€how€the€mark€isĻused.€€For€example,€the€trademark€EXXON€is€generally€thought€to€be€a€coined€mark,€such€that€itĻwould€preclude€any€use€by€others,€even€where€the€use€might€be€for€non-petroleum€goods€andĻservices.€€The€scope€of€rights€for€other,€lesser-known€trademarks,€is€usually€narrower€than€theŠ .E+5 Šscope€of€rights€for€coined€marks,€such€that€the€use€of€the€mark€in€one€area€will€generally€notĻprevent€the€use€of€the€mark€in€other€goods€and€service€areas.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąUse€of€a€trademark€is€demonstrated€with€specimens€that€show€how€the€mark€is€used€with€theŠ Cs Šgoods.€€The€best€way€to€show€trademark€usage€may€be€to€impress€the€trademark€directly€uponĻthe€goods.€€Tags€and€labels€applied€to€the€goods€are€another€proper€way€to€use€the€trademark.€ĻHowever,€it€must€be€kept€in€mind€that€a€use€which€is€too€greatly€removed€from€a€directĻassociation€with€the€goods€may€fail€as€a€proper€use.Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąBecause€there€are€no€"goods"€upon€which€to€affix€a€service€mark,€an€advertisement€is€generallyŠ ) Y  Šthe€only€way€to€show€a€connection€between€a€service€mark€and€the€services€to€be€associated€withĻthe€mark.€€Aside€from€the€differences€in€which€the€use€is€shown,€the€application€and€examinationĻprocedure€is€approximately€the€same.Š 4¬&4¬& Š€€€€€Ģą „ ąą Ü ą5.ą0 4 ąNote€that€there€are€two€basic€mechanisms€for€naming€a€business€which€have€nothing€to€do€withŠ >n  Štrademarks.€€The€county€designation€"doing€business€as,"€or€DBA,€and€the€state€corporate€filingĻare€both€employed€to€insure€that€there€will€be€a€responsible€entity€doing€business€in€the€county€orĻstate,€and€that€the€responsible€entity€is€distinguishable€from€other€entities.€€These€designationsĻhelp€to€be€sure€that€no€two€entities€have€the€same€name€either€locally€or€on€a€statewide€level.Š 4¬&4¬& ŠĢą „ ąą Ü ą6.ą0 4 ąTherefore,€the€steps€necessary€for€acquiring€a€federally€registered€trademark€are€generally€asŠ $T Šfollows:Š 4¬&4¬& Šą „ ąą Ü ąą 4 ą(a)ą0 Œ ąSelect€the€mark€using€the€following€guidelines:ŠĘöŒ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPick€a€name€that€is€NOT€in€the€dictionaryŠ—Ēä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPick€a€name€that€is€NOT€similar€to€someone€elseššsŠh˜ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPick€an€UNUSUAL€name€Š9iä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPick€a€name€that€is€NOT€a€personššs€last€nameŠ :ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPick€a€name€that€is€NOT€descriptive€of€the€goods€or€services€(the€PTO€is€veryŠ Ū  Šstrict€on€this€point,€and€even€if€you€get€past€the€PTO,€a€descriptive€mark€is€likelyĻto€cost€you€precious€profits€in€the€long-run)Š ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPick€a€name€that€does€NOT€end€in€a€descriptive€nounŠN~ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPick€a€name€that€excludes€descriptive€wordsŠOä ¬&ä ¬& Šą „ ąą Ü ąą 4 ą(b)ą Œ ąUse€the€mark€properly€in€interstate€commerceŠ š   Šą „ ąą Ü ąą 4 ą(c)ą Œ ąApply€for€federal€registration€of€the€markŠ Įń! Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPTO€may€examine€the€application€in€about€1€yearŠ’Ā"ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąPTO€will€publish€the€potential€mark€to€give€an€opportunity€for€members€of€theŠ c“# Špublic€to€oppose€registration€of€the€markŠ ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąRegistration€of€the€mark€will€occur€in€approximately€6€months€after€publication,Š !5% Šassuming€no€opposition€was€filed€or,€if€an€opposition€was€filed,€assuming€it€wasĻnot€successfulŠ ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą ä ąFirst€renewal€is€due€after€5€years€continuous€use€(šš8)Š x#Ø ( Šą „ ąą Ü ąą 4 ąą Œ ąšāšą ä ąThe€mark€becomes€incontestable€after€5€years€of€€use€(šš15)Š I$y!) Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąDuration€of€the€trademark€protection€(i.e.,€actual€ownership)€extends€for€10€yearsŠ %J"* Šafter€first€renewalŠ ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąšāšą0 ä ąThese€selection€rules€dominate€the€tax€treatment€in€future€years.м&ģ#,ä ¬&ä ¬& ŠĢą „ ąą Ü ą7.ą0 4 ąIn€the€tax€section€of€this€outline,€it€can€be€seen€that€the€above€selection€rules€can€be€critical€inŠ ^(Ž%. Šhaving€a€successful€outcome€for€trademark.Š 4¬&4¬& ŠĢą „ ąą Ü ą8.ą0 4 ąAs€you€can€see,€from€the€first€use,€incontestability€can€be€achieved€in€about€6€years€fromŠ Ń*(1 Šapplication€(assuming€no€problems€during€the€application€process.€€Many€things€can€stop€theĻprocess,€including€a€rejection€by€the€Examiner,€an€opposition€filed€by€another€who€believes€heĻwill€be€damaged€by€your€registration,€a€petition€to€cancel€the€registration€from€others,€and€worstĻof€all,€forgetting€about€the€trademark€and€allowing€it€to€lapse€by€failure€to€file€the€šš8€&€šš15Š .E+5 Šaffidavit.Š 4¬&4¬& ŠĢą „ ąC.ą0 Ü ąTRADE€SECRETŠr¢Ü¬&ܬ& ŠĢą „ ąą Ü ą1.ą0 4 ąA€trade€secret€is€considered€to€be€any€information€(including€a€formula,€pattern,€compilation,Š D Šprogram,€device,€method,€technique€or€process)€which€(1)€derives€independent€economic€valueĻ(actual€or€potential)€from€not€being€generally€known€to€the€public€or€to€other€persons€who€couldĻobtain€economic€value€from€its€disclosure€or€use;€and€(2)€€is€the€subject€of€efforts€that€areĻreasonable€under€the€circumstances€to€maintain€its€secrecy.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąIt€is€illegal€to€acquire€a€trade€secret€of€another€where€the€acquiring€person€knows€or€has€reason€toŠ ś *  Šknow€that€the€trade€secret€was€obtained€by€improper€means.€€Improper€means€include€theft,Ļbribery,€misrepresentation,€breach€or€inducement€of€breach€of€a€duty€to€maintain€secrecy,€orĻespionage€through€electronic€or€other€means.€€Reverse€engineering€or€independent€derivationĻalone€is€generally€not€considered€improper€means.€€There€is€also€a€companion€definition€in€theĻpenal€code€which€makes€trade€secret€theft€a€felony.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąWhether€a€trade€secret€has€been€truly€protected€is€not€merely€a€question€of€whether€it€was€keptŠ ±į  Šsecret;€the€systematic€steps€and€procedures€taken€to€keep€it€secret€are€crucial€to€the€determinationĻof€protection.€€Evidence€of€locking€doors,€assigning€keys,€and€segregating€personnel€based€on€aĻneed€to€know€will€be€dispositive€in€determining€whether€one€has€acted€to€protect€secret€a€tradeĻsecret.Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąThis€area€of€law€cuts€a€fine€distinction€where€control€of€people€is€concerned.€€Oneššs€ability€to€useŠ —Ē Šthe€knowledge€gained€from€an€employer€is€distinguishable€from€oneššs€right€to€use€oneššs€skillsĻand€knowledge,€apart€from€the€specifics€of€the€trade€secret,€in€a€specialized€area.€€€These€factorsĻare€carefully€weighed€by€the€courts,€especially€where€the€secret€is€related€to€the€specialized€areaĻof€knowledge.Š 4¬&4¬& ŠĢą „ ąD.ą0 Ü ąPATENTŠ}­Ü¬&ܬ& ŠĢą „ ąą Ü ą1.ą0 4 ąThere€are€generally€three€kinds€of€patents:€design,€plant,€and€utility.€€Design€patents€protect€theŠ O Šway€something€looks,€e.g.,€the€look€of€an€automobile,€a€computer,€a€pair€of€tennis€shoes,€or€aĻvacuum€cleaner.€€Plant€patents€protect€varieties€of€plants€such€as€orchids,€roses,€flowers,€andĻother€agricultural€plants.€€Utility€patents€provide€protection€for€things€and€the€way€they€work,Ļe.g.,€circuits,€machines,€chemicals,€and€processes.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąPatentable€subject€matter€includes€machines,€processes,€compositions€of€matter,€articles€ofŠ !5% Šmanufacture,€software€and€computer€processes.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąTwo€common€categories€into€which€utility€patents€fall€are€(1)€process€and€apparatus€forŠ x#Ø ( Špracticing€a€process,€and€(2)€compositions€of€matter€and€processes€involving€compositions€ofĻmatter.€€A€new,€unexpected€use€for€an€old,€known€composition€of€matter€can€qualify€for€a€patent.€ĻAn€apparatus€and€process€steps€for€use€of€the€apparatus€are€generally€intertwined;€therefore,€newĻuses€for€an€old€machine€are€rarely€patentable.Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąTraditionally,€the€copyrighting€of€software€was€an€accident€resulting€from€a€characterization€ofŠ ^(Ž%. Šthe€early€programming€as€language€rather€than€machine€setting.€€As€a€result,€computer€programsĻbegan€under€the€characterization€of€language€composition€and€thus€copyright.€EventuallyĻsoftware€came€be€seen€as€dual€recognition€matter,€with€copyright€protecting€the€style€of€programĻwriting€and€patent€protecting€a€programmed€machine€step.€€Even€in€these€uncertain€times€(untilĻthe€Supreme€Courts€speaks€through€the€œBilski›€case,€it€is€helpful€for€applicants€to€consider€thatĻsoftware€should€be€tied€to€spatial,€visual,€electrical€and€mechanical€aspects€of€the€real€worldĻwhere€possible).Š.E+54¬&4¬& Їą „ ąą Ü ą5.ą0 4 ąSoftware€patentability€has€undergone€a€change€over€the€past€decade.€ŠŠ4¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ą€In€State€Street€Bank€&€Trust€v.€Signature€Financial€Group,€Inc.,€149€F.œ3d›€1368€(Fed.Š r¢ ŠCir.€1998),€the€U.S.€Court€of€Appeals€for€the€Federal€œCircuit€(CAFC)›€held€that€(1)€ALLĻsoftware€is€patentable€and€(2)€business€methods€are€patentable.€€The€rule€that€methods€ofĻdoing€business€were€not€patentable€had€been€in€force€for€100€years€prior€to€this€decision.€ĻThis€ruling€has€been€accepted€by€the€US€Patent€Office,€and€has€been€validated€andĻexpanded€in€subsequent€rulings€of€the€CAFC.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąCurrently€a€case€which€has€limited€the€patentability€of€some€computer€software€isŠ ) Y  Šcurrently€before€the€U.S.€Supreme€Court.€€In€re€Bilski€545€F.3d€943€(Fed.€Cir.€2008)€Š Œ ¬&Œ ¬& ŠĢĢą „ ąą Ü ą6.ą0 4 ąThe€following€results€have€gradually€grown€out€of€the€State€Street€Bank€decision:€Šm  4¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ą€ą ä ąThe€public€policy€blunder€of€having€previously€placed€software€under€theŠ ?  Štax-disadvantaged€copyright€protection€is€somewhat€remedied€by€a€substantial€removal€ofĻsoftware€from€the€tax-disadvantaged€categories.€€Consequently,€software€which€embodiesĻbusiness€methods€and€gaming€software€which€utilizes€new€engineering€advances€can€bothĻtake€advantage€of€the€patent€arena.€€It€should€be€that€the€only€software€developers€left€inĻthe€old€domain€are€those€who€create€new€software€which€is€not€patentably€distinct€fromĻtheir€older€versions.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąInstant€capital€gains€are€available€for€software€creators€under€IRC€šš1235€if€the€softwareŠ —Ē Šhas€a€chance€at€patentability.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąMost€software€may€now€be€expensed€under€IRC€šš174.Š :Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąBoth€patents€and€trade€secrets€result€in€instant€capital€gains€under€IRC€(1235€for€bothŠ ¬Ü Šcreators€and€those€in€privity€with€creators€before€the€invention€is€proven.€€Likewise,€bothĻpatents€and€trade€secrets€allow€for€expensing€and€capitalization€under€IRC€(174€for€costsĻof€creation€and€patenting€activities.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąGenerally,€copyrighted€material€and€associated€software€receive€the€mostŠ Įń! Štax-disadvantaged€treatment,€including€denial€of€capital€asset€status€to€creators,Ļnon-deductibility€of€creation€costs,€ordinary€income€on€sale€by€the€creator,€and€onlyĻregular€capital€gains€on€resale€once€the€asset€leaves€the€purchaser(s€hands.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ą7.ą0 4 ąEffect€of€Dependence€on€Prior€LawŠÖ!&4¬&4¬& ŠĢ€ą „ ąą Ü ąą 4 ą(a)ą0 Œ ą€Software€and€other€works€which€have€traditionally€been€considered€š šcopyright-likeššŠ x#Ø ( Šreceive€the€following€tax€treatment:€€(1)€such€works€are€not€capital€assets€in€the€hands€ofĻthe€creator;€(2)€development€costs€for€such€works€may€not€be€capitalized€by€the€creator;Ļ(3)€development€costs€for€such€works€have€previously€not€been€expensible€by€non-creatorĻpayors€(though€this€is€not€the€case€currently);€(4)€such€works€have€a€longer€write-offĻperiod€based€upon€the€life€of€the€author€plus€70€years€for€general€copyright,€with€someĻshorter€write-off€exceptions€specific€to€software.€€As€a€result€of€these€factors,€andĻdepending€upon€the€type€of€business€in€which€a€taxpayer€is€engaged€money€earned€willĻbe€ordinary€income€in€any€event.€Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąIndividual€software€creators/inventors€are€much€more€keenly€affected€by€the€ability€toŠ ¢+Ņ(2 Šclaim€patent€rights€since€the€patent€protection€is€much€more€powerful€and€tax-favored.€ĻSome€of€the€commentators€from€the€1990s€have€commented€that€merely€seekingĻcopyright€protection€can€result€in€the€less€favorable€copyright-like€tax€treatment.€€ThereŠ .E+5 Šare€some€copyright€deduction€rules€for€off-the-shelf€software,€but€immediate€expensingĻunder€the€patent€tax€rules€are€still€preferable.€€Electing€to€capitalize€a€patent€may€only€beĻlogical€where€there€is€a€net€operating€loss€carry-forward€that€would€be€lost€if€one€electedĻto€expense€the€patent.Š Œ ¬&Œ ¬& ŠĢ€ą „ ąą Ü ąą 4 ą(c)ą0 Œ ąExpansion€of€the€current€controversy€has€continued€along€the€same€lines€as€theŠ å Šcontroversy€between€design€patents€and€3-D€copyrights.€€The€regulations€take€the€viewĻthat€if€property€is€only€protected€under€the€patent€laws,€IRC€šš€1221(3)€denying€assetĻstatus€will€not€apply.€€Gilson€v.€Commissioner€states€that€if€the€taxpayer€is€not€utilizingĻcopyright€laws,€he€should€not€be€subject€to€harsher€tax€treatment.€€In€the€software€area,Ļthe€degree€of€dual€protection€is€even€greater,€since€patent€protects€a€method,€and€aĻsoftware€copyright€protects€only€the€expression€of€the€process€in€a€specified€language.€ĻHowever,€licenses€should€be€carefully€drawn€to€distinguish€these€rights.€€This€differsĻfrom€the€design€and€3-D€copyright€dichotomy,€where€there€is€a€bright€line€separationĻbetween€the€two€areas€based€upon€whether€the€item€is€utilitarian€in€nature.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąAs€set€forth€below,€the€ability€to€write€off€development€of€software€along€the€same€linesŠ ą  Šas€patent€is€now€more€clearly€available.€€Tax€treatment€for€sale€of€copyright€remainsĻgrossly€different€from€tax€treatment€for€sale€of€patent€by€two€primary€factors:€€(1)€sale€ofĻcopyright€by€a€creator€results€in€ordinary€income€because€a€copyrighted€work€is€not€aĻcapital€asset,€and€(2)€the€waiting€period€for€capital€gains€treatment€on€sale€of€copyright€isĻone€year,€even€where€an€individual€purchases€a€copyright€and€can€thus€hold€it€as€a€capitalĻasset.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąAnother€recent€case,€AT&T€Corp.€v.€Excel€Communications€Inc.,€98„1338€CAFC,€hasŠ h˜ Ševen€further€extended€the€patentability€of€software€rule.€€Generally,€this€case€stated€that,Ļso€long€as€an€algorithm€is€not€usurped€and€so€long€as€the€claims€are€drawn€to€theĻalgorithm€in€a€USEFUL€way,€the€algorithm€may€be€patented.€€This€change€inĻclassification€of€software€is€definitely€here€to€stay.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(f)ą0 Œ ąThere€may€be€some€confusion€about€the€statement€that€š šall€software€is€now€patentablešš,Š N~ Šas€this€statement€merely€means€that€all€software€is€within€the€šš101€definition€ofĻpatentable€subject€matter.€€Thus,€it€is€implied€that€perhaps€only€a€small€portion€ofĻsoftware€may€actually€be€patentable.€€This€may€not€matter€from€either€a€practical€or€a€taxĻstandpoint.€€To€wit,€you€will€recall€that€patents€and€trade€secrets€are€treated€the€sameĻfrom€a€tax€perspective;€we€believe€the€reason€for€this€could€be€because€the€taxingĻauthority€was€not€interested€in€waiting€years€to€determine€whether€an€item€wasĻpatentable.€€Additionally,€an€idea€which€is€patentable€is€technically€a€trade€secret€until€itĻis€publicly€disclosed.€€€Because€software€is€now€treated€no€differently€than€otherĻpatentable€matter,€there€is€also€no€barrier€to€treating€software€as€a€trade€secret.€Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(g)ą0 Œ ąFor€example:€A€software€program€in€2009€is€very€similar€to€one€which€was€patented€andŠ I$y!) Špublished€in€2007,€i.e.,€it€differs€only€by€a€few€kinks€and€twists€which€are€clearly€tradeĻsecrets,€but€which€do€not€rise€to€a€level€beyond€the€obviousness€threshold.€€This€softwareĻis€a€trade€secret€and€is€given€the€same€benefits€as€if€it€were€a€patentable€trade€secret.€ĻBoth€the€patentable€and€unpatentable€versions€of€the€software€may€be€sold€as€tradeĻsecrets€with€corresponding€capital€asset€treatment€and€instant€capital€gains€under€IRCĻšš1235.€€Both€may€be€the€subject€of€a€patent€application€(after€all,€the€obviousness€issueĻmust€be€addressed€by€the€examiner,€and€if€the€examiner€rejects€the€claims€in€the€finalĻanalysis,€this€may€not€occur€until€years€later).€€Patent€applications€for€both€the€patentableĻand€unpatentable€versions€of€the€software€may€be€the€subject€of€an€assignment€within€theĻPatent€Office€to€show€title,€and€either€version€may€be€the€subject€of€an€appeals€processĻwhere€there€is€a€holding€of€non-patentability.€Further,€both€applications€may€be€theĻsubject€of€later€continuation-in-part€applications€which€may€include€added€details€thatŠ .E+5 Šresult€in€patent€issuance.€Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(h)ą0 Œ ąIn€summation,€ultimate€patentability€based€upon€how€good€the€invention€is€has€never€hadŠ r¢ Šanything€to€do€with€tax€treatment.€€Conversely,€the€classification€of€subject€matter€asĻpatentable€or€non-patentable€has€been€crucial€to€tax€treatment.€€For€this€reason,€theĻmischaracterization€of€machine€steps€as€copyrightable€has€always€been€problematic.€ĻWith€software€patent€and€trade€secrets€looming€on€the€horizon,€we€can€only€hope€that€theĻIRS€stands€ready€with€an€intelligent€position€to€avoid€clogging€the€courts.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ą8.ą0 4 ąPatent€Enforcement:€Making€the€System€WorkŠ) Y 4¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąThere€are€multiple€considerations€for€the€patentee€who€finds€it€necessary€to€activelyŠ Ė ū  Šenforce€patent€rights.€€Careful€thought€must€be€given€to€setting€the€tone€of€negotiations€orĻlicensing;€crafting€the€notice€of€infringement;€laches€and€estoppel;€applying€andĻmaintaining€pressure€on€infringers;€ITC€actions€for€imports;€marshaling€infringers€toĻfinance€the€action;€and,€acquiring€patent€insurance€to€cover€suits€against€infringers€asĻwell€as€to€insure€against€the€possibility€that€a€patent€may€be€invalidated.€€It€is€of€note€thatĻthere€are€few€companies€which€provide€offensive€patent€insurance€that€may€be€used€toĻpursue€infringers.€€Intellectual€Property€Insurances€Services€Corporation€has€recentlyĻmade€available€a€policy€for€the€loss€of€intellectual€property€value,€and€they€may€beĻcontacted€by€mail€at€Suite€114,€10503€Timberwood€Circle,€Louisville,€Kentucky€40223;Ļby€phone€at€1-800-537-7863;€or€by€e-mail€at€info@infringeins.com.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąValue€may€be€extracted€from€an€issued€patent€by€either€(1)€running€a€manufacturingŠ —Ē Šoperation€as€a€monopoly,€or€(2)€licensing€other€manufacturers€to€make€the€patentedĻproduct.€€An€exclusive€license€is€a€permission€granted€to€a€single€manufacturer.€€AĻnon-exclusive€license€may€be€granted€to€one€or€more€manufacturers.€The€centralĻdifference€between€an€exclusive€and€a€non-exclusive€license€may€lie€in€what€actions€areĻcontractually€assumed€in€the€license€if€the€patent€is€infringed.€€It€is€much€more€likely€thatĻan€exclusive€licensee€will€undertake€to€sue€to€protect€the€patent.€Where€there€areĻnon-exclusive€licensees,€the€patent€owner€will€generally€be€the€one€to€undertake€suit€toĻprotect€the€patent.Š Œ ¬&Œ ¬& Š€€€€€Ģą „ ąą Ü ąą 4 ą(c)ą0 Œ ąPatent€holders€who€find€themselves€in€the€unfortunate€position€of€accused€infringer€alsoŠ Įń! Šhave€multiple€considerations.€€Intensive€investigation€and€careful€planning€should€ensueĻimmediately:€defensive€insurance€status€should€be€determined;€an€opinion€onĻpatentability€should€be€acquired;€economic€analysis€should€be€performed€as€a€prelude€toĻpotential€licensing€agreements;€data€on€other€potential€infringers€should€be€gathered;Ļinformation€damaging€to€the€patent€should€be€documented;€and,€a€re-examination€requestĻmay€be€in€order€where€there€is€sufficient€printed€matter€to€support€it.Š Œ ¬&Œ ¬& ŠĢņņIII.ą „ ąTax€Treatment€of€PatentsŠ I$y!) ŠóóĢą „ ąA.ą Ü ąDEDUCTION€OF€DEVELOPMENT€EXPENSESŠ P&€#+ ŠĢą „ ąą Ü ą1.ą0 4 ąIn€general,€IRC€šš174(a)€allows€research€or€experimental€expenditures€to€be€treated€as€deductibleŠ ņ'"%- Šexpenses€if€they€(1)€are€paid€or€incurred€by€a€taxpayer€during€the€taxable€year,€and€(2)€are€inĻconnection€with€the€taxpayerššs€trade€or€business.€€The€term€"in€connection€with"€is€deliberatelyĻless€stringent€than€the€"ongoing€business€concernšš€requirement€found€in€other€sections€of€theĻcode.€€For€example,€IRC€šš162€allows€deductibility€only€for€(1)€ordinary€&€necessary€expensesĻwhich€are€(2)€paid€or€incurred€in€carrying€on€a€trade€or€business.€€This€would€seem€to€indicateĻthat€a€presently€functioning€business€is€a€precondition€of€deductibility€under€IRC€šš162.€ĻAlternatively,€IRC€šš174(b)€allows€expenses€to€be€capitalized€and€amortized€over€a€period€of€notŠ ©-Ł*4 Šless€than€60€months;€however,€capitalization€is€typically€only€used€to€avoid€losing€carryover€netĻoperating€losses€from€prior€years.€€Although€the€š šin€connection€withšš€language€loosens€theĻoperation€of€IRC€šš174€appreciably,€recent€cases€have€applied€what€we€refer€to€as€an€š šin€businessĻof€the€inventionšš€test,€rejecting€IRC€šš174€treatment€for€entities€which€are€not€intimatelyĻconcerned€with€exploiting€the€technology.€€As€a€result,€the€inventor€should€be€actively€›pursuingĻbusiness€or€licensing€with€respect€to€the€patent€prior€to€taking€advantage€of€deductibility€underĻIRC€šš174.€As€yet€another€alternative,€IRC€šš59(e)€allows€a€taxpayer€to€capitalize€and€amortizeĻover€a€10€year€period.€€This€election€can€be€made€for€separate€projects,€and€regulationsĻgoverning€IRC€šš59(e)€can€be€found€at€REG-124405-03.Š 4¬&4¬& Š€Ģą „ ąą Ü ą2.ą0 4 ą€In€general,€IRC€šš174€enables€a€taxpayer€to€deduct€fees€paid€to€a€patent€attorney€to€procure€eitherŠ ś *  Ša€U.S.€or€a€foreign€patent.€€IRC€šš174€also€allows€a€deduction€for€money€spent€on€generalĻresearch,€as€well€as€on€product€design,€development,€or€improvement.€€However,€to€takeĻadvantage€of€the€deduction€for€the€cost€of€procuring€a€foreign€patent,€U.S.€patent€rights€shouldĻalready€be€in€place€(Rev.€œRul›.€68-471€1968-2€CB€109).€€Where€a€taxpayer€has€expendituresĻrelated€to€procuring€foreign€rights€but€does€not€own€corresponding€U.S.€rights,€the€expendituresĻfor€the€foreign€patent€are€not€likely€to€be€deductible€(Rev.€œRul›.€66-30,€1966-1€CB€55).€€OtherĻnon-deductible€expenses€include€environmental€impact€studies€and€the€cost€of€acquiring€theĻpatent€of€another.€€Also,€relatively€wealthy€non-corporate€taxpayers€may€be€subject€to€theĻalternative€minimum€tax€computation,€which€requires€the€expenditures€to€be€capitalized€andĻdeducted€ratably€over€10€years€(for€alternative€minimum€tax€purposes€only).€€An€exception€to€theĻalternative€minimum€tax€capitalization€is€made€where€the€taxpayer€(materially€participates(€inĻthe€research€and€development€as€a€business.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ą€Note€that€there€are€dozens€of€tax€cases€relating€to€non-existent€technology€where€individuals,Š h˜ Šparticularly€tax€practitioners,€sought€to€set€up€business€models€to€enable€investors€to€write€offĻtheir€š šinvestment.šš€€In€these€cases,€the€IRC€šš174€write€off€(expensing€treatment)€is€denied.€€InĻanother€line€of€cases,€the€š šactively€in€businessšš€test€has€been€applied€to€deny€IRC€šš174€treatmentĻwhere€the€main€investment€vehicle€was€not€immediately€able€to€continue€exploiting€theĻtechnology€or€was€not€ready€to€take€the€technology€elsewhere.€€€We€view€this€as€a€furtherĻexpansion€of€the€prohibition€on€purely€investment€partnerships,€and€a€discussion€of€this€line€ofĻcases€is€set€forth€after€the€discussion€of€the€Green€case€below.Š 4¬&4¬& Š€€€€€Ģą „ ąB.ą Ü ąCREDITSŠ Įń! ŠĢ€ą „ ąą Ü ą1.ą0 4 ąIRC€šš41€gives€taxpayers,€typically€large€corporate€taxpayers,€a€credit€€based€upon€either€(a)€aŠ c“# Šregular€credit€for€qualified€research€expenditures€which€exceed€some€fixed€base€percentage€of€Ļaverage€annual€gross€receipts€or€(b)€an€incremental€credit€based€upon€(current(€qualified€researchĻexpenditures€which€exceed€research€intensity€for€a€given€base€period.€€Although€a€percentageĻpopularly€stated€with€respect€to€this€credit€is€š š20%šš€there€are€other€limitations€to€both€€creditsĻwhich€reduce€the€20%€value€to€a€much€lower€figure.€€€In€the€first€case€(regular€credit)€the€20%€isĻapplied€to€the€lesser€of€€50%€of€the€qualified€research€expenditure€or€the€amount€of€qualifiedĻresearch€expenditure€above€some€percentage€of€last€yearššs€gross€receipts.€€In€the€second€caseĻ(incremental€credit)€the€20%€figure€is€multiplied€times€the€EXCESS€of€qualified€researchĻexpenditure€over€a€somewhat€complicated€base€period€amount.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąThe€rules€for€what€qualifies€as€š šresearch€expenditurešš€has€been€liberalized€over€the€past€fewŠ ^(Ž%. Šyears€and€in€some€cases€includes€internal€expenditure€for€software€which€will€not€be€usedĻoutside€the€organization.€€For€companies€and€individuals€willing€to€crank€through€theĻcomputations€and€rules,€the€savings€can€be€substantial.€€Several€specialist€companies€have€arisesĻwho€specialize€in€performing€this€specialized€task€for€large€integrated€companies,€taking€aĻpercentage€of€the€tax€savings€for€the€specialist€with€€enough€left€over€for€the€use€of€the€credit€toĻremain€lucrative€for€the€companies€who€choose€to€take€advantage€of€this€provision.Š 4¬&4¬& Š€€€€€Š .E+5 Šą „ ąą Ü ą3.ą0 4 ą€To€make€matters€worse,€IRC€šš280C(c)€disallows€deduction€of€that€portion€of€research€expensesŠ Š Šwhich€are€equivalent€to€the€credit,€while€offering€as€an€alternative€the€reduction€of€the€creditĻ(which€would€otherwise€be€completely€lost€under€this€complete€take-away€rule)€of€about€40%Ļ(taxpayerššs€tax€rate);€€i.e.,€the€taxpayer€gets€to€keep€60%€of€the€an€amount€l€resulting€less€thanĻthe€10%-20%€full€credit.€€The€taxpayer€most€in€need€of€this€provision€is€one€who€has€undergoneĻthe€burden€of€increasing€research€rapidly€and€in€excess€of€normal€gross€income;€unfortunately,Ļthis€kind€of€taxpayer€also€has€the€greatest€limitations€on€the€credit,€namely€60%€times€the€10%Ļlimited€credit.€€Therefore,€the€best€case€scenario€might€well€involve€a€poor€taxpayer€with€a€0%Ļtax€rate€who€experiences€a€less€than€50%€increase€in€research€and€who€can€magically€claim€theĻfull€20%€credit!Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąThe€Pension€Protection€Act€of€2006€(PPA)€includes€a€š šsimplifiedšš€research€credit€alternativeŠ Ė ū  Šmore€likely€to€impact€small€inventors€in€2007:Š 4¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąThe€prior€and€still€effective€€research€expense€credit€(claimed€on€Form€6765)€equals€theŠ >n  Šsum€of:€(1)€20%€of€any€excess€of€qualified€research€expenses€for€the€tax€year€over€a€ņ ņbaseŠ ?  Šamountó ó,€(unless€the€taxpayer€elects€the€alternative€incremental€credit,€which€would€thenŠ ć  Šreplace€this€item);€(2)€The€"university€basic€research€credit,"€i.e.,€20%€of€the€basicĻresearch€payments€determined€under€Code€Sec.€41(e)(1)(A);€and€(3)€20%€of€theĻtaxpayer's€expenditures€on€qualified€energy€research€undertaken€by€an€energy€researchĻconsortium.€(Code€Sec.€41(a))€.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąThe€ņ ņbase€amountó ó€is€a€fixed-base€percentage€of€taxpayer's€average€annual€gross€receiptsŠ Ģü Šfrom€a€U.S.€trade€or€business,€net€of€returns€and€allowances,€for€the€four€tax€years€beforeĻthe€credit€year,€and€can't€be€less€than€50%€of€the€year's€qualified€research€expenses.€TheĻfixed€base€percentage€for€a€non-startup€company€that€isn't€using€the€alternativeĻincremental€credit€is€the€percentage€(not€exceeding€16%)€that€taxpayer's€total€qualifiedĻresearch€expenses€is€of€total€gross€receipts€for€tax€years€beginning€after€1983€and€beforeĻ1989.€Special€rules€apply€to€a€š šstartup€companyšš€that€has€qualified€research€expenses.Ļ(Code€Sec.€41(c)(3))€Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąAs€a€first€alternative,€taxpayers€are€allowed€to€elect€an€alternative€incremental€researchŠ (X Šcredit€regime€in€lieu€of€the€regular€research€credit€in€which€the€taxpayer€is€assigned€aĻthree-tiered€fixed-base€percentage.€(IRC€šš€41(c)(4)(A))€The€new€act€increases€theĻapplicable€percentages€for€the€incremental€credits.€2.65%€rising€to€3%,€3.3%€rising€toĻ4.0%€and€3.75%€rising€to€5.0%Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąIn€a€new€alternative€simplified€research€credit,€a€taxpayer€can€elect€(in€lieu€of€the€20%Š !>% Šcredit€otherwise€determined€under€Code€Sec.€41(a)(1)€)€a€credit€equal€to€12%€of€theĻexcess€of€the€qualified€research€expenses€for€the€tax€year€over€50%€of€the€averageĻqualified€research€expenses€for€the€three€tax€years€preceding€the€tax€year€for€which€theĻcredit€is€being€determined.€(IRC€šš€41(c)(5)(A)).€€If€a€taxpayer€has€no€qualified€researchĻexpenses€in€any€one€of€the€three€preceding€tax€years,€the€alternative€simplified€researchĻcredit€is€6%€of€the€qualified€research€expenses€for€the€tax€year€for€which€the€credit€isĻbeing€determined.€(IRC€šš€41(c)(5)(B),€as€added€by€Act€Sec.€104(c)(1))€.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąCalifornia€has€a€credit€similar€to€the€Federal€Credit€in€structure,€but€only€for€researchŠ g(—%. Šconducted€ņņwithin€the€stateóó.€€Compare€Canadaššs€Federal€35%€refundable€tax€credit€forŠ 8)h&/ Šresearch€by€Canadian€Controlled€Private€Corporations€(Internal€Revenue€ActĻšš127(10.1)),€along€with€supporting€refundable€tax€credits€from€the€provinces:€OntarioĻsuper€allowance€(125%€up€to€152.5%);€Quebec€refundable€tax€credit€(20%);€Nova€ScotiaĻ(15%€refundable);€Manitoba€(15%€non„refundable);€New€Brunswick€(10%€non„¼refundable);€Newfoundland€(15%€refundable);€and€Ontario€Business„Research€InstituteĻ(OBRI)€(refundable€tax€credit€of€20%€for€corporate€sponsored€R&D€performed€at€OntarioŠ .N+5 Šuniversities).Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(f)ą0 Œ ąThe€general€trend€these€days€is€toward€š šCost€Segregationšš€a€technique€in€which€eachŠ r¢ Šelement€of€expense€is€analyzed€to€see€if€it€can€fit€into€a€credit€category.€Firms€such€asĻKBKG€operate€web€sites€offering€free€CPE€to€accountants€and€other€tax€professional€toĻeducate€them€about€the€technique.€€Expenses,€if€properly€segregated,€can€result€in€aĻbenefit€which€goes€beyond€the€benefit€of€a€mere€deduction.€€In€some€cases€a€deductionĻmay€fit€into€several€tax€credit€categories.€Several€firms€have€arisen€making€money€byĻoffering€the€service€of€optimizing€a€firms€tax€credit€categories.Š Œ ¬&Œ ¬& ŠĢą „ ąC.ą Ü ąCAPITAL€GAINS€TREATMENT€ON€THE€SALE€OF€TECHNOLOGYŠ ś *  ŠĢą „ ąą Ü ą1.ą0 4 ą€Just€as€a€simple€sale€or€exchange€where€the€title€to€a€patent€is€transferred,€a€domestic€patentŠ œ Ģ  Šlicense€which€transfers€all€substantial€rights€in€a€patent€is€treated€as€a€sale€or€exchange€of€theĻpatent€for€tax€purposes.€€Recall€that€capital€gains€are€available€under€IRC€šš1235€(with€bothĻadvantages€and€disadvantages),€outside€IRC€šš1235,€or€by€sale€of€stock,€etc.,€in€the€unfortunateĻcircumstance€where€a€patent€has€been€assigned€to€a€corporation.€€Although€extremely€ill-advised,Ļthis€may€be€the€case€where€venture€capitalists€are€involved.€Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąAccording€to€IRC€šš1235,€which€addresses€the€sale€or€exchange€of€patents:ŠSƒ4¬&4¬& ŠĢą „ ąą Ü ąą0 4 ąGENERAL.-€A€transfer€(other€than€by€gift,€inheritance,€or€devise)€of€property€consisting€of€allĻsubstantial€rights€to€a€patent,€or€an€undivided€interest€therein€which€includes€a€part€of€all€suchĻrights,€by€any€holder€shall€be€considered€the€sale€or€exchange€of€a€capital€asset€held€for€moreĻthan€1€year,€regardless€of€whether€or€not€payments€in€consideration€of€such€transfer€are-Š 4¬&4¬& Šą „ ąą Ü ąą 4 ąą Œ ą(1)ą0 ä ą€payable€periodically€over€a€period€generally€coterminous€with€the€transfereeššsŠ 9i Šuse€of€the€patent,€orŠ ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ą(2)ą0 ä ącontingent€on€the€productivity,€use,€or€disposition€of€the€property€transferred.ŠŪ ä ¬&ä ¬& ŠĢą „ ąą Ü ą3.ą0 4 ą€Holder€Defined€-€For€the€purposes€of€this€section,€the€term€š šholderššmeans-Š}­4¬&4¬& Šą „ ąą Ü ąą 4 ą(a)ą0 Œ ąany€individual€whose€efforts€created€such€property,€orŠN~Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(b)ą0 Œ ąany€other€individual€who€has€acquired€his€interest€in€such€property€in€exchange€forŠ O Šconsideration€in€money€or€money(s€worth€paid€to€such€creator€prior€to€actual€reduction€toĻpractice€of€the€invention€covered€by€the€patent,€if€such€individual€is€neither-Š Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ąą Œ ą(A)€the€employer€of€such€creator,€norĢą „ ąą Ü ąą 4 ąą Œ ą(B)€related€to€such€creator€(within€the€meaning€of€sub€(d)).*ĢĢą0 „ ąą0Ü„¬&„¬&ąą04ܬ&ܬ&ąą0Œ 4¬&4¬&ąą0ä Œ ¬&Œ ¬&ą*[members€of€a€family,€individual€&€25%€owned€corporation,€two€corporationsĻwhich€are€members€of€the€same€control€group,€grantor€&€fiduciary€of€a€trust,€andĻmore.€Constructive€ownership€of€stock€is€limited€to€an€individualššs€spouse,Ļancestors€and€lineal€descendants]€referencing€(267(b),€&€707(b).Š ä ¬&ä ¬& ŠĢą „ ąą Ü ą4.ą0 4 ąDuring€the€tax€years€ending€between€5/6/97€and€12/31/97,€the€capital€gains€were€split€into€(1)€aŠ %J"* Šlong€term€rate€of€20%€for€holding€periods€over€18€months,€and€(2)€a€mid-term€rate€of€28%€forĻholding€periods€over€12€months.€€The€IRS€issued€a€holding€based€on€IRC€šš1235€which€statedĻthat€the€real€intent€was€to€give€the€more€liberal€18€month€holding€period€with€the€20%€long€termĻrate€for€patent€holders.€€Since€the€law€changed€again€for€tax€years€after€1997€(back€to€a€unifiedĻone€year€holding€period€and€20%€rate),€the€one€year€provision€in€IRC€(1235€changed€for€only€aĻlimited€time€before€the€IRS€re-affirmed€its€holding€that€IRC€(1235€always€operates€to€give€theĻmost€favorable€capital€gains€rate€available.€€Thus,€for€patents,€an€invention€made€on€one€day€canĻbe€sold€the€very€next€day€and€still€receive€what€we€often€refer€to€as€š šinstantšš€capital€gainsĻtreatment.€Š 4¬&4¬& ŠĢą „ ąą Ü ą5.ą0 4 ąCapital€gains€rates€for€individuals,€in€2009,€are€currently€split€into€four€categories.**€€At€theŠ .E+5 Šlower€end€of€the€income€scale,€taxpayers€in€the€15%€income€tax€bracket,€the€long€term€gainĻ(which€was€previously€10%)€has€dropped€to€0%.€Next,€for€taxpayers€in€higher€bracket,€the€longĻterm€capital€gains€rate€is€15%.€€Two€other€rates€have€been€imposed€for€special€situations.€€AĻcapital€gains€tax€rate€of€28%€has€been€set€for€collectible€items.€€A€capital€gains€rate€of€25%€isĻimposed€upon€unrecaptured€šš1250€depreciation€(the€depreciation€which€is€above€the€straight€lineĻlevel€of€depreciation,€but€below€the€acquisition€basis).€€Corporate€taxpayers€are€not€eligible€forĻcapital€gains€rates€and€do€not€qualify€for€holder€status€in€any€event.€€A€corporation€which€buys€aĻpatent€and€holds€it€for€more€than€a€year€technically€has€a€capital€gain,€but€will€still€be€taxed€atĻcorporate€rates.€€The€characterization€of€the€gain€as€a€capital€gain€is€only€slightly€advantageousĻbecause€it€enables€an€offset€against€long€term€capital€loss.Š 4¬&4¬& ŠĢą „ ąą Ü ąą0 4 ąą Œ ą**€In€the€United€States,€the€capital€gains€rate€is€in€flux.€€As€of€January€11,€2009,€aĻprevious€20%€rate€(earlier€reduced€from€28%)€remains€at€15%.€€The€rate€was€reduced€in€2003€toĻ15%,€or€to€5%€for€individuals€in€the€lowest€two€income€tax€brackets€and€more€recently€with€theĻ5%€rate€dropping€to€a€zero€percent€rate.€€€This€current€capital€gains€rate€was€previously€expectedĻto€expire€without€further€action€in€2008,€but€has€been€extended€through€2010€as€a€result€of€theĻTax€Increase€Prevention€and€Reconciliation€Act€signed€into€law€by€President€Bush€on€May€17,Ļ2006€(P.L.€109-222).€In€2011€these€reduced€tax€rates€will€"sunset,"€or€revert€to€the€rates€in€effectĻbefore€2003,€which€were€generally€20%.€€However,€€President€Obama's€budget,€announced€onĻFebruary€25,€2009,€calls€for€the€Capital€Gains€Tax€to€be€reverted€to€the€20%€rate€before€theĻSunset€date€of€2011,€and€which€might€be€made€retroactive€depending€upon€a€great€many€factorsĻto€a€date€much€earlier€than€its€date€of€passage.€€As€a€result€both€the€15%€and€the€20%€rate€shouldĻbe€planned€for,€as€well€as€a€complete€uncertainty€as€to€which€one€will€apply€to€sales/exchangesĻin€2010€depending€upon€the€details€and€timing€of€the€final€statute.Š 4¬&4¬& ŠĢą0 „ ąą0Ü„¬&„¬&ąą04ܬ&ܬ&ąŠ 4¬&4¬& Šą „ ąą Ü ą6.ą0 4 ąThe€key€to€capital€gains€treatment€is€to€be€a€"holder"€as€defined€in€the€Internal€Revenue€Code.€€AŠ  : Šholder€can€be€the€inventor€or€one€who€bought€from€the€inventor,€but€not€those€who€are€merely€inĻprivity€with€the€inventor.€€A€holder€is€further€defined€as€one€who€obtains€an€interest€in€theĻtechnology€before€it€is€actually€reduced€to€practice.€€Investment€partners€and€investmentĻco-owners€who€contribute€capital€can€qualify€as€holders,€so€long€as€the€contribution€is€madeĻbefore€actual€reduction€to€practice.€€(Note€that€constructive€reduction€to€practice,€meaning€thatĻthe€inventor€has€filed€a€patent€application,€does€not€apply€here.€See€Reg€šš1.1235-2(d)(3)).€€ĻFurther,€a€holder€must€actually€own€a€portion€of€the€invention€rather€than€a€contractual€right€toĻfuture€income€(which€would€constitute€some€form€of€loan€or€option).€€According€to€Reg.Ļšš1.1234,€an€actual€reduction€to€practice€is€defined€as€follows:Š 4¬&4¬& ŠĢą „ ąą Ü ą7.ą0 4 ąFor€the€purposes€of€determining€whether€an€individual€is€a€holder€under€paragraph€(d)€of€thisŠ !5% Šsection,€the€term€š šactual€reduction€to€practicešš€has€the€same€meaning€as€it€does€under€sectionĻ102(g)€of€title€35€of€the€United€States€Code.€€Generally€,€an€invention€is€reduced€to€actualĻpractice€when€it€has€been€tested€and€operated€successfully€under€operating€conditions.€€This€mayĻoccur€either€before€or€after€application€for€a€patent€but€cannot€occur€later€than€the€earliest€timeĻthat€commercial€exploitation€of€the€invention€occurs.€€This€presents€a€real€problem€for€inventorsĻto€move€the€invention€to€the€š šproof€of€workabilityšš€stage€before€seeking€capital€to€further€exploitĻthe€invention€to€an€acceptable€level€of€efficiency€required€for€commercial€viability.Š 4¬&4¬& ŠĢĢą „ ąą Ü ą8.ą0 4 ąThus,€š šreduction€to€practicešš€means€totally€different€things€in€the€patent€law€versus€the€tax€law.€Š /)_&/ ŠIn€patents,€reduction€to€practice€means€either€the€building€of€the€device€to€the€level€of€inventionĻto€be€claimed€in€a€patent,€OR€the€filing€of€an€enabling€patent€application.€€In€the€tax€law€it€meansĻthe€actual€building€of€a€device€which€demonstrates€the€MINIMUM€level€of€operability.€€In€aĻpatent,€this€would€correspond€to€the€broadest€claim.€€In€a€patent€clearly€drawn€to€an€improvementĻover€a€prior€art€device,€it€would€be€a€showing€of€a€non„obvious€level€of€improvement€over€thatĻminimum€level€of€prior€art.€€Thus,€where€such€an€invention€is€the€case,€a€careful€documentingŠ .E+5 Šand€identification€of€that€breakthrough€would€be€required€to€prove€up€š šreduction€to€practiceššĻAFTER€an€investor€invests€in€the€invention.Š 4¬&4¬& ŠĢĢą „ ąą Ü ą9.ą 4 ąImportant€points€to€remember:Š D ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ą€If€possible,€bring€investors€on€board€before€the€patent€is€reduced€to€practice€so€that€theyŠ ¶ę Šcan€be€š šholders.ššŠ Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ą€Inventors€and€other€holders€do€not€have€to€wait€the€traditional€year€in€order€to€get€longŠ ) Y  Šterm€capital€gains€on€the€sale€of€the€technology,€but€instead€have€instant€long€term€capitalĻgain€status.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąThe€term€š ša€patentšš€refers€to€a€patent€in€its€entirety.€€Unlike€copyrights,€subdivisionalŠ m   Športions€of€a€patent€(which,€of€course,€covers€a€single€country)€cannot€be€š šsoldšš€(ratherĻthan€licensed)€and€still€have€the€transaction€qualify€for€capital€gains€treatment.€€It€is€ourĻunderstanding€that€this€point€has€never€been€litigated.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąA€transaction€with€a€š šrelated€partyšš€will€destroy€the€capital€gains€treatment€under€IRCŠ ‚² Ššš1235.€(or€even€outside€šš1235)Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąWhere€an€employee€is€paid€an€amount€of€royalty,€even€over€the€full€term€of€the€patent,Š õ% Šthis€will€generally€constitute€compensation€for€services€as€ordinary€income,€and€capitalĻgains€are€not€likely€to€be€available.€€However,€some€cases€have€indicated€that€capitalĻgains€may€be€available€where€(a)€the€employee€was€not€hired€to€invent,€(b)€the€servicesĻare€ancillary€to€the€patent€transfer,€and€(c€)€the€taxpayer€has€an€arrangement€beforeĻbeginning€employment.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(f)ą0 Œ ąSince€actual€reduction€to€practice€under€the€regulations€may€occur€later€than€theŠ ¬Ü Šapplication€for€patent,€an€opportunity€exists€for€bringing€in€investor-holders€after€theĻapplication€for€patent€is€submitted.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(g)ą0 Œ ąThe€right€to€deduct€research€and€development€expenditures€as€set€forth€in€above€is€evenŠ š   Šmore€critical€to€new€technology€ventures€because€the€tax€advantage€of€these€deductionsĻare€not€recaptured€if€the€technology€is€later€sold.€€To€illustrate€an€extreme€example,Ļassume€that€$1,000,000€of€personal€monies€is€spent€on€research€in€year€1€and€is€deductedĻas€an€expense€under€šš174.€€(Ignore€ademption€of€personal€deductions€and€other€š šhiddenĻtaxšš€for€the€high€income€rate€payer.)€€The€value€of€this€tax€deduction€at€a€35%€topĻmarginal€rate€is€$350,000.€€Although€the€invention€would€usually€be€sold€for€much€more,Ļif€the€invention€is€sold€for€$1,000,000€under€IRC€šš1235€on€the€day€after€the€patent€filingĻdate€and€is€taxed€at€a€current€federal€capital€gains€rate€of€15%,€the€tax€burden€would€beĻ$150,000.€€€In€this€case,€the€taxpayer€will€have€netted€(absent€other€considerations)Ļ$200,000€based€upon€the€tax€rate€differential€between€the€ordinary€income€write-off€andĻthe€long€term€capital€gains€tax€rate.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(h)ą0 Œ ą€IRC€šš174€is€so€disrupts€the€direct€connection€between€general€research€and€a€patentŠ '½$- Šproject€that€there€is€no€recapture€(Rev.€Rul.€73-395,€1973-2€CB€87).€For€financialĻillustration€purposes€only,€and€referencing€the€recapture€case€(using€IRC€šš1245€property)Ļpurely€for€contrast,€assume€that€an€item€costs€$1,000,000€and€has€been€depreciated€(overĻthe€greater€than€12€month€holding€period€so€that€the€15%€capital€gains€rate€applies)€soĻthat€it€has€an€accounting€book€value€(or€basis)€of€$600,000.€€If€the€capital€item€were€toĻsell€for€$2,000,000,€the€sales€price€would€be€treated€as€follows:€€$600,000€wouldĻrepresent€a€non-tax€return€of€capital;€$400,000€of€the€gain€over€basis€would€beĻš šrecapturedšš€depreciation€and€would€be€taxed€at€ordinary€rates€(since€it€was€previouslyŠ .E+5 Šdepreciated€with€a€savings€based€upon€ordinary€rates);€and,€the€$1,000,000€gain€over€theĻpurchase€price€would€be€taxed€at€capital€gains€rates.€If€recapture€rules€had€applied,€theĻ$200,000€tax€š šarbitragešš€savings€would€not€be€possible€because€the€sale€would€have€beenĻtaxed€at€ordinary€rates.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(i„€)ą0 Œ ąMost€inventors€confuse€patent€ownership€with€manufacturing€liability.€€A€patent€is€aŠ å Šnegative€right,€i.e.,€the€right€to€prevent€others€from€making,€using€and€selling€theĻinvention.€A€license€is€essentially€acceptance€of€money€as€consideration€for€not€suing€theĻlicensee.€€There€is€virtually€no€liability€to€a€patent€owner€for€merely€owing€a€patent.€Ļ(However,€abusing€or€misusing€a€patent€can€result€in€liability,€for€example,€where€theĻowner€attempts€to€enforce€a€patent€he€knows€to€be€invalid.)€€A€manufacturer€can€hold€aĻpatent€passively€while€manufacturing€the€patented€article,€but€is€not€necessarily€subject€toĻliability€merely€by€doing€so.€€Consequently,€there€is€really€no€advantage€to€be€gained€byĻputting€a€patent€into€a€corporation€in€an€IRC€(351€transaction;€doing€so€would€essentiallyĻeliminate€an€inventorššs€tax€advantages€for€subsequent€sale€both€under€IRC€šš€1235Ļš šinstant€capital€gainsšš€and€outside€IRC€šš1235€(one€year€holding€period€requirement),Ļbecause€corporations€are€taxed€on€capital€gain€property€at€the€same€rate€as€ordinaryĻprofits.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(j)ą0 Œ ąThe€manufacturing€side€of€the€business€should€have€some€liability€shields,€such€as€aŠ Sƒ Šcorporate€or€LLC€form,€adequate€commercial€liability€insurance,€and€preferably€a€patentĻrider€in€the€event€that€the€manufactured€product€infringes€someone€elseššs€patent.€If€aĻcorporation€is€an€exclusive€licensee,€it€can€make€its€own€decisions€about€who€should€beĻsued€for€infringement€of€its€patent,€as€well€as€when€and€where€suit€should€be€brought.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(k)ą0 Œ ą€Patent€rights€may€also€be€divided€with€a€license€agreement€according€to€geography,€typeŠ 9i Šof€product,€time€duration,€and€the€like.€€An€agreement€for€the€sale€of€a€patent,€rather€thanĻa€license,€must€involve€the€sale€of€substantially€all€of€the€rights€in€the€patent.€€TheĻregulations€provide€that€a€license€is€not€a€sale€where:€(a)€the€transfer€is€geographicallyĻlimited€to€less€than€all€of€the€geographical€area€of€the€country€of€issuance;€(b)€the€transferĻis€limited€to€a€time€period€less€than€the€length€of€the€patent€protection€period;€(c€)€theĻlicensor€limits€the€licensee€to€specific€industries€or€trades;€(d)€the€licensor€attempts€toĻlicense€some€claims€and€exclude€others;€(e)€the€licensor€prohibits€further€sublicensing;€(f)€Ļthe€right€to€use€or€sell€are€retained€by€the€licensor;€(g)€the€right€to€terminate€the€license€isĻunilaterally€retained€and€exercisable€by€the€transferor;€and,€(h)€the€licensor€has€the€rightĻto€terminate€on€a€condition€subsequent€beyond€the€control€of€the€licensor.€€Conversely,Ļnote€that€foreign€rights€can€be€sold€and€retained€individually,€by€country,€with€eachĻcountryššs€rights€constituting€a€separate€asset.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(l)ą0 Œ ąRetained€rights€which€do€not€prevent€a€holding€that€substantially€all€rights€wereŠ §"×' Štransferred€in€the€license€(i.e.,€retention€of€rights€such€that€a€true€sale€of€the€patent€is€notĻundermined)€include€(a)€retention€of€an€option€to€sue€on€the€patent,€(b)€an€agreement€inĻthe€license€to€jointly€pursue€litigation€with€the€licensee,€(c€)€a€provision€where€either€theĻlicensor€or€the€licensee€could€bring€suit€for€infringement,€(d)€retention€by€the€licensor€of€aĻsecurity€interest,€and€(e)€retention€by€the€transferor€of€the€right€to€use€the€invention.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(m)ą0 Œ ąOnly€where€substantially€all€of€the€rights€are€transferred€can€capital€gains€treatment€beŠ ^(Ž%. Šafforded.€€Otherwise,€the€money€received€from€the€purported€sale€will€be€treated€asĻordinary€income.€€In€other€instances€the€taxpayer€may€have€divided€the€patent€rights€in€aĻseries€of€non-exclusive€licenses.€€Where€the€taxpayer€is€highly€involved€in€administeringĻthe€licenses€and€is€involved€sufficiently€to€consider€it€as€a€business,€self-employment€taxĻmust€be€paid.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ą10.ą0 4 ąLEAVING€CALIFORNIA:€€In€the€preceding€example€which€illustrates€the€advantage€and€theŠ .E+5 Šdifferential€tax€rates€available€from€a€federal€tax€perspective,€it€should€be€kept€in€mind€that€theĻstate€of€California€does€not€offer€any€break€for€capital€gains€income.€€As€a€result,€selling€a€zeroĻbasis€patent€for€$1,000,000€would€cause€the€taxpayer€to€pay€about€10%€of€that€amount€to€theĻstate.€€It€might€be€a€good€idea€to€be€a€bona€fide€resident€of€Nevada€or€Texas€at€the€time€of€sale,Ļparticularly€if€the€net€present€value€of€the€income€stream€tops€one€or€two€million€dollars.€€TheĻtax€savings€could€potentially€support€the€purchase€of€a€modest€house€in€Nevada.Š 4¬&4¬& ŠĢĢą „ ąą Ü ą11.ą 4 ąDONATING€A€PATENTŠ X ˆ ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąThe€tax€code€is€littered€with€cases€from€financial€maneuvers€that€revolve€aroundŠ ś *  Šnon-existent€inventions,€as€to€matters€NOT€involving€nonprofits.€However,€in€the€pastĻfew€years,€individuals€and€companies€have€attempted€to€donate€worthless€patents€atĻoverstated€values€to€take€advantage€of€a€charitable€mechanism€enabling€a€write-off€forĻfair€market€value€of€appreciated€assets.€€The€usual€rule€is€that€the€donee€takes€the€donorššsĻbasis€and€that€a€charitable€donor€can€write€off€only€the€amount€of€cash€basis€that€theĻdonor€had€in€the€property.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąFor€charitable€donations,€the€donor€has€previously€been€able€to€write€off€the€fair€marketŠ ‚² Švalue€of€the€item€(perhaps€the€theory€was€that€a€donor€should€not€be€forced€to€sell€theĻitem€even€at€a€15%€capital€gains€rate€and€then€donate€the€leftover€cash€to€the€charity,Ļespecially€where€such€a€sale€followed€by€cash€donation€might€result€in€a€limitation€on€theĻdeduction€where€the€amount€exceeds€the€50%,€30%€or€20%€limits€).€€The€limit€is€stillĻthere,€but€will€operate€to€reduce€deductibility€without€inclusion€into€income.€€This€ruleĻimproves€the€efficiency€of€charitable€transfers,€and€is€especially€helpful€for€charitiesĻbecause€it€enables€them€to€get€the€items€they€want.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąThe€area€of€charitable€donations€as€related€to€patents€seems€so€lucrative€that€promotersŠ Ū  Šhave€entered€the€field€to€attract€investors€who€promise€to€pass€the€tax€benefit€ofĻcharitable€donation€back€to€the€investor.€Charitable€donation€of€patents€is€also€suspectĻbecause€most€patents€have€a€zero€basis€because€of€the€ability€to€deduct€under€IRC€šš174.€ĻThe€IRS€has€issued€warnings€that€it€will€challenge€such€attempted€write-offs€based€uponĻthe€following€paragraph€from€Notice€2004-7:€Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ąą ä ą(I„)ą0 < ąTransfer€of€a€nondeductible€partial€interest€in€intellectual€property;€2)€theŠ ’Ā" Štaxpayerššs€expectation€or€receipt€of€a€benefit€in€exchange€for€the€transfer;Ļ3)€inadequate€substantiation€of€the€contribution;€and€4)€overvaluation€ofĻthe€intellectual€property€transferred.€The€purpose€of€this€notice€is€to€adviseĻtaxpayers€that,€in€appropriate€cases,€the€IRS€intends€to€disallow€all€or€partĻof€these€improper€deductions€and€may€impose€penalties€under€šš6662.€InĻaddition,€this€notice€advises€promoters€and€appraisers€that€the€IRS€intendsĻto€review€promotions€of€transactions€involving€these€improper€deductions,Ļand€that€the€promoters€and€appraisers€of€the€intellectual€property€may€beĻsubject€to€penalties€under€€šššš€6700,€€6701,€and€6694.Š <¬&<¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ąą ä ą(ii)ą0 < ąAs€of€the€effective€date€of€HR€4520,€IRC€šš170(e)(1)€was€amended€toŠ '½$- Šinclude,€along€with€prohibitions€on€write-offs€in€excess€of€the€lesser€ofĻbasis€or€FMV€for€unrelated€property€and€for€donations€to€privateĻfoundations,€the€prohibition€on€donations€of€intellectual€property.€€TheĻadded€section€reads:€Š <¬&<¬& Š€€€€€Ģą „ ąą Ü ąą 4 ąą Œ ąą ä ą(iii)ą0 < ąof€any€patent,€copyright€(other€than€a€copyright€described€in€šš1221(a)(3)Š s,£)3 Šor€šš1231(b)(1)(C)),€trademark,€trade€name,€trade€secret,€knowššhow,Š D-t*4 Šsoftware€(other€than€software€described€in€šš197(e)(3)(A)(I)),€or€similarŠ .E+5 Šproperty,€or€applications€or€registrations€of€such€property.Š <¬&<¬& Š€Ģą „ ąą Ü ąą 4 ąą Œ ąą ä ą(iv)ą0 < ąHowever,€new€sections€(IRC€šššš170(m)€and€(n))€were€added€which€enableŠ r¢ Šdonors€to€take€an€additional€write-off€for€donated€intellectual€propertyĻbased€upon€the€income€it€generates€for€the€charity,€calculated€according€toĻa€declining€rate€schedule.€€This€gives€the€donor€a€generally€linearlyĻdeclining€amount€of€write-off€for€income€received€from€the€charity€over€aĻ12€year€period,€ranging€from€100%€in€the€first€two€years€and€reduced€byĻten€percent€per€year€to€a€level€of€10%€in€the€last€two€years.€€The€intent€ofĻboth€IRC€šš170(e)(1)€and€IRC€šššš170(m)&(n)€taken€together€is€toĻencourage€donation€only€of€items€having€real€value€and€to€limit€theĻwrite-off€based€upon€real€income€potential.€€It€is€also€a€realization,€asĻdiscussed€elsewhere€in€this€paper,€that€the€value€of€intellectual€propertyĻfocused€at€a€moment€in€time€may€be€speculative,€a€better€idea€being€toĻreward€donors€based€upon€the€actual€amounts€of€money€received€by€theĻcharity.€€€However,€given€a€patentššs€20€year€life€and€a€discounted€system,Ļeven€neglecting€the€losses€in€value€from€the€donor€being€forced€to€sell€theĻpatent€at€a€15%€rate€to€get€a€tax€write-off€on€the€85%€remaining€amountĻwill€be€preferable€to€a€20€year€weighted€average€write-off€of€33%.Š <¬&<¬& Š€ĢĢą „ ąą Ü ąą 4 ąą Œ ąą ä ą(v)ą0 < ąŌ‡ XW:XXXW:ŌThe€stated€limitation€is€based€upon€the€lower€of€fair€market€value€or€theŠ õ% Štaxpayerššs€basis.€€As€mentioned,€unless€there€is€a€possibility€of€loss€ofĻNOLššs€(less€likely€with€the€new€5€year€look€back€period€„„€withĻappropriate€limitations€of€the€ability€to€offset€no€more€than€50%€of€theĻtaxpayers€income€in€the€5th€year)€the€vast€majority€of€taxpayers€will€electĻto€expense€all€research€expenditures€under€šš197€as€soon€as€they€occur.€€AsĻa€result,€for€€patents€they€will€have€a€zero€basis€and€will€not€yield€anyĻdeduction€upon€donation.€€To€the€extent€that€some€value€exists€within€aĻpatent€based€upon€a€basis€greater€than€zero,€the€value€is€supposed€to€beĻapportioned€over€the€life€of€the€patent.Š <¬&<¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ąą ä ą(vi)ą0 < ąIRC€šš€170(e)€states€that€the€charitable€contribution€of€property€shall€beŠ š   Šreduced€by€the€sum€of€non„long€term€capital€gain€which€would€haveĻresulted€upon€sale€(generally),€and€combined€with€the€amount€that€wouldĻbe€long€term€capital€gain€which€would€have€been€realized€had€the€propertyĻbeen€sold€by€the€donor,€for:€(a)€tangible€personal€property€which€isĻunrelated€or€œwhich€›is€related€and€subject€to€recapture,€(b)€privateĻfoundation€donee€property,€(c)€patents€&€copyrights,€trade€secrets,€tradeĻnames,€know€how€or€similar€property,€or€(d)€taxidermy€property.Š <¬&<¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ąą ä ą(vii)ą0 < ąWhere€patents€and€other€intellectual€property€has€been€donated€and€whereŠ I$y!) Šsuch€property€generates€income€for€the€charity,€IRC€šš170(m)€allows€theĻdonor€to€count€such€donee€income€received€due€to€the€patent€orĻintellectual€property€as€an€š šadditionalšš€deduction.€€This€provision€isĻlimited€to€a€10„year€period€after€the€date€of€donation€(IRC€šš170(m)(5)),Ļand€also€limited€to€the€life€of€the€property€€(IRC€šš170(m)(6)).€€ThisĻprovision€is€consistent€with€other€provisions€which€(1)€enable€a€donorĻlimited€to€the€basis€of€the€property€to€receive€deductions€based€upon€actualĻcash€flow€from€the€donated€property,€and€(2)€limit€a€donorššs€deductionĻwhere€the€charity€sells€š šunrelated€purposešš€property€donated€for€less€thanĻthe€property€was€valued€at€the€time€of€donation.€€Both€of€these€types€ofĻprovisions€extend€the€š šlifelinešš€between€the€charity€and€the€donor€andĻkeep€them€somewhat€tied€together€regarding€donated€property.Š.E+5<¬&<¬& ŠŌ#†XW:XX XW:##ŌĢĢą „ ąą Ü ą12.ą 4 ąAVOID€THE€šš351€IMPERMISSIBLE€TYPE€š šAšš€REORGANIZATION€€TRAP!Š r¢ ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ą€Despite€warnings€by€us€to€avoid€putting€a€patent€into€a€foreign€entity,€we€continue€toŠ D Šencounter€inventors€who€are€enticed€into€(tax€suicide(€along€the€following€lines.€€AĻyoung€start€up€company€(YST)€sees€that€an€inventorššs€patent€is€valuable,€but€cries€(poor(Ļat€any€mention€that€the€inventor€should€receive€any€money€at€all€for€his€invention.€€TheĻYST€offers€extremely€restricted€stock€in€exchange€for€the€patent,€but€the€inventor€knowsĻthat€the€value€of€such€restricted€stock€is/may€be€significant€and€that€the€IRS€would€valueĻit€and€then€send€the€inventor€a€bill€for€ššselling(€his€patent.€€Even€a€great€15%€tax€rate€canĻbe€steep€if€the€inventor€has€no€other€funds€to€cover€the€tax€bill.€€The€inventor€urges€thatĻthe€invention€is€so€valuable€that€the€YST€should€dissolve€and€reorganize€around€theĻinventor€in€a€(351€transaction€in€which€the€inventor€will€receive€15%€of€the€stock€of€theĻnew€company€and€will€depend€upon€stock€growth€to€compensate€him.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąThe€YST€president€remembers€that€he€has€already€used€up€most€of€the€investment€moneyŠ ą  Šof€the€current€investors€and€knows€that€any€suggestion€to€start€again€from€scratch€wouldĻresult€in€his€being€shot,€hung,€and€shot€again.€€The€president€of€YST€says€š šInventor,€ifĻyour€patent€was€in€a€corporation,€we€could€merge;€you€would€end€up€with€15%€of€theĻYST€stock,€and€mergers€are€tax€free!šš€€This€gives€the€inventor€the€idea€to€start€up€a€smallĻcompany,€Patco,€in€a€šš351€transaction,€most€likely€with€the€patent€forming€the€totality€ofĻthe€investment.€€The€inventor€then€presents€his€suggestion€that€Patco€merge€with€YST,€inĻwhich€merger€Patco€stock€is€transferred€to€YST€in€exchange€for€YST€stock.€€Patco€isĻdiscarded,€inventor€has€20%€of€the€YST€stock,€and€Inventor€is€sure€he€is€well€on€his€wayĻto€riches.€€The€problem€is€that€this€is€a€classically€impermissible€type€š šAšš€reorganization.€ĻThe€result€is€that€the€whole€transaction€is€treated€as€a€simple€sale€of€the€patent.€€TheĻinventor€gets€a€bill€from€the€IRS€(and€his€state€taxing€authorities€where€applicable)€forĻtax€based€upon€the€value€of€the€restricted€stock€received.€€Further,€the€IRS€is€likely€to€beĻvery€liberal€in€ascribing€value€to€the€restricted€stock€using€the€IRS€re-characterizationĻrules.€The€president€of€YST€is€not€concerned€because€he€acquired€the€patent€in€exchangeĻfor€15%€of€his€companyššs€stock,€which€is€what€he€wanted.€€The€inventor,€on€the€otherĻhand,€is€in€a€bind.€€YST€is€not€about€to€try€to€help€undo€the€transaction,€has€no€money€toĻgive€the€inventor€(and€even€if€it€had€the€money€it€likely€would€not€give€it€to€the€inventor),Ļand€the€inventor€begins€to€rack€up€penalties€and€interest€on€the€liberally€determined€shareĻvalue.€€Evidence€gathered€at€YST€does€not€help€the€inventor€either.€€Since€YST€isĻprobably€still€attracting€investors,€the€value€of€the€patent€set€forth€by€YST€will€be,€withinĻthe€bounds€of€securities€law,€at€least€as€bright€as€the€bill€of€goods€that€YST€sold€theĻinventor.€€Inventor€has€no€recourse€against€YST,€since€YST€did€not€participate€in€theĻšš351€transaction,€YST€did€not€ask€many€questions€about€the€origins€of€Patco,€and€since€itĻis€the€same€as€a€sale€in€exchange€for€stock€YST€does€not€care.€€It€is€a€sad€tale€of€woe,Ļindeed,€and€is€intended€to€be€a€caution€against€falling€for€a€similar€scheme.€€Despite€theĻfact€that€capital€gains€rates€are€less€than€15%€for€paupers,€pauper€status€must€be€proven€toĻthe€IRS,€and€going€negative€(i.e.,€owing€the€IRS€money€you€do€not€have)€is€the€same€forĻeveryone€regardless€of€financial€status.€Š Œ ¬&Œ ¬& Š€€€€€Ģą „ ąą Ü ąą 4 ą(c)ą0 Œ ąThere€are€two€doctrines€at€work€here.€€The€first€doctrine€is€the€transaction€doctrine,€whichŠ ^(Ž%. Šempowers€the€IRS€to€look€at€the€totality€of€the€transaction€and€reduce€it€to€its€most€directĻterms,€especially€if€the€intermediate€steps€add€nothing€to€the€transaction€especiallyĻnothing€more€than€an€attempt€at€tax€avoidance.€€When€a€patent€or€application€is€hastilyĻshoved€into€a€newly€formed€corporation€not€having€a€business,€the€corporation€is€thenĻmerged€to€call€the€patent€into€ownership,€and€the€newly€formed€corporation€is€discarded,Ļit€is€clear€that€the€IRS€will€discard€the€interim€transaction€and€allege€a€straight€sale.€€TheĻsecond€doctrine€at€work€here€is€continuity€of€interest.€€All€of€the€revenue€rulings€listedŠ .E+5 Šbelow,€namely€Rev.€Rul.€67-274,€Rev.€Rul.€70-225,€and€Rev.€Rul.€81-25,€emphasize€thatĻthe€continuity€of€business€does€not€apply€to€the€acquiring€corporation,€but€to€theĻtransferring€corporation€(also€known€as€the€transferor€of€the€assets).€€Therefore,€it€is€theĻtransferorššs€business€which€is€assessed€for€continuity€under€the€continuity€of€interestĻstandard.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąThe€continuity€of€interest€principle€contemplates€an€ongoing€business.€€In€the€case€of€aŠ ¶ę Špatent€which€has€been€put€in€the€name€of€a€corporation,€what€is€the€(business(€of€such€aĻcorporation€that€is€to€be€continued?€€Most€of€the€time,€the€corporation€is€created€for€theĻimpermissible€type-A€reorganization,€and€it€has€no€business€to€begin€with€so€will€have€noĻbusiness€to€continue.€€We€are€typically€NOT€speaking€of€a€manufacturing€corporationĻwhen€we€talk€about€a€corporation€as€patent€holder,€but€a€mere€holder€of€the€patent.€€WithĻreference€to€a€corporation€as€a€mere€patent€holder,€the€only€legitimate€business€of€such€aĻcorporation€might€be€the€business€of€licensing€to€third€parties.€€In€this€case,€the€acquiringĻcorporation€would€merely€be€acquiring€the€right€to€a€stream€of€income€for€an€alreadyĻlicensed€patent,€and€the€acquiring€corporation€might€well€be€unable€to€acquire€aĻmonopoly€(i.e.,€100%€of€the€patent)€depending€upon€existing€licenses.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąIn€the€event€that€a€corporation€has€a€patent€and€an€existing€business,€and€provided€that€theŠ ‚² Šcontinuity€of€business€standard€can€be€met,€the€reorganization€will€not€be€impermissibleĻbecause€the€inventor€will€have€merged€an€ongoing€business€(as€opposed€to€a€corporateĻshell€which€would€be€empty€but€for€the€patent).€€However,€if€a€corporation€is€already€inĻbusiness€and€has€an€income€stream,€why€would€it€be€allowed€to€merge€with€a€corporationĻwhich€has€restricted€stock€and€no€income€to€the€inventor?€This€introduces€the€possibilityĻof€cutting€off€the€inventorššs€salary,€so€how€might€one€structure€the€transaction€to€exploitĻthe€tax€law€in€an€effort€to€preserve€the€inventorššs€or€the€patent€holderššs€tax€advantages?Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(f)ą0 Œ ąA€major€indicator€of€how€to€structure€businesses€both€(1)€to€insure€that€the€deductibilityŠ Ū  Šof€research€and€development€is€maintained,€and€(2)€to€protect€the€rights€of€the€inventorsĻand€holders€may€be€found€in€the€cases€Green€v.€Commissioner,€83€T.C.€667€(1984),€andĻScoggins€v.€Commissioner€95-1€USTC€50,061;€46€F3D€950€(9th€Cir).€€Although€otherĻstrategies€may€work,€these€cases€introduce€a€base€strategy€which€assumes€that€little€or€noĻliability€will€be€incurred€from€simply€owning€a€patent.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ą13.ą0 4 ąPROHIBITION€ON€€š šNON-TECHNICALLY€ACTIVEšš€INVESTMENTŠ ’Ā" ŠVEHICLES/PARTNERSHIPSŠ 4¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ą€In€the€Green€case,€the€deductibility€of€research€and€development€expenditures€wasŠ !5% Šdenied€where€the€invention€was€placed€in€a€limited€partnership€which€functioned€only€asĻa€š švehicle€for€injecting€risk€capital€into€the€development€and€commercialization€ofĻinventions.šš€€Thus,€an€entity€which€seeks€to€claim€a€deduction€should€be€one€which€is€setĻup€so€that€it€has€a€chance€to€enter€the€regular€business€relating€to€the€technologyĻdevelopment€(as€opposed€to€one€whose€only€function€is€to€inject€investment€and€collectĻprofits).Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąThe€š šactive€businessšš€rule€really€translates€into€an€š šactive€technologyšš€rule.€€As€theŠ '½$- ŠScoggins€case€demonstrates,€the€partnership€vehicle€was€ready,€willing€and€able€to€moveĻon€with€the€technology€had€the€option€holder€not€brought€commercialization€to€the€mark.€ĻThe€Scoggins€case€emphasized€that€after€the€technology€is€sold,€being€š šready€to€move€onĻwith€the€technologyšš€is€impossible€because€one€no€longer€has€the€technology€required€forĻmoving€on;€however,€several€other€cases€have€more€subtlety€outlined€what€isĻimpermissible.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąLDL€Research€&€Development€II,€Ltd,€124€F.3d€1338€(10th€Cir.€1997)€involved€a€limitedŠ .E+5 Špartnership,€LDL€Research€&€Development€II,€which€paid€development€money€to€aĻdeveloper,€Larson-Davis€Laboratories,€to€develop,€manufacture€and€market€acoustic€andĻvibration€test€equipment.€€Although€it€appears€from€the€name€of€the€partnership€that€theĻinventors€were€involved,€the€facts€of€the€case€have€shown€that€the€partnership€containedĻno€technical€expertise€and€was€in€no€position€to€do€anything€with€the€technology€should€it€Ļhave€been€placed€in€the€care€of€the€partnership.€€€There€was€a€group€of€inconsistentĻagreements,€some€of€which€would€have€given€exclusive€ownership€to€the€partnership,€andĻothers€of€which€would€have€given€the€developer€a€non-exclusive€license€in€exchange€forĻa€15%€royalty€and€5%€of€the€developer€stock€to€the€partnership.€€The€developer€neverĻexercised€its€non-exclusive€license€option,€and€the€partnership€never€made€a€move€toĻexploit€the€technology.€€€In€continuing€to€raise€money,€the€main€selling€point€for€theĻpartnership€was€the€ability€of€the€investors€to€deduct€money€under€IRC€šš174.€€It€is€clearĻthat€the€partnership€could€properly€have€paid€others€to€carry€out€the€research€(Treas.€Reg.Ļ(1.174-2(a)(2)),€but€the€taxpayer€must€be€actively€involved€in€the€trade€or€business,€orĻmust€at€least€have€a€š šrealistic€prospectšš€of€such€involvement.€€The€devastating€facts€wereĻas€follows:€(1)€the€partnership€had€no€real€prospect€of€doing€anything€with€theĻtechnology;€(2)€the€developer€was€relied€upon€to€conduct€all€activities€related€to€theĻtechnology;€(3)€there€was€only€a€š šmere€possibilityšš€that€the€partnership€would€ever€act.€ĻThe€final€holding€categorized€the€partnership€as€a€š špassive€investoršš€that€was€not€entitledĻto€the€IRC€šš174€deduction.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ą€In€the€9th€circuit€case€of€Kantor€v.€Commissioner€998€F.2d€1514€(CA€9th€1993),€aŠ õ% Špartnership€had€an€arrangement€with€a€developer€such€that€the€developer€could,€under€aĻTechnology€Transfer€Agreement,€for€a€nominal€sum€and€a€royalty€obligation,€obtain€theĻexclusive€right€to€market€the€technology.€€This€fact€alone€indicates€that€the€partnershipĻwas€taking€itself€out€of€the€business€of€dealing€with€the€technology.€€To€make€mattersĻworse,€when€the€developer€needed€more€cash,€one€of€the€partners€acting€on€behalf€of€theĻpartnership€(1)€negotiated€to€arrange€financing€for€the€developer,€(2)€arrangedĻcancellation€of€the€Technology€Transfer€Agreement,€and€(3)€had€himself€appointed€to€theĻboard€of€the€developer.€Later,€the€partnership€signed€other€agreements€with€otherĻcompanies€to€market€in€Europe€and€America.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąThus,€in€this€case,€the€partnership€(1)€was€actively€involved€in€overseeing€the€research,Š š   Š(2)€got€rid€of€the€agreement€to€sell€the€technology€to€the€developer€for€a€nominal€sum,Ļand€(3)€had€other€firms€sell€on€behalf€of€the€partnership.€€€These€facts€would€seem€toĻweigh€in€favor€of€the€partnership€had€they€not€occurred€as€a€reversal€of€initial€direction.€ĻHad€the€contract€been€honored€as€initially€drafted,€it€is€clear€that€there€would€have€been€aĻsale.€€The€holding€against€the€taxpayerššs€deduction€included€these€factors:€€(1)€AĻš šrealistic€prospectšš€of€entering€the€business€concerned€with€the€technology€must€beĻmanifested€early€in€time,€i.e.,€at€the€time€the€taxpayer€incurs€the€research€expenditures;Ļ(2)€a€realistic€prospect€for€entering€the€business€concerned€with€the€technology€must€beĻcoupled€with€the€capability€for€doing€so;€(3)€the€business€into€which€the€taxpayer€showsĻability€and€intent€to€enter€must€be€its€own€business€and€not€the€business€of€another.€€Here,Ļthere€was€no€(realistic€prospect(€of€the€partnershipššs€subsequently€entering€its€ownĻbusiness€concerning€the€technology.€€The€option€to€grant€exclusive€rights€for€a€nominalĻsum,€coupled€with€the€lack€of€objective€intent€and€the€lack€of€actual€capability€of€enteringĻthe€business€provided€a€clear€showing€that€the€partnership€was€not€(in€connection€with€itsĻtrade€or€business.(€€Put€another€way,€the€partnershipššs€trade€or€business€was€that€of€aĻpassive€investment€vehicle.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(f)ą0 Œ ąBoth€the€Kantor€and€LDL€Research€cases€were€distinguished€from€Scoggins€and€wereŠ ¢+Ņ(2 Špresented€to€emphasize€the€favorable€elements€of€Scoggins,€and€magnify€criticism€ofĻScoggins.€The€Scoggins€case€illustrates€a€generally€optimum€way€to€set€up€a€venture€bothĻ(1)€to€insure€deductibility€of€research€and€development,€and€(2)€to€leverage€theŠ .E+5 Šinventor/holderššs€interests€to€afford€maximum€advantage€from€exploiting€both€theĻtechnology€and€the€business€developing€the€technology.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(g)ą0 Œ ąScogginsŠCsŒ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ą(I„)ą0 ä ąIn€Scoggins,€the€inventors€formed€a€partnership€to€hold€rights€in€the€technologyŠ å Šand€to€pay€for€the€research.€€At€issue€in€Scoggins€was€whether€the€partnershipĻcould€take€a€deduction€for€the€research€expenditures€it€paid€to€a€researchĻcorporation€in€which€the€inventors,€incidentally,€had€a€majority€shareholderĻinterest.€€The€inventor-partners€granted€to€the€inventor€corporation€(1)€a€limited,Ļnon-exclusive€right€to€exploit€the€invention,€and€(2)€an€option€to€buy€theĻtechnology€for€$5€million.€€Cash€from€the€license€flowed€back€to€the€partnershipĻas€did€cash€from€expensing€development€of€the€corporation.€€Š ä ¬&ä ¬& Šą „ ąĢą „ ąą Ü ąą 4 ąą Œ ą(ii)ą0 ä ąThis€structure€has€several€advantages,€as€well€as€a€few€disadvantages.€€Since€theŠ >n  Špatent€is€held€in€a€partnership€of€the€inventors,€the€inventors€continue€their€holderĻstatus,€and€any€sale€of€the€patent€to€an€unrelated€entity€will€result€in€IRC€šš1235Ļcapital€gains€to€the€individual€inventors€at€the€15%€long€term€rate.€€Holding€theĻassets€for€longer€than€12€months€results€in€the€15%€long€term€rate€outside€of€IRCĻšš1235,€including€permissible€aspects€of€the€transaction€such€as€the€25%€aggregateĻownership€limitation€on€the€seller-related€persons€in€the€buyer€corporation.€€Š ä ¬&ä ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ą(iii)ą0 ä ąIf€there€is€little€liability€in€holding€the€patent,€the€flow€through€of€liabilities€to€theŠ Ęö Šinventors€should€not€be€a€concern.€€If€the€corporation€cannot€make€a€success€ofĻthe€technology,€the€partnership€continues€to€exploit€the€technology€elsewhere€andĻis€thus€in€the€business€of€exploitation€of€the€technology,€rather€than€simply€beingĻa€vehicle€for€injecting€venture€capital.€This€enables€a€deduction€for€expendituresĻto€flow€through€the€partnership€and€to€the€partners.Š ä ¬&ä ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ą(iv)ą0 ä ąIn€contrast€to€Kantor€and€LDL€Research,€note€that€the€driving€force€behind€theŠ }­ Špartnership€and€the€developing€corporation€was€the€know-how€of€the€inventors.€ĻIf€the€developing€corporation€had€not€exercised€a€significant€cost€option€to€moveĻahead,€the€partnership€was€ready,€willing€and€able€to€develop€the€technologyĻfurther€in€different€products€elsewhere.Š ä ¬&ä ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ą(v)ą0 ä ąThe€inventors€here€also€have€a€majority€share€of€the€corporation€and€control€of€theŠ c“# Šbusiness€exploitation.€€If€the€corporation€begins€to€generate€large€amounts€of€cash,Ļthe€inventors€can€have€the€corporation€exercise€its€option€from€the€partnership€andĻpurchase€the€technology€outright€for€$5M,€which€will€result€in€taxation€to€theĻinventors€through€the€partnership€at€the€15%€instant€long-term€capital€gains€rate€ifĻthe€corporation€is€unrelated.€€The€criticisms€in€this€case€are€that€(1)€the€inventorsĻown€more€than€50%€of€the€corporation€for€purposes€of€creating€a€sale€outside€ofĻIRC€šš1235,€and€(2)€the€inventors€as€an€aggregate€own€more€than€25%€of€theĻcorporation€for€effecting€a€sale€within€IRC€šš1235.€€As€a€result,€it€is€clear€that€theĻmost€desirable€action€would€be€to€secure€long€term€gain€through€stock.€€As€theĻcorporation€grows,€it€may€be€successful€enough€to€go€public,€in€which€case€theĻinventorššs€stock€will€increase€but€will€not€be€tax-recognized€until€the€sale€of€theĻstock,€which€will€again€invoke€capital€gains€tax€rates€(assuming€it€is€held€for€moreĻthan€a€year).€€Š ä ¬&ä ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ą(vi)ą0 ä ąIn€the€case€of€a€partnership,€it€is€the€individual€partner€who€can€qualify€a€patentŠ ¢+Ņ(2 Šholder€rather€than€the€partnership€as€a€whole.€€A€partner€who€does€notĻindependently€qualify€as€a€patent€holder€does€not€qualify€for€instant€capital€gainĻtreatment€under€šš1235.€€It€may€be€that€two€inventors€can€arrange€to€have€theirŠ .E+5 Štechnology€held€together€so€as€not€to€be€in€partnership,€although€it€is€uncertainĻwhether€such€an€endeavor€would€be€successful;€for€example,€a€commonĻdisposition€agreement€could€be€drafted€to€avoid€cumulating€their€interests€asĻpartners€for€either€the€50%€provision€outside€IRC€šš1235€or€the€25%€provisionĻwithin€IRC€šš1235.€€However,€a€move€to€isolate€the€inventors€from€each€other€mayĻalso€be€likely€to€eliminate€the€š šin€connection€with€its€trade€or€businessšš€aspect,€asĻper€the€Kantor€and€LDL€Research€cases,€causing€loss€of€the€investment.Š ä ¬&ä ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ą(vii)ą0 ä ąBecause€an€the€inventorsšš€ability€to€move€sale€money€through€to€themselves€at€aŠ X ˆ Š15%€tax€rate€as€holders€within€IRC€šš1235,€or€even€as€owners€outside€of€IRCĻšš1235,€it€might€have€been€prudent€if€they€(1)€had€severely€limited€inventorĻownership€of€the€developer€corporation,€and€(2)€had€given€the€holder€corporationĻthe€option€to€buy€the€technology€from€the€unrelated€inventorššs)€for€a€significantĻoutlay.€€Without€a€significant€outlay,€the€courts€are€likely€to€hold€that€theĻinventors€are€making€a€simple€sale€through€an€investment€partnership.€€Only€aĻsignificant€barrier€to€š šbuy€offšš€the€inventors€will€keep€the€inventors€in€a€positionĻof€being€š šin€connection€with€its€trade€or€business.šš€€Š ä ¬&ä ¬& Šą „ ąĢą „ ąą Ü ąą 4 ąą Œ ą(viii)ą0 ä ąOn€the€other€hand,€if€the€inventors€are€so€committed€to€corporate€growth€that€theyŠ ‚² Šexpect€to€derive€all€of€their€income€from€the€accumulated€value€of€stock,€theĻinventors€may€as€well€enter€the€corporation€from€the€outset.€€An€option€to€buyĻfrom€a€corporate-related€taxpayer€will€either€have€(1)€a€sales€price€magnitudeĻlarge€enough€to€meet€the€Kantor€and€LDL€Research€cases€(thereby€producing€aĻhuge€undesirable€ordinary€taxable€income€stream),€or€(2)€a€negligible€sales€priceĻmagnitude,€such€that€a€partnership€will€lose€its€IRC€šš174€deduction,€and€thereĻwill€perhaps€be€a€delay€of€money€to€the€inventor€where€a€negligible€magnitudeĻoption€is€set€to€trigger€at€a€much€later€time.Š ä ¬&ä ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ą(ix)ą0 ä ąIt€makes€no€sense€to€split€the€inventor/€inventive€partnership€compensationŠ ¬Ü Šbetween€future€stock€growth€and€the€initial€sale/option€of€the€technology.€€WhereĻa€developing€corporation€claims€poverty€in€the€early€years€of€development,€anĻinitial€sale€by€license€with€an€escalating€royalty€rate€can€give€the€inventors€theĻability€to€reap€the€benefits€of€a€maturing€industry€while€leaving€the€developerĻsome€leeway€in€the€early€years€for€development€which€is€not€substantiallyĻburdened€by€inventor€payment€considerations.Š ä ¬&ä ¬& ŠĢą „ ąą Ü ąą 4 ąą Œ ą(x)ą0 ä ąAn€immediate€question€which€arises€from€the€foregoing€is€whether€an€LLC€willŠ 4 d$ Šbe€given€the€same€respect€as€a€partnership.€€Unless€one€wishes€to€try€to€make€newĻlaw,€it€may€be€advisable€to€stay€with€the€established€partnership€precedent,Ļparticularly€since€there€should€be€no€significant€downside€from€simply€holdingĻhonestly€and€truthfully€obtained€patents.€€Moreover,€a€partnership€need€not€beĻregistered€with€the€state€and€will€not€be€taxed,€even€at€the€low€rate€of€an€LLC.Š ä ¬&ä ¬& ŠĢą „ ąą Ü ą14.ą0 4 ąTAX€TREATMENT€OF€THE€PURCHASER/LICENSEEŠė%#+4¬&4¬& Š€€€€€Ģą „ ąą Ü ąą 4 ą(a)ą0 Œ ąIn€general,€€the€purchaser€of€a€capital€asset€is€required€to€capitalize€the€purchase€price€andŠ '½$- Šdepreciate€a€portion€of€the€assetššs€value€each€year,€such€as€for€a€building€or€a€piece€ofĻequipment.€€This€is€true€for€lump€sum€purchases€and€usually€true€for€periodic€paymentsĻnot€based€on€productivity€or€use.€€Where€a€series€of€payments€are€made,€the€transaction€isĻtreated€as€a€sale€subject€to€a€loan,€and€the€IRS€commissioner€will€impute€a€reasonableĻinterest€rate€into€the€transaction.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąWhere€the€payments€are€dependent€upon€the€patentššs€use€or€production,€it€is€consideredŠ D-t*4 Šthat€the€payments€are€closely€related€enough€to€the€value€of€the€patent€that€they€areŠ .E+5 Šdeductible€in€the€year€paid€or€accrued.€€This€rule€is€from€Associated€Patentees,€Inc.€4ĻT.C.€979€(1945),€and€it€has€clearly€survived€for€over€half€a€century.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąPurchasers€may€hold€the€patent€as€a€capital€asset€under€IRC€šš1221(where€it€is€not€used€inŠ Cs Šbusiness)€or€IRC€šš1231€(but€only€where€gains€exceed€losses).€€The€holding€period€is€oneĻyear€for€long€term€tax€rates€(15%),€but€court-modified€tax€laws€have€established€thatĻactual€reduction€to€practice€is€necessary€before€the€holding€period€will€begin.€€Again,Ļreduction€to€practice€means€an€actual€reduction€to€practice€sufficient€to€demonstrate€thatĻthe€inventorššs€idea€works.Š Œ ¬&Œ ¬& ŠĢĢą „ ąą Ü ą15.ą0 4 ąA€POSSIBLE€BETTER€ARRANGEMENT?ŠĖ ū 4¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąA€better€arrangement€might€be€where€the€transferee€corporation€has€less€than€25%€of€itsŠ m   Šownership€in€common€with€the€inventor€partnership,€with€the€best€scenario€being€zeroĻcommon€ownership€between€the€transferee€corporation€and€the€inventor€partnership.€€TheĻinventor€partnership€would€optimally€grant€to€the€transferee€corporation€(1)€a€limited,Ļnon-exclusive€right€to€exploit€the€invention,€and€(2)€an€option€to€buy€the€technology€forĻbig€money,€possibly€on€an€escalating€schedule.€€Conversely,€the€transferee€corporationĻwould€sell€its€stock€to€the€inventor€partnership€for€a€de€minimis€price€(or€would€simplyĻgive€the€stock€to€the€inventor€partnership).€€The€transferee€corporation€would€ideallyĻmake€an€IRC€šš83(b)€election€so€restricted€that€it€is€ineffective€for€ownership,€or€wouldĻpossibly€give€incentive€stock€options€contingent€upon€purchase.€€Low-level€cash€to€coverĻexpenses€would€flow€into€the€inventor€partnership€as€a€result€of€the€license,€as€wouldĻcash€resulting€from€the€corporations€expensing€of€development€costs.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąThe€non-exclusive€limited€license€is€only€necessary€where€it€is€required€that€theŠ  : Šdeveloping€company€have€an€exclusive€or€non-exclusive€right€to€exploit.€€Normally,Ļwhere€no€š šexploitation€testingšš€is€necessary,€a€simple€license/sale€with€an€initial€lowĻroyalty€followed€by€escalating€royalties€can€achieve€the€same€result€as€the€non-saleĻfollowed€by€sale€treatment,€at€least€from€an€economic€standpoint;€additionally,€thisĻapproach€affords€early€tax€breaks€on€the€initial€royalty€dollar.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąIn€the€proposed€scheme,€the€grant€option€to€buy€the€technology€for€big€money€on€aŠ Įń! Špotentially€escalating€schedule€will€be€necessary€keep€the€investment€partnershipĻš šactive.šš€The€use€of€use€of€the€option€will€leave€the€partnership€active€while€putting€theĻbuyer€to€the€test€in€terms€of€exercising€the€option.€€Much€of€the€mix€of€these€options€willĻdepend€upon€product€development€in€terms€of€funds€required,€time€required,€and€fundsĻexpected.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąEven€where€corporate€profit€participation€is€sought,€insure€that€true€ownership€onlyŠ x#Ø ( Šbegins€when€the€option€and€sale€finally€occurs.€€Note€that€before€the€sale,€it€is€a€good€ideaĻto€set€any€cash€flow€approximately€equal€to€any€expenditure€by€the€partnership€forĻresearch€under€IRC€šš174.€€Allocations€of€this€nature€should€always€be€used€to€avoidĻgenerating€funds€which€would€be€taxed€at€40%€while€using€money€for€expenses€whichĻwould€be€taxed€at€15%.€€Warning:€if€an€entity€or€person€begins€to€generate€patents,€thereĻis€a€danger€that€the€patents€might€begin€to€be€treated€as€inventory.€€In€this€event,€many€ofĻthe€tax€advantages€will€be€lost.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ą16.ą0 4 ąWHAT€IS€IT€WORTH?ŠŃ*(14¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąToday,€so€many€pro-big-government€taxaholics€relate€tax€issues€to€š šgovernmental€loss€ofŠ s,£)3 Šincome,šš€when€in€reality€the€citizen€and€business€that€funds€government€should€look€toĻgovernment€as€a€service€rather€than€as€a€master.€€The€capitalization€and€subsequentŠ .E+5 Šamortization€or€deduction€of€funds€invested€represent€interest€free€loans€of€an€advance€ofĻtax€revenue€to€the€government.€€€As€an€illustration,€where€an€investor€spends€$1000€on€aĻproject€and€makes€the€$1000€back€before€the€end€of€the€year,€he€has€broken€even€andĻshould€report€no€profit€for€that€year€and€pay€no€tax.€€Real€cash€flow€profits€will€be€madeĻin€the€future,€not€during€the€break-even€year.€€Where€the€$1000€must€be€capitalized€andĻwritten€off€at€10%€per€year,€the€government€is€in€effect€causing€the€payment€of€tax€onĻ$900€profit€in€the€first€year,€and€will€repay€the€š šadvancešš€taxes€paid€on€the€$900€profit€toĻthe€taxpayer€in€nine€increments€in€the€future,€with€no€adjustment€to€the€taxpayer€for€theĻloss€of€the€time€value€of€the€10€year€€loan€to€the€government.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ą€The€value€to€the€individual€licensor-inventor/holder€with€a€high€tax€rate€isŠ ś *  Šstraightforward€at€the€20%€differential€between€the€top€ordinary€rate€of€35%€and€the€15%Ļlong€term€capital€gains€rate€(patents€instantly€and€other€capital€assets€if€held€for€moreĻthan€12€months€before€sale).€€This€differential€may€rise€and€fall€slightly€where€theĻindividual€is€in€the€š šsurtaxšš€or€š šademption€of€allowancesšš€region€of€income€where€hisĻstandard€or€schedule€A€deductions€and€his€personal€exemptions€are€being€recaptured.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąHigher€tax€rates€may€actually€be€more€than€35%€due€to€the€ademption€of€€personalŠ ±į  Šdeductions€and€other€deductions.€€However€this€aspect€should€only€be€considered€whereĻthe€taxpayer€can€shift€his€or€her€efforts€into€patent€activities€(or€indeed€other€capital€gainsĻsale€activities)€to€thus€transfer€the€otherwise€ordinary€income€into€capital€gain€income.€ĻFurther,€the€effect€is€usually€so€small€so€as€to€be€considered€negligible.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąTo€assess€value€to€the€licensee,€we€can€begin€by€assuming€that€the€purchase€price€for€theŠ —Ē Špatent€is€the€same€as€the€stream€of€income€associated€with€the€productivity€of€the€patent.€ĻThis€ignores€any€additional€royalty€which€should€be€due€from€eliminating€the€risk€of€newĻtechnology€on€the€part€of€the€licensee,€because€a€series€of€payments€based€upon€actualĻuse€of€the€patent€should€equate€to€greater€business€gains€associated€with€the€risk.€€In€otherĻwords,€where€a€licensee€buys€a€patent€outright€and€the€technology€changes,€permittingĻthe€patented€item€to€be€made€much€better€by€a€different€method,€the€patent€will€becomeĻworthless.€€This€is€what€is€meant€by€š šrisk€of€change€in€technology.ššŠ Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąNext,€we€can€compare€20€year€straight€line€amortization€versus€expensing€of€the€patentŠ š   Šbased€on€a€license€where€the€licensee€pays€a€flat€rate€per€patented€item€produced.€€TheĻfull€20€years€can€be€used€where€the€patent€application€is€sold€immediately€after€filing,Ļbecause€IRC€šš1239(e)€enables€depreciation€of€the€patent€application€(as€well€as€an€issuedĻpatent),€but€only€in€the€hands€of€a€transferee.€€€Remember€that€the€case€of€a€5€yearĻamortization€under€IRC€šš174(b)€is€only€for€development€costs€expended€by€the€taxpayer,Ļwhich€are€not€expensed€under€IRC€šš174(a)€and€which€are€not€otherwise€depreciableĻunder€šš167,€and€thus€NOT€related€to€the€purchase€(and€depreciation)€of€a€patentĻapplication.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(f)ą0 Œ ąWhere€a€patent€is€sold€having€a€life€of€less€than€20€years€the€difference€between€the€saleŠ %J"* Šand€expense€cases€begins€to€diminish.€€For€simplicity,€a€shorter€period€than€20€years€isĻnot€considered€because€the€effects€are€less€pronounced.€€The€regulations€underĻšš1.167(a)-3€provide€that€a€patent€is€depreciable€over€the€shorter€of€its€legal€life€(theĻportion€of€the€remaining€20€year€period)€or€its€useful€life,€and€this€comparison€assumesĻthat€there€is€no€special€excuse€justifying€a€life€of€less€than€20€years.€€Corporate€andĻindividual€rates€are€now€the€same€at€35%.€Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(g)ą0 Œ ąThe€Tax€on€an€Unexpensed€Portion€is€an€amount€of€present€tax€Lent€to€Government€to€beŠ ¢+Ņ(2 Šrepaid€over€19€years.€€I€used€a€net€present€value€of€return€over€time€of€4.0%.€€For€a€$1000Ļprice,€and€where€5%€of€this€amount€can€be€currently€deducted€(as€1/20th€of€the€value€ofĻthe€patent€written€off€this€year),€the€$950€portion€which€could€not€be€written€off€results€inŠ .E+5 Ša€tax€of€€$950€x€35%€=€$332.50.€€€The€amount€of€$332.50€would€be€paid€back€to€theĻtaxpayer€in€19€payments€of€$332.50€or€$17.50€per€year.€€Using€the€4.0%€discount€rate,Ļthis€has€a€net€present€value€of€$229.84.€€€Subtracting€this€amount€from€the€amount€theĻtaxpayer€loaned€the€government,€$332.50„€$229.84€=€€$102.65.€€This€is€the€amount€theĻtaxpayer€š šlostšš€by€his€interest€free€loan€to€the€government.€€Of€the€initial€$1000Ļinvestment,€the€š šlossšš€is€10.26%.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(h)ą0 Œ ąSimilarly,€a€15€year€payback€attainable€under€šš197€would€yield€a€loss€of€8.02%.€€Thus,Š ‡· Šignoring€all€other€factors,€a€buyer€would€give€at€least€an€additional€10.26%€to€aboutĻ8.02%€to€avoid€having€to€capitalize.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(I„)ą0 Œ ąA€flat€sale€may€be€disadvantageous€for€the€licensor€where€the€licensee€might€have€paidŠ Ė ū  Š10.3%€more€if€the€licensee€did€not€have€to€amortize.€€A€flat€sale€might€beĻdisadvantageous€for€the€licensee€because€he€risks€his€entire€investment€over€the€term€ofĻthe€patent€for€everything€from€a€general€business€downturn€to€the€arrival€of€new,Ļsubstitute€technology.€€Because€of€this€risk,€the€licensee€might€offer€to€pay€less;€this,€inĻturn,€can€harm€the€licensor.€€Š Œ ¬&Œ ¬& Š€€€€€Ģą „ ąą Ü ąą 4 ą(j)ą0 Œ ąA€license€based€on€productivity€will€potentially€yield€more€profit€to€the€licensor€and€lessŠ ‚² Šrisk€to€the€licensee.€€However,€because€the€licensee€can€switch€production€to€aĻnon-infringing€technology,€or€can€simply€stop€production€and€payments€to€the€licensor,Ļthe€licenseeššs€risk€is€now€minimal.€€The€licensor€has€the€ability€to€make€more€money€ifĻthe€product€does€well,€but€the€licensor€now€bears€the€risk€of€change€in€technology€andĻbusiness€downturns.€€From€a€tax€standpoint,€the€money€received€by€the€licensor€is€theĻsame,€whether€received€as€a€lump€sum€or€as€a€periodic€stream€of€income€on€which€theĻlicensor€will€pay€tax€based€on€long€term€capital€gain.€€The€licensor€pay€tax€based€on€longĻterm€capital€gains€regardless€of€whether€the€sale€price€is€received€as€lump€sum€orĻperiodic€or€both.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(k)ą0 Œ ąThe€even€treatment€normally€afforded€cash€flow€problems€is€distorted€when€one€attemptsŠ }­ Što€analyze€an€annuity€stream€based€upon€productivity€of€the€patent.€€The€distortions€areĻdue€to€(1)€spreading€of€risk€which€is€higher€to€the€purchaser€at€sale,€yet€which€yieldsĻhigher€returns€as€more€sales€are€made,€(2)€product€life€cycle,€which€may€yield€highĻproductivity€in€later€years,€thus€diminishing€or€back-loading€the€comparison€of€anĻassociated€repayment€of€a€loan€by€the€government€in€the€case€of€a€purchase,€and€(3)€theĻfact€that€a€purchaser€would€probably€pay€less€of€a€lump€sum€payment€for€the€patentĻwhere€he€bears€the€risk€of€performance€or€where€he€is€aware€of€the€negative€taxĻconsequences€of€a€straight€sale.€€It€is€also€worthy€of€note€that€licensing€fees€not€tied€toĻproductivity€(such€as€a€minimum€license€fee€which€cannot€be€applied€against€a€unit€cost)Ļwill€probably€be€required€to€be€capitalized,€even€where€other€productivity€basedĻconsideration€is€present.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(l)ą0 Œ ąIn€summary,€the€primary€benefits€that€patent€practitioners€can€give€to€their€clients€are€to:Š %J"* Š(1)€preserve€the€clientššs€(holder(€status,€either€by€keeping€title€in€the€inventors,€or€at€byĻholding€the€title€in€a€partnership;€(2)€ensure€that€all€entities€will€be€entitled€to€take€theirĻIRC€šš174€deductions€by€keeping€any€partnership€(in€the€game(€of€further€exploiting€theĻpatents€(intent€and€ability€per€the€Kantor€and€LDL€Research€cases)€in€the€event€that€theĻfirst€license€does€not€work€out;€(3)€ensure€that€the€licensor€will€have€capital€gainsĻtreatment€by€using€€IRC€šš1235€to€make€sure€that€an€exclusive€license€amounts€to€a€sale,Ļ(4)€ensure€that€the€licensee€will€be€able€to€expense€patent€payments€by€using€the€ĻAssociated€Patentees€case€to€associate€the€purchase€price€with€the€productivity€and€use€ofĻthe€œpatent,€and€this›œ€will€also€likely€result€in€a€greater€percentage€for€the€licensor€since€theĻlicensee€risk€of€loss€will€have€been€reduced;€(5)€advise€the€clients€that€if€the€invention€hasĻnot€yet€been€reduced€to€practice,€the€investors€still€have€time€to€acquire€holder€status€byŠ .E+5 Šinvesting€in€the€project€before€actual€reduction€to€practice,€and€(6)€load€the€benefit€to€theĻinventor(s)€using€›either€a€sale€by€the€inventor(s)€as€a€group€with€less€than€25%Ļcumulative€stock€ownership€in€the€buyer,€or€using€stock€appreciation€in€a€corporationĻformed€under€IRC€(351€where€the€inventors€cumulatively€own€more€than€50%€of€theĻstock.Š Œ ¬&Œ ¬& ŠĢņņIV.ą „ ąTax€Treatment€of€CopyrightsŠ ¶ę ŠóóĢą „ ąA.ą Ü ąDEDUCTION€OF€DEVELOPMENT€EXPENSESŠ ½ ķ ŠĢą „ ąą Ü ą1.ą0 4 ąAlthough€IRC€šš174€is€drafted€broadly€to€enable€current€expensing€of€research€andŠ _   Šexperimentation,€most€copyrightable€property€will€not€qualify.€€Current€regulations€prohibit€theĻdeduction€of€expenditures€for€"literary,€historical€or€similar€projects."€€IRC€šš174,€when€read€inĻconjunction€with€IRC€šš263A,€requires€capitalization€of€expenditures€in€connection€withĻcopyrightable€subject€matter.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąIn€general,€the€first€question€to€be€asked€in€copyright€is€whether€the€copyrightable€work€is€theŠ Eu  Špursuit€of€a€hobby€or€non-business€nature.€€If€it€is,€IRC€šš183€can€eliminate€deductions€related€toĻproduction€costs€for€the€activity€altogether,€subject€to€deductions€not€in€excess€of€the€incomeĻfrom€the€project,€if€any.€€Other€instances€of€deductibility€are€couched€in€terms€of€whether€theĻtaxpayer€is€actively€engaged€in€business,€even€where€amortization€is€required.€€Where€the€projectĻis€abandoned,€a€deduction€under€IRC€šš165€is€available.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąWorse€still€for€creators€of€copyright€property,€IRC€šš1221€excludes€copyrights€from€capital€assetŠ ü, Šstatus€for€taxpayers€(1)€whose€personal€efforts€created€the€copyright€property,€(2)€for€whom€suchĻproperty€was€prepared€or€produced,€and€(3)€in€whose€hands€the€basis€of€such€property€isĻdetermined€for€the€purposes€of€determining€gain€from€sale€or€exchange.Š 4¬&4¬& Š€€€€€Ģą „ ąą Ü ą4.ą0 4 ąHowever,€there€has€been€a€recent€change€to€this€statute€forņņ€music€copyrights€€onlyóó.€According€toŠ A Šprevious€law,€all€copyrights€were€classified€as€non-capital€assets,€such€that€gain€on€sale€ofĻcopyrighted€material€was€generally€subject€to€taxation€as€ordinary€income.€€Under€IRCĻšš1221(a)(3),€exclusions€from€capital€asset€classification€included:Š 4¬&4¬& Šą „ ąą Ü ąą 4 ąą0 Œ ąA€copyright,€a€literary,€musical,€or€artistic€composition,€a€letter€or€memorandum,€orĻsimilar€property,€held€by--Š Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(A)€a€taxpayer€whose€personal€efforts€created€such€property,Ģą „ ąą Ü ąą0 4 ą(B)€in€the€case€of€a€letter,€memorandum,€or€similar€property,€a€taxpayer€for€whom€such€propertyĻwas€prepared€or€produced,€orŠ 4¬&4¬& Šą0 „ ąą0Ü„¬&„¬&ąą04ܬ&ܬ&ą(C)€a€taxpayer€in€whose€hands€the€basis€of€such€property€is€determined,€for€purposes€ofĻdetermining€gain€from€a€sale€or€exchange,€in€whole€or€part€by€reference€to€the€basis€of€suchĻproperty€in€the€hands€of€a€taxpayer€described€in€subparagraph€(A)€or€(B);Š 4¬&4¬& ŠĢą „ ąą Ü ą5.ą0 4 ąą Œ ąCurrently,€IRC€šš1221(b)(3)€excepts€from€the€IRC€šš1221(a)(3)€exclusion€certainŠ ®$Ž!) Šself-created€musical€works:€Š 4¬&4¬& ŠĢą „ ąą Ü ąą 4 ąą8 Œ ąSale€or€exchange€of€self-created€musical€works.--At€the€election€of€the€taxpayer,Ļparagraphs€(1)€and€(3)€of€subsection€(a)€shall€not€apply€to€musical€compositionsĻor€copyrights€in€musical€works€sold€or€exchanged€before€January€1,€2011,€by€aĻtaxpayer€described€in€subsection€(a)(3).€Š Œ T$Œ T$ ŠĢą „ ąą Ü ą6.ą0 4 ąThis€recent€change€means€that€gain€on€sale€or€exchange€of€a€self-created€musical€work€has€theŠ 6+f(1 Špotential€to€be€taxed€as€capital€gain€at€the€preferential€15%€rate€enjoyed€on€a€sale€of€patent€orĻtrade€secret.€€However,€the€š šinstant€capital€gainšš€benefit€that€IRC€šš1235€bestows€on€patents€andĻtrade€secrets€does€not€apply€here;€instead,€IRC€šš1223(3)€appears€to€require€a€one-year€holdingŠ ©-Ł*4 Šperiod€before€the€taxpayer€can€take€advantage€of€the€capital€gain€tax€rate€for€the€sale€or€exchangeĻof€a€self-created€musical€work€(like€most€regular€capital€assets).€€Š 4¬&4¬& ŠĢą „ ąą Ü ą7.ą0 4 ąAn€additional€change€which€has€taken€place€via€the€Tax€Increase€Prevention€and€ReconciliationŠ Cs ŠAct€of€2005€involves€an€election€whereby€a€taxpayer€can€depreciate€certain€expenses€incurred€inĻcreating€or€acquiring€music€or€music€copyrights€according€to€the€income€forecast€method.€€€IRCĻšš167(g)€was€amended€to€include€the€following€special€rules€for€certain€musical€works€andĻcopyrights:Š 4¬&4¬& ŠĢą0 „ ąą0Ü„¬&„¬&ąą84ܬ&ܬ&ą(A)€IN€GENERAL.--If€an€election€is€in€effect€under€this€paragraph€for€any€taxable€year,Ļthen,€notwithstanding€paragraph€(1),€any€expense€which--Š 4T$4T$ Šą8 „ ąą Ü ąą 4 ąą0Œ „T$„T$ą(I)€is€paid€or€incurred€by€the€taxpayer€in€creating€or€acquiring€any€applicableĻmusical€property€placed€in€service€during€the€taxable€year,€and€(ii)€is€otherwiseĻproperly€chargeable€to€capital€account,€shall€be€amortized€ratably€over€the€5-yearĻperiod€beginning€with€the€month€in€which€the€property€was€placed€in€service.€TheĻpreceding€sentence€shall€not€apply€to€any€expense€which,€without€regard€to€thisĻparagraph,€would€not€be€allowable€as€a€deduction.Š Œ T$Œ T$ ŠĢą „ ąą Ü ąą0 4 ą(B)€EXCLUSIVE€METHOD.--Except€as€provided€in€this€paragraph,€no€depreciation€orĻamortization€deduction€shall€be€allowed€with€respect€to€any€expense€to€which€subparagraph€(A)Ļapplies.Š 4¬&4¬& ŠĢą „ ąą Ü ąą0 4 ą(C)€APPLICABLE€MUSICAL€PROPERTY.--For€purposes€of€this€paragraph--Š 4¬&4¬& Šą „ ąą Ü ąą 4 ąą0 Œ ą(I„)€IN€GENERAL.--The€term€'applicable€musical€property'€means€any€musicalĻcomposition€(including€any€accompanying€words),€or€any€copyright€with€respect€to€aĻmusical€composition,€which€is€property€to€which€this€subsection€applies€without€regard€toĻthis€paragraph.Š Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ąą0 Œ ą(ii)€EXCEPTIONS.--Such€term€shall€not€include€any€property--Š Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ąą0 Œ ąą0ä Œ ¬&Œ ¬&ą"(I)€with€respect€to€which€expenses€are€treated€as€qualified€creative€expenses€toĻwhich€section€263A(h)€applies,Š ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąą0 ä ą"(II)€to€which€a€simplified€procedure€established€under€section€263A(j)(2)€applies,ĻorŠ ä ¬&ä ¬& Šą „ ąą Ü ąą 4 ąą Œ ąą0 ä ą"(III)€which€is€an€amortizable€section€197€intangible€(as€defined€in€sectionĻ197(c)).Š ä ¬&ä ¬& Šą0 „ ąą0Ü„¬&„¬&ąą04ܬ&ܬ&ą(D)€ELECTION.--An€election€under€this€paragraph€shall€be€made€at€such€time€and€in€such€formĻas€the€Secretary€may€prescribe€and€shall€apply€to€all€applicable€musical€property€placed€inĻservice€during€the€taxable€year€for€which€the€election€applies.Š 4¬&4¬& ŠĢą0 „ ąą0Ü„¬&„¬&ąą04ܬ&ܬ&ą(E)€TERMINATION.--An€election€may€not€be€made€under€this€paragraph€for€any€taxable€yearĻbeginning€after€December€31,€2010.".Š 4¬&4¬& ŠĢą „ ąą0 Ü ą8.ą04ܬ&ܬ&ąOne€provision€upon€which€some€single-project€taxpayers€have€attempted€to€rely€is€IRC€šš195.€Š I$y!) ŠIRC€šš195€denies€deductibility€of€start-up€expenditures€(i.e.,€expenditures€incurred€beforeĻbusiness€actually€begins),€but€allows€amortization€of€start-up€expenditures€over€a€60-monthĻperiod.€€€The€fact€that€the€costs€amortized€under€this€provision€would€have€been€currentlyĻdeductible€for€an€ongoing€business€eliminates€a€majority€of€those€who€use€copyrights.€€UnderĻIRC€šš195(d),€the€taxpayer€must€elect€to€use€the€IRC€šš195€amortization€at€the€time€of€filing€of€theĻfirst€tax€return€after€business€begins.€€It€is€thus€recommended€that€the€taxpayer€make€aĻprophylactic€IRC€šš195€election€in€the€event€that€the€IRS€finds€any€of€the€expenditures€to€haveĻoccurred€before€business€actually€begins.Š 4¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąPrecedents€in€which€IRC€šš195€have€been€most€effective€involve€entities€that€are€enteringŠ s,£)3 Šthe€publishing€business€and€have€paid€the€salaries€or€other€service€costs€in€the€creation€ofĻbooks€and€articles.€€The€passage€of€IRC€šš263A,€which€requires€the€capitalization€ofŠ .E+5 Šnon-inventory€costs€but€which€usually€relates€to€pre€business€start€inventory,€has€createdĻa€presumption€that€most€items€of€pre-business€expense€should€be€capitalized€on€their€ownĻaccount€rather€than€amortized€under€IRC€šš195.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąOf€course,€where€the€taxpayer€is€in€the€business€of€creating€copyright€property,€andŠ D Šwhere€the€copyright€property€is€inventory€for€sale,€and€the€taxpayer€is€already€in€businessĻand€current€expenses€of€running€the€business€are€deductible.€€Even€when€the€taxpayer€isĻin€business,€specific€project€expenditures€relating€to€the€acquisition€of€copyrightableĻproperty€have€been€held€to€be€capitalizable€rather€than€expensible.€€The€dividing€lineĻwould€seem€to€be€the€relationship€of€the€copyrighted€work€to€the€normal€operation€of€theĻbusiness.€Where€the€business€involves€the€operation€of€a€copyrighted€newsletter,€it€isĻdoubtful€that€capitalization€would€be€required.€€Where€the€business€revolves€about€theĻcreation€of€one€or€two€major€works€requiring€significant€expenditures€of€time€or€money,Ļcapitalization€would€seem€to€be€necessary.€€Most€tax€practitioners€push€the€line€as€far€asĻpossible€toward€an€inventory€treatment,€irrespective€of€a€balanced€inquiry€as€to€the€sizeĻof€the€business€and€relative€size€and€importance€of€specific€copyrightable€projects.Š Œ ¬&Œ ¬& Š€Ģą „ ąą0 Ü ąą04ܬ&ܬ&ą(c)ą0Œ 4¬&4¬&ąFor€amateur€authors€and€creators€who€have€gone€beyond€the€IRC€šš183€hurdles€ofŠ ±į  Šactually€being€in€business€for€profit,€there€are€other€obstacles.€€€The€copyrightableĻproperty€is€not€an€IRC€šš1221€(capital)€asset€in€the€hands€of€the€creator,€and€the€sale€of€theĻproperty€by€its€creator€(or€one€who€commissioned€its€creation)€will€not€result€in€capitalĻgains€treatment.€€The€same€is€true€for€a€taxpayer€who€obtained€the€property€by€gift€orĻinheritance€from€the€creator.€€Of€course,€a€taxpayer€who€subsequently€purchases€theĻcopyright€property€will€purchase€a€capital€asset.€€The€purchased€capital€asset€can€then€beĻdepreciated€under€IRC€šš167€and€other€provisions€of€the€Internal€Revenue€Code,€and€mayĻbe€sold€at€profits€eligible€for€capital€gains€treatment,€provided€that€the€1-year€holding€ruleĻis€met€and€the€copyright€is€not€inventory.€€Recapture€is€had€if€there€has€been€anyĻdepreciation.Š Œ ¬&Œ ¬& ŠĢą „ ąą0 Ü ąą04ܬ&ܬ&ą(d)ą0Œ 4¬&4¬&ąStraight€line€depreciation€can€be€utilized€where€a€copyrighted€work€is€not€made€for€hireŠ }­ Šand€can€be€taken€over€a€35€year€period.€€This€35€year€period€represents€the€minimum€timeĻbefore€an€author€or€his€successor€can€unilaterally€terminate€the€transfer€under€17€U.S.C.Ļšš203.€€The€termination€provision€allows€authors€(and€their€heirs€owning€more€than€a€50%Ļinterest€in€the€work)€to€(back€out(€of€any€agreement,€transfer,€or€license.€€It€was€aĻcompromise€during€the€transition€from€a€system€in€which€a€copyright€was€valid€for€a€firstĻperiod€of€about€28€years€and€renewable€by€the€author€for€a€second€28€years,€where€theĻauthor€had€primary€rights€during€the€second€period€and€could€thus€š šre-sellšš€his€copyrightĻduring€that€period€if€he€wished.€€Under€current€law,€a€copyright€is€good€for€the€life€of€theĻauthor€plus€70€years.€€If€there€are€two€authors,€the€copyright€expires€70€years€after€theĻdeath€of€the€last€surviving€author.€€Pseudonymous€works€expire€95€years€fromĻpublication€or€120€years€from€creation,€whichever€expires€first.€€Currently,€where€theĻeconomic€life€can€be€shown€to€be€less€than€35€years,€various€other€computationalĻmethods€and€procedures€can€be€used€to€properly€depreciate€the€copyrightable€property.Š Œ ¬&Œ ¬& ŠĢą0 „ ąą0Ü„¬&„¬&ąą04ܬ&ܬ&ą(e)ą0Œ 4¬&4¬&ąFragmentation€by€medium€enables€a€copyright€owner€author€to€sell€a€copyright€work€in€aŠ ¼&ģ#, Šsingle€medium,€while€retaining€rights€in€other€separately€identifiable€media,€even€thoughĻsuch€separately€identifiable€media€are€related€to€the€medium€sold.€€The€copyright€of€anĻearlier€version€of€a€computer€program€can€be€retained€while€the€copyright€to€a€laterĻversion€of€a€computer€program€can€be€sold€in€its€entirety.€€An€author€of€a€novel€can€alsoĻcreate€a€screenplay€based€upon€the€novel€and€then€sell€both€to€a€buyer.€€The€buyer€holdsĻboth€as€capital€assets.€€Subsequently,€the€buyer€can€sell€one€without€the€other,€and€theĻsale€will€not€be€treated€as€a€license€even€though€the€two€are€creatively€related.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(f)ą0 Œ ąA€subsequent€sale€may€qualify€for€capital€gains,€but€not€if€the€seller€is€in€the€business€ofŠ .E+5 Šholding€such€properties€for€sale€to€customers.€€This€is€similar€to€the€treatment€ofĻinventory,€which€is€also€not€allowed€to€be€capitalized.€€The€authority€for€this€is€underĻboth€IRC€šš1221(1)€(pertaining€to€stock€in€trade)€and€IRC€šš1231(b)(1)(A)€&€(B)Ļ(pertaining€to€the€definition€of€property€used€in€the€trade€or€business).Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(g)ą0 Œ ąA€€partial€saving€provision€can€be€found€in€IRC€šš195.€€IRC€šš195€permits€the€amortizationŠ å Šof€the€otherwise€capitalizable€startup€costs€over€a€period€not€to€exceed€60€months.€€ThisĻprovision€will€allow€some€accelerated€cost€recovery,€but€it€is€not€nearly€as€favored€as€theĻtax€treatment€of€patents.€€This€provision€can€be€used€where€the€expenditures€are€forĻcopyrights€which€are€not€major€components€of€the€property€upon€which€the€business€isĻbased.€€One€example€from€the€pertinent€cases€involves€paying€for€articles€for€use€in€aĻpublication;€in€this€instance,€articles€purchased€before€the€first€issue€is€printed€would€beĻcapitalized€as€a€startup€cost.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(h)ą0 Œ ą€IRC€šš197,€which€became€law€in€1993,€has€provided€some€relief€to€trademark€owners€andŠ >n  Šalso€a€measure€of€relief€to€certain€patent€and€copyright€owners.€€IRC€(197€allows€theĻamortization€of€any€intangible€acquired€by€the€taxpayer€after€August€9,€1993€and€held€inĻthe€conduct€of€a€trade€or€business€within€the€meaning€of€IRC€(212€(expenses€incurred€inĻthe€production€of€income).€€€The€period€of€amortization€under€IRC€šš197€is€15€years.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(I„)ą0 Œ ąIRC€(197€intangibles€includes€(1)€goodwill;€(2)€going€concern€value;€(3)€work€force€inŠ $T Šplace,€including€composition€and€terms€and€conditions€of€employment;€(4)€businessĻbooks€and€records,€operating€systems,€or€any€other€information€base;€(5)€any€patent,Ļcopyright,€formula,€process,€design,€pattern,€know-how,€format,€or€similar€item;€(6)€anyĻcustomer€based€intangible;€(7)€any€supplier€based€intangible;€(8)€any€other€similar€item;Ļ(9)€any€covenant€not€to€compete;€and,€(10)€any€franchise,€trademark,€or€trade€name.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(j)ą0 Œ ąFor€copyright€generally,€IRC€šš197€excludes€self-created€intangibles,€with€the€possibleŠ Ū  Šexception€of€trademarks€(especially€since€the€buyer€is€buying€from€someone€else).ĻPerhaps€this€provision€helps€to€destroy€a€sale-lease€back€transaction.€€IRC€šš197€alsoĻexcludes€an€interest€in€a€film,€sound€recording,€video€tape,€book€or€similar€property,Ļpatent€or€copyright€€unless€it€is€acquired€in€a€transaction€for€the€acquisition€of€assetsĻconstituting€a€trade€or€business.€€The€rationale€appears€to€be€that€the€IRS€does€not€want€aĻsale€of€business€and€goodwill€where€the€buyer€loads€goodwill€value€into€the€copyright€toĻwrite€it€off€after€three€years.€€This€provision€of€IRC€šš197€creates€a€presumption€that,Ļwhere€a€business€is€sold,€the€real€value€will€lie€in€the€goodwill€rather€than€a€copyrightedĻcomputer€program,€and€thus€the€write€off€will€be€limited€to€the€15€year€amortizationĻperiod€for€goodwill.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(k)ą0 Œ ąA€copyright€or€patent€owner€who€cannot€use€IRC€šš197€must€capitalize€the€asset€for€theŠ §"×' Šshorter€of€its€legal€or€useful€life.€€Since€trademarks€cannot€be€acquired€without€someĻvestige€of€the€underlying€business,€all€trademarks€should€properly€be€IRC€šš197€assets,Ļand€the€fact€that€the€trademark€is€self-created€will€probably€not€prevent€the€use€of€IRCĻšš197€in€depreciating€the€asset.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(l)ą0 Œ ąIRC€šš197€is€intended€to€relate€to€software€because€IRC€šš197€excludes€two€types€ofŠ '½$- Šcomputer€software:€(1)€computer€software€which€is€readily€available€for€purchase€by€theĻgeneral€public,€is€subject€to€a€nonexclusive€license,€and€has€not€been€substantiallyĻmodified;€and,€(2)€other€computer€software€which€is€not€acquired€in€a€transactionĻinvolving€acquisition€of€assets€constituting€a€trade€or€business.€€IRC€šš197€also€excludesĻcomputer€software€which€is€not€owned€by€virtue€of€an€exclusive€license€for€the€full€termĻof€the€copyright€(which€would€constitute€a€sale€of€the€copyright€or€its€fragment).Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(m)ą0 Œ ąA€further€provision€may€also€offer€software€developers€relief.€€This€provision€hasŠ .E+5 Špreviously€appeared€in€the€statutes€as€IRC€(167(f),€but€was€repealed€and€is€now€reinstatedĻas€current€IRC€(167(f):Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(n)ą0 Œ ąTreatment€of€certain€property€excluded€from€šš197:ŠCsŒ ¬&Œ ¬& Šą „ ąą0 Ü ąą04ܬ&ܬ&ąą0Œ 4¬&4¬&ą(1)Computer€Software.€€Š Œ ¬&Œ ¬& Šą8 „ ąą0Ü„T$„T$ąą04ÜT$ÜT$ąą0Œ 4T$4T$ą(A)€In€general.€€If€a€depreciation€deduction€is€allowable€under€subsection€(a)*Ļwith€respect€to€any€computer€software,€such€deduction€shall€be€computed€byĻusing€the€straight€line€method€and€a€useful€life€of€36€months.€€Š Œ T$Œ T$ Šą8 „ ąą0Ü„T$„T$ąą04ÜT$ÜT$ąą0Œ 4T$4T$ą(B)€Computer€Software.€€For€purposes€of€this€section,€the€term€(computerĻsoftware(€has€the€meaning€given€to€such€term€by€section€197(e)(3)(B)€(non-dataĻtype€software);€except€that€such€term€shall€not€include€any€software€which€is€anĻamortizable€šššš197€intangible.Š Œ T$Œ T$ Šą „ ąą Ü ąą 4 ąą0 Œ ą*šš167(a)€requires€the€property€to€be€used€in€a€trade€or€business€or€held€for€the€productionĻof€income.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(o)ą0 Œ ąClearly,€if€the€software€is€not€excludable€from€IRC€šš197,€the€15€year€amortizationŠ ?  Šschedule€of€IRC€šš197€controls.€€IRC€šš167(f)€is€available€where€IRC€šš197€is€notĻavailable.€€In€some€instances,€neither€IRC€šš167(f)€nor€IRC€šš197€is€available.€€Where€aĻcustom€piece€of€software€is€intended€only€for€highly€controlled€licensing€and€use,€andĻwhere€the€software€was€not€obtained€in€a€transaction€involving€the€sale€of€a€business,Ļneither€IRC€šš167(f)€nor€IRC€šš197€was€previously€available.€Where€software€is€š šoff€theĻshelf,šš€its€product€life€is€generally€much€shorter€and€therefore€deserving€of€a€shorterĻamortization€period.€€Where€a€single€product€will€undergo€significant€change€each€year,ĻIRC€šš167€will€enable€a€period€of€amortization€most€closely€approximating€a€yearlyĻexpensing€of€the€development€costs.€€Consequently,€developers€of€the€shelf€software€areĻexpected€to€rely€more€heavily€upon€IRC€šš167(f).Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(p)ą0 Œ ąTaxpayers€previously€relied€on€Revenue€Procedure€69-21€(now€superseded€by€RevenueŠ Ū  ŠProcedure€2000-50),€an€early€(1969)€statement€which€analogized€some€softwareĻdevelopment€to€patent-type€development€and€where€the€service€previously€stated€thatĻthey€would€not€disturb€a€taxpayerššs€method€of€either€current€expensing€of€softwareĻdevelopment,€or€5€year€(60€month)€amortization€where€it€was€(in€accordance€with€rulesĻsimilar€to€those€of€IRC€šš174€(relating€to€research€&€development).(€€For€developmentĻpurposes,€a€taxpayer€would€prefer€to€expense€the€costs€under€IRC€šš174.€€However,ĻRevenue€Procedure€69-21€also€contained€a€section€entitled€(Costs€of€PurchasedĻSoftware,(€and€where€the€cost€of€the€software€is€š šseparately€statedšš€(remembering€thisĻwas€1969€and€software€was€possibly€purchased€with€hardware€more€often€at€that€time),Ļthe€amortization€period€is€stated€as€being€(5€years€or€such€shorter€period€as€can€beĻestablished€by€the€taxpayer.(€€Since€Revenue€Procedure€69-21€is€an€invitation€to€hedgeĻthe€15€year€amortization€period€for€IRC€šš197€software,€or€at€least€to€use€it€as€evidenceĻthat€5€years€should€be€the€minimum€time€for€amortization€with€any€shorter€life€period€forĻamortization€to€be€shown€by€clear€proof.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(q)ą0 Œ ąRev.€Proc.€2000-50€supersedes€Rev.€Proc.€69-21€for€(non-informational€data€base(€typeŠ ė%#+ Šprograms€and€provides€for€current€expensing€of€development€costs.€€This€can€be€deductedĻsimilar€to€the€current€expensing€available€under€IRC€(174(a),€or€such€costs€may€beĻvoluntarily€amortizable€in€accord€with€rules€similar€to€IRC€(174(b)€or€over€36€months€asĻoutlined€in€IRC€šš167(f)(1).€€The€definition€section€of€Rev.€Proc.€2000-50€distinctlyĻexcludes€(data€or€information€bases,€customer€lists,€and€client€files,€€unless€they€areĻincident€to€an€application€program.€€The€IRS€is€thus€recognizing€that€data€base€contentsĻare€probably€not€patentable€and€that€they€should€have€applied€the€other€rules€onĻdeductibility,€such€as€the€š šordinary€and€necessaryšš€rules€which€will€be€specific€toĻdifferent€types€of€businesses.Š Œ ¬&Œ ¬& ŠŠ .E+5 Šą „ ąą Ü ąą 4 ą(r)ą0 Œ ąWhere€a€copyright€is€purchased€by€itself,€it€may€be€depreciated€over€the€shorter€of€itsŠ Š Šlegal€or€useful€life.€€€Since€the€legal€life€of€a€work€made€for€hire€is€120€years€fromĻcreation,€this€represents€the€longest€legal€life€for€a€work.€€In€the€case€of€an€ordinaryĻcopyright€(rather€than€a€work€made€for€hire),€the€amortization€period€should€initially€beĻonly€35€years€because€this€is€the€time€after€publication€at€which€the€author€or€hisĻsuccessors€can€unilaterally€terminate€the€transfer.€€The€Associated€Patentees€case€shouldĻalso€work€for€copyrights€licensed€based€upon€their€productivity.Š Œ ¬&Œ ¬& ŠĢą „ ąE.ą Ü ąWHAT€IS€IT€WORTH?€€Deductions€and€ExpensesŠ X ˆ ŠĢą „ ąą Ü ą1.ą0 4 ąFor€copyright,€there€are€several€alternative€methods€to€compare,€including€a€straight€line,€120Š ś *  Šyear€amortization€for€works€made€for€hire€for€straight€purchases;€a€straight€line,€35€yearĻamortization€for€non-work€made€for€hire€copyrights€for€straight€purchases€(as€well€as€a€periodĻafter€the€first€35€years€when€it€can€be€safely€relied€upon€that€heirs€will€not€take€the€rights€back);Ļthe€15€year€amortization€under€IRC€šš197€for€purchasers€of€software;€the€3€year€amortizationĻunder€IRC€šš167(f)€for€developers€of€off-the-shelf€software;€expensing€of€the€copyright€purchaseĻroyalties€where€the€license€is€based€upon€productivity;€and,€finally,€expensing€copyrightĻdeveloped€internally.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąAgain,€the€value€to€the€individual€licensor-inventor/holder€is€straightforward€at€the€differentialŠ Sƒ Šbetween€the€top€ordinary€rate€of€35%€and€the€15%€long€term€capital€gains€rate.€€Remember€thatĻthis€differential€rises€slightly€where€the€individual€is€in€the€surtax€region€of€income€where€hisĻstandard€or€schedule-A€deductions€and€personal€exemptions€are€being€recaptured.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąThe€risk€of€sale€versus€license€value€to€the€licensee€is€identical€to€that€which€was€set€forth€forŠ h˜ Špatents.€€However,€since€fragmentation€is€available,€there€should€be€less€risk€to€a€purchaser€of€aĻsmaller€portion€of€the€copyright.€€€There€is€also€less€risk€to€the€licensor/seller€because€he€isĻspreading€the€risk€of€performance€among€several€people.€The€only€comparison€to€be€made€hereĻis€straight€purchase€versus€license€based€upon€use,€and€this€comparison€considers€that€the€sellerĻis€NOT€the€creator.€Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąUsing€the€analysis€previously€stated,€it€can€be€readily€computed€that€the€project€cost€for€the€15Š O Šyear€writeoff€under€IRC€Ō% €- Ōšš197€has€a€cost€of€an€additional€10.2%€of€the€cost€of€the€asset,€whereasĻa€writeoff€under€IRC€šš167(f)€has€a€cost€of€an€additional€2.0%€of€the€cost€of€the€asset.€€ThisĻcomputation€would€takes€to€account€the€1/15,€š@š€portion€written€off€in€first€year€as€having€noŠ ’Ā" Šdiscounted€value,€and€NPV€includes€the€first€years€payment.€€€These€additional€costs€representĻthe€additional€cost€to€the€buyer€of€having€to€capitalize€the€sale€price.€€Where€the€license€sets€forthĻpayments€based€upon€current€use€or€productivity,€the€provisions€of€Associated€Patentees€enablesĻthe€buyer/licensee€to€expense€his€yearly€royalty€payments.€€Thus€there€is€roughly€an€8%Ļdifferential€in€project€cost€between€classifying€a€piece€of€software€as€an€off-the-shelf€item€underĻIRC€šš167(f)€versus€a€specialty€software€item€under€IRC€šš197.Š 4¬&4¬& ŠĢą „ ąą Ü ą5.ą0 4 ąThe€even€treatment€normally€afforded€cash€flow€problems€is€distorted€when€one€analyzes€anŠ %J"* Šannuity€stream€based€upon€productivity€of€the€patent.€€The€distortions€are€due€to€(1)€spreading€ofĻrisk€which€is€higher€to€the€purchaser€at€sale€yet€yields€higher€returns€as€more€sales€are€made,€(2)Ļproduct€life€cycle,€which€may€yield€high€productivity€in€later€years,€thus€diminishing€orĻback-loading€the€comparison€of€an€associated€€repayment€by€the€government€of€a€loan€in€the€caseĻof€a€purchase,€and€(3)€the€fact€that€a€purchaser€would€probably€pay€less€of€a€lump€sum€paymentĻfor€the€patent€where€he€bears€the€risk€of€performance€or€where€he€is€aware€of€the€negative€taxĻconsequences€of€a€straight€sale.Š 4¬&4¬& ŠĢą „ ąą Ü ą6.ą0 4 ąAssuming€for€a€moment€that€minimum€royalties€could€be€used€to€approximate€a€flat€cash€flow€toŠ s,£)3 Šthe€seller/licensor,€the€above€math€should€also€be€effective€for€a€differential€to€be€applied€in€theĻcase€of€a€straight€sale€versus€a€license€agreement€based€upon€performance.€However,€the€aboveŠ .E+5 Šdifferential€will€mean€more€profit€to€the€licensor€(for€which€the€individual€licensor€will€pay€lessĻtax€based€on€long€term€capital€gain)€subject€to€the€licensorššs€assumption€of€the€additional€risk.Š 4¬&4¬& ŠĢĢą „ ąF.ą Ü ąPATENTABILITY/COPYRIGHTABILITY€OVERLAPŠ D ŠĢą „ ąą Ü ą1.ą0 4 ąRegulation€šš1.1221-1(c)(1),€which€defines€the€exclusion€from€capital€asset€status,€states€that€"forŠ ¶ę Špurposes€of€this€subparagraph,€the€phrase€'similar€property'€does€not€include€a€patent€or€anĻinvention,€or€a€design€which€may€be€protected€only€under€the€patent€law€and€not€under€theĻcopyright€law."€€Thus,€property€which€is€only€patentable€is€exempted€from€the€exclusions€of€IRCĻšš1221€and€is€treated€as€a€capital€asset€in€the€hands€of€the€creator.€€Copyrights€are€excluded€fromĻcapital€asset€status€where€created€by€the€taxpayer.€€The€State€Street€Bank€case€and€Rev.€Proc.Ļ2000-50€has€made€the€outcome€favorable€for€developers€who€expend€funds€to€get€the€softwareĻdeveloped,€but€excludes€asset€treatment€where€the€developer€is€the€creator.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąThe€rule€clearly€allows€companies€to€deduct€amounts€paid€to€employees€who€are€developingŠ ?  Šinternal€use€software.€€Where€the€taxpayer€is€a€programmer,€he€can€deduct€funds€paid€to€others;Ļhowever,€he€will€still€be€saddled€with€ordinary€income€upon€sale€of€the€software.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąEarlier€questionable€strategies€of€foregoing€copyright€protection€no€longer€make€sense.€€A€seriesŠ Sƒ Šof€versions€of€the€copyright€can€each€be€copyrighted,€and€the€patent€for€the€underlying€idea€canĻbe€patented,€with€sale€treatment€arising€differently€for€the€different€rights€sold.€€Patent€willĻdominate,€because€someone€who€can€make€copies€still€cannot€practice€the€invention€embodied€inĻthe€software€copied.€€Licenses€should€set€forth€exactly€what€rights€are€being€licensed,€andĻallocation€of€sale€moneys€should€be€(properly)€attributed€to€the€sale€of€the€patent€rights€to€giveĻbetter€tax€treatment€to€the€inventor.Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąIn€cases€where€the€developer€will€sell€the€patented€or€copyrighted€product€and€retain€ownershipŠ Ū  Šof€the€copyright€and€patent,€the€tax€effect€of€owning€a€copyright€or€patent€(or€both)€should€beĻminimal€because€there€is€no€sale€and€both€the€patent€and€copyright€are€being€held€for€productionĻof€income.€Patents€are€tax-favored,€and€attorney's€fees€expended€in€obtaining€a€patent€are€alsoĻexpensible.€€Where€a€sale€within€the€first€two€years€is€a€likely€occurrence,€applying€for€a€patent€isĻa€good€investment€in€a€tax€strategy€hedge€because€favorable€tax€treatment€will€be€afforded€evenĻif€the€patent€does€not€ultimately€issue.€€Moreover,€patents€are€also€a€good€investment€to€protectĻthe€technology.€Š 4¬&4¬& ŠĢĢą „ ąą Ü ą5.ą0 4 ą€It€should€also€be€kept€in€mind€that€where€a€copyright€is€treated€as€a€capital€asset€(where€it€wasŠ !5% Šnot€created€by€the€taxpayer€and€has€a€basis€that€was€not€determined€in€the€hands€of€the€taxpayer),Ļthe€sale€of€a€depreciated€copyright€may€be€subject€to€recapture€for€the€depreciation€in€excess€ofĻthe€straight€line€depreciation,€even€where€the€seller€can€treat€it€as€a€long€term€capital€gain.€€SomeĻrelief€to€copyright€developers€can€be€had€under€IRC€šš197€as€outlined€above.€Š 4¬&4¬& ŠĢą „ ąą Ü ą6.ą0 4 ąIn€summary,€the€main€benefits€which€tax€practitioners€can€give€to€their€clients€are€to€(1)Š ė%#+ Šinvestigate€whether€the€software€is€even€narrowly€patentable,€and€if€so€to€file€a€patent€applicationĻnot€only€to€protect€the€software€but€to€bolster€the€ability€to€expense€development€costs€whereĻdata€is€a€significant€part€of€the€software;€(2)€evaluate€the€value€of€filing€for€copyright€within€3Ļmonths€after€publication€and€preferably€as€early€as€the€copyright€program€is€operable,€so€as€toĻconstitute€a€work;€(3)€in€a€close€case,€structuring€the€license€agreement€to€increase€the€likelihoodĻof€qualification€under€IRC€šš167(f)€rather€than€IRC€šš197,€such€as€by€emphasizing€that€it€is€beingĻacquired€along€with€other€assets€constituting€a€business,€or€by€reciting€facts€which€show€that€theĻcomputer€software€is€readily€available€for€purchase€by€the€general€public,€is€subject€to€aĻnonexclusive€license,€and€has€not€been€substantially€modified;€(4)€make€certain€to€takeĻadvantage€of€fragmentation€of€copyright€to€insure€that€the€seller€is€able€to€attain€capital€gainŠ .E+5 Štreatment€by€properly€fragmenting€the€copyright€and€clearly€stating€the€bounds€of€theĻsale/license€to€insure€that€fragmentation€is€recognized;€(5)€structure€a€license€based€uponĻproductivity€and€use€to€save€the€licensee/purchaser€from€having€to€capitalize€the€purchaseĻprice/royalties€(even€if€the€seller/developer€has€to€treat€sums€received€as€ordinary€income);€and,Ļ(6)€structure€licenses€and€sales€which€clearly€treat€the€copyright-like€rights€separate,€apart,€andĻsubordinate€to€the€patent-like€rights,€to€insure€that€the€patent€is€not€fragmented€so€as€to€lose€theĻpotential€for€capital€gain€treatment.Š 4¬&4¬& ŠĢĢņņV.ą „ ąTax€Treatment€of€TrademarksŠ ) Y  ŠóóĢĢą „ ąA.ą Ü ąWHAT€IS€IT€WORTH?€€TRADEMARK€EXPENSES€ń!>ńń>ńœń>ńń!>ńCAPITń>ńALń>ńń >ńLń >ńIZATION,€SALEŠ  1  ŠĢą „ ąą Ü ą1.ą0 4 ąExpenditures€to€develop,€acquire€and€defend€a€Trademark€cannot€be€properly€expensed.€€Since€aŠ £Ó  Štrademark€can€last€forever,€it€has€no€determined€life€period€over€which€to€depreciate€or€amortizeĻits€cost.€€Costs€of€advertising€which,€in€fact,€develop€the€trademark€are€expensible,€as€is€anyĻother€form€of€advertising€under€IRC€šš162.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąFurther,€IRC€šš195,€which€allows€the€amortization€of€start-up€costs,€does€not€apply€toŠ øč Šexpenditures€for€trademark€development€and€acquisition.€€Even€payments€to€a€competitor€to€buyĻout€their€use€of€a€name€or€to€get€them€to€contractually€agree€to€avoid€using€a€name€areĻcapitalizable.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąExpenditures€for€trademark€development€can€be€recovered€when€the€trademark€ceases€to€be€usedŠ Ķż Šor€when€the€trademark€rights€are€sold.€€However,€expenditures€to€challenge€another's€right€to€aĻtrademark€using€litigation€have€occasionally€been€held€to€be€expensible.€€Money€expended€toĻdefend€a€trademark€is€capitalizable.€€Funds€spent€in€challenging€the€trademark€of€another€haveĻsometimes€been€held€to€be€deductible€where€it€is€shown€that€the€main€questions€involved€in€theĻsuit€do€not€relate€to€either€acquisition€of€a€mark€or€an€attempt€to€force€someone€else€intoĻabandonment€so€that€the€mark€could€be€obtained.Š 4¬&4¬& ŠĢą „ ąB.ą Ü ąTRADEMARK€SALE€AND€LICENSE€TRANSACTIONSŠ U…  Š€€€€€Ģą „ ąą Ü ą1.ą0 4 ąLicensing€revenues€represent€ordinary€income€to€the€recipient€and€are€deductible€to€the€payor.€Š ÷'" ŠThe€sale€of€a€trademark€is€treated€as€the€sale€of€a€capital€asset€by€the€seller.€€Payments€toĻpurchase€a€trademark€are€capitalized.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ą€In€some€close€situations,€the€grant€of€a€perpetual€right€to€exploit€and€use€a€trademark€can€beŠ ;"k& Šconsidered€a€sale.€€IRC€šš1253€was€enacted€to€clearly€distinguish€a€sale€from€a€license.€€IRCĻšš1253€states€that€"a€transfer€of€a€franchise,€trademark€or€trade€name€shall€not€be€treated€as€a€saleĻor€exchange€of€a€capital€asset€if€the€transferor€retains€any€significant€power,€right,€or€continuingĻinterest€with€respect€to€the€subject€matter€of€the€franchise,€trademark,€or€trade€name."Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąSignificant€rights€include€(1)€the€right€to€disapprove€of€any€[further]€assignment€of€such€interest;Š !'Q$, Š(2)€the€right€to€terminate€at€will;€(3)€the€right€to€prescribe€the€standards€of€quality€of€productsĻused€or€sold€(or€of€services€furnished)€and€the€quality€of€equipment€and€facilities€used€toĻpromote€such€products€or€services;€(4)€the€right€to€require€that€the€transferee€sell€or€advertiseĻonly€the€product€or€services€of€the€transferor;€(5)€the€right€to€require€that€the€transferee€purchaseĻsubstantially€all€of€his€supplies€and€equipment€from€the€transferor;€and,€(6)€the€right€to€paymentsĻcontingent€on€the€productivity,€use,€or€disposition€of€the€subject€matter€of€the€interest€transferred,Ļif€such€payments€constitute€a€substantial€element€under€the€transfer€agreement€(IRCĻšš1253(b)(2)).€€Any€of€the€foregoing€retained€rights€will€be€sufficient€to€re-characterize€theŠ ©-Ł*4 Špayment€as€a€license€payment€rather€than€a€sale.€€A€license€payment€is€deductible€by€the€licenseeĻand€includible€as€ordinary€income€of€the€licensor.Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąWith€respect€to€current€deductions,€the€rule€available€in€copyright€and€patent€cases€and€derivedŠ Cs Šfrom€Associated€Patentees€has€been€codified€as€IRC€šš1253(d)(1),€which€provides€that€paymentsĻmade€during€the€year€for€trademark€rights€contingent€on€productivity,€use€or€disposition€of€theĻtrademark,€or€any€amount€which€is€paid€as€part€of€a€series€of€equal€payments€no€less€frequentlyĻthan€annually,€may€be€currently€deducted.€€This€is€the€only€exception€to€the€exclusivity€of€IRCĻ(197€in€allowing€amortization€of€a€trademark€capital€account.Š 4¬&4¬& ŠĢą „ ąą Ü ą5.ą0 4 ąIRC€šš197€has€the€greatest€impact€on€trademarks€because€the€capitalized€amounts€cannot€beŠ ś *  Šamortized€outside€of€IRC€šš197€(except€under€IRC€šš1253(d)(1)).€€Copyrights€can€be€amortizedĻunder€IRC€šš197,€but€only€where€the€copyrights€were€not€created€by€the€author€or€created€as€aĻwork€for€hire€for€the€taxpayer,€or€where€the€copyright€is€acquired€in€a€transaction€for€theĻacquisition€of€assets€constituting€a€trade€or€business.€€For€patents,€the€more€lucrative€treatmentĻunder€IRC€šš174,€which€allows€the€alternatives€of€(1)€expensing€the€development€costs,€(2)Ļamortizing€over€60€months,€or€(3)€depreciating€under€IRC€šš167,€are€preferable€to€the€15€yearĻamortization€provided€under€IRC€šš197.€€Again,€see€T.D.€8865€for€changes€affecting€trademarks.Š 4¬&4¬& ŠĢĢą „ ąC.ą Ü ąEFFECTS€OF€SELECTING€A€WEAK€MARKŠ $T ŠĢą „ ąą Ü ą1.ą0 4 ąAll€of€the€above€information€indicates€that€a€mark€should€be€acquired€so€as€to€avoid€bothŠ Ęö Šlitigation€and€anotherššs€ability€to€use€the€mark€legitimately.€€When€a€dictionary€word€is€selected,Ļthe€chances€are€relatively€high€that€(1)€someone€else€has€chosen€the€same€mark,€or€(2)€if€theĻtrademark-related€business€is€successful,€others€will€have€an€incentive€to€imitate€the€mark€usingĻlook-alike,€sound-alike,€or€spell-alike€variants.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ąThere€are€many€ways€that€the€owner€of€a€weak€trademark€can€(and€almost€invariably€will)€loseŠ ¬Ü Šmoney.€€For€example,€if€the€mark€is€descriptive,€money€spent€advertising€will€boost€competitorsššĻsales€more€than€oneššs€own€sales.€€If€the€mark€is€popular,€a€lawsuit€will€almost€surely€ensue,€andĻcosts€to€defend€the€mark€are€not€deductible.€€€It€should€be€clear€that€where€a€weak€mark€isĻselected,€there€may€be€no€funds€left€available€upon€which€to€sail€into€the€sunset€at€a€15%€tax€rateĻat€the€end€of€oneššs€working€life.€€As€a€more€detailed€example,€assume€that€a€business€earnsĻ$1,000,000€in€profits€but€has€to€spend€$1,000,000€on€attorneysšš€fees€to€defend€its€trademark.€ĻDoes€the€company€break€even?€Absolutely€not!€€The€company€will€have€to€borrow€$340,000€toĻpay€the€tax€on€the€$1,000,000€in€profit€that€it€earned,€and€the€$1,000,000€it€spent€on€legal€feesĻwill€have€to€be€š šcapitalized.ššŠ 4¬&4¬& ŠĢĢņņVI.ą „ ąTax€Treatment€of€Trade€Secrets€&€Know€HowŠ x#Ø ( ŠĢóóą „ ąA.ą Ü ąTrade€Secrets€are€Patent„LikeŠ ä%#* ŠĢą „ ąą Ü ą1.ą0 4 ąTrade€secrets€appear€to€have€characteristics€which€are€patent-like,€yet€which€can€also€be€treatedŠ †'¶$, Šlike€property€under€general€principles€of€exchange€of€property.€€In€some€cases,€the€sale€ofĻproperty€with€potential€patentability€may€come€within€IRC€šš1235,€enabling€the€owner€to€realizeĻcapital€gains€on€the€sale€of€the€property€even€when€the€property€is€held€for€less€than€a€year.€ĻRemember€that€a€complete€sale€of€a€trade€secret,€much€like€the€sale€of€a€patent,€will€prohibit€theĻseller€from€practicing€the€trade€secret.€€Sale€of€a€trade€secret€followed€by€a€non-exclusive€licenseĻback€to€the€seller€would€likely€be€re-characterized€as€a€non-exclusive€license€from€the€seller€toĻthe€buyer€because€the€seller€has€kept€the€right€to€utilize€the€trade€secret.Š 4¬&4¬& ŠŠ .>+4 Šą „ ąą Ü ą2.ą0 4 ąThe€ability€to€treat€trade€secrets€and€know-how€as€patent-like€comes€from€the€emphasis€onŠ Š Šdevelopment€and€the€favorable€treatment€given€to€investment€which€occurs€before€the€tradeĻsecrets€and€know-how€are€reduced€to€practice.€€In€the€landmark€case€Gilson€v.€Commissioner,€48ĻT.C.M.€922,€a€creator€of€82€designs€was€allowed€design€patent€tax€treatment€even€though€onlyĻtwo€of€the€designs€were€patented.€€Gilson€is€also€cited€by€some€for€the€premise€that,€so€long€asĻcopyright€protection€is€not€sought,€the€property€may€be€treated€as€patent-like.Š 4¬&4¬& ŠĢą „ ąą Ü ą3.ą0 4 ąOther€similar€principles€apply€to€the€transfer€of€know-how€and€trade€secrets.€€Where€a€taxpayerŠ ‡· Šdevelops€or€collects€and€sells€trade€secrets€in€the€course€of€business,€ordinary€income€will€ariseĻunder€the€inventory€principle.€€In€other€cases,€there€may€be€an€attempt€to€determine€if€there€hasĻbeen€a€sale€or€merely€a€license.€€As€in€the€case€of€patents,€the€Internal€Revenue€Service€requiresĻa€transfer€of€all€substantial€rights€in€the€trade€secret€or€know-how.€However,€because€a€tradeĻsecret€can€have€an€indefinite€life€much€like€a€trademark,€the€transfer€should€be€without€anyĻterm-of-years€limitation.€€Of€course,€at€such€time€that€a€trade€secret€becomes€generally€known,€itĻwill€cease€to€exist.Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąWith€regard€to€fragmentation,€the€trade€secret€or€know-how€sold€should€be€as€complete€asŠ ą  Špossible€to€enable€an€independent€singular€commercial€exploitation.€€The€contract€of€sale€shouldĻrecite€what€the€buyer€will€be€enabled€to€do,€even€perhaps€in€the€form€of€a€guarantee,€to€insureĻthat€the€technology€will€be€an€enabling€package.€€Much€of€the€parallel€treatment€of€trade€secretsĻand€patents€stems€from€the€fact€that€an€invention€is€a€trade€secret€until€disclosed€to€the€public.€€InĻmany€cases,€especially€chemical€cases,€the€patent€applicant€may€apply€for€patent,€beginĻexploiting€the€invention€as€a€trade€secret,€and€then€watch€to€see€if€competitors€can€reverseĻengineer€it.€€Once€the€patent€is€allowed,€if€it€is€allowed,€one€or€two€years€will€probably€haveĻpassed,€and€the€applicant/trade€secret€owner€will€have€a€single€opportunity€to€decide€whether€toĻ(1)€allow€the€patent€to€go€abandoned€and€keep€the€invention€as€a€trade€secret,€or€(2)€allow€theĻpatent€to€issue€and€destroy€the€trade€secret€through€publication€of€the€patent.Š 4¬&4¬& ŠĢą „ ąB.ą0 Ü ąSale€Requires€the€transferor€to€not€only€give€up€his€rights,€but€to€confer€power€in€the€transferee€to€sue.Š ¬Ü Š(Otherwise,€it€is€a€sharing€and€not€a€sale).Рܬ&ܬ& ŠĢņņVII.ą „ ąMiscellaneous€MattersŠ O ŠóóĢą „ ąA.ą0 Ü ąINTERNATIONAL€LICENSING€OF€INTELLECTUAL€PROPERTYŠ&V!ܬ&ܬ& ŠĢą „ ąą Ü ą1.ą0 4 ąIntroduction:€People€engaged€in€international€licensing€or€sales€of€intellectual€property€haveŠ Čų# Šmany€considerations€to€address,€such€as€the€availability€of€credits€or€deductions€for€taxes€paid€toĻforeign€countries,€the€taxation€of€U.S.€source€income€to€foreign€persons,€withholding€andĻreporting€obligations,€the€authority€granted€to€the€I.R.S.€to€allocate€income€and€deductionsĻamong€related€parties,€taxation€of€outbound€and€inbound€transfers,€and€foreign€tax€laws.€ĻTypically,€a€transferor€must€consider€whether€to€structure€the€transfer€as€a€sale€or€license,Ļdetermine€whether€there€is€an€immediate€or€deferred€imposition€of€taxes,€and€establish€eligibilityĻof€a€sale€for€long€term€capital€gain€treatment.€€A€transferee€must€consider€not€only€whether€toĻstructure€the€transfer€as€a€sale€or€license,€but€must€determine€deductibility€of€the€licenseĻpayments€as€well€as€the€eligibility,€extent,€and€rate€of€amortization€of€the€purchase€price€in€aĻsales€transaction.Š 4¬&4¬& Š€€€€€Ģą „ ąą Ü ą2.ą0 4 ąInternational€Agreements:€When€drafting€international€agreements,€several€considerations€mustŠ ”)Ä&/ Šbe€addressed:€(1)€place€of€royalty€payments€and€determination€of€exchange€rates€betweenĻcountries;€(2)€allocation€of€tax€burdens;€(3)€governmental€approval;€(4)€registration,€notificationĻor€recordation€of€the€transaction;€(5)€choice€of€law;€(6)€termination€issues;€(7)€availability€ofĻarbitration;€(8)€applicable€language;€(9)€definitions,€and€(10)€treaty€provisions€between€countriesĻof€use/residence.Š©-Ł*44¬&4¬& Їą „ ąą Ü ą3.ą0 4 ąA€transferor€will€probably€want€payments€to€be€made€in€his€home€country€and€in€the€currency€ofŠ Š Šthat€country.€€However,€the€transferee€will€originally€pay€the€transferor€in€the€currency€of€itsĻhome€country.€€Thus,€there€may€be€a€need€to€prescribe€a€method€to€determine€which€currency€toĻuse€and€how€the€exchange€rates€between€the€currencies€of€each€country€will€be€established.Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąThe€agreement€should€set€forth€the€allocation€of€tax€burdens€between€the€parties.€€A€transferorŠ å Šwould€obviously€try€to€prevent€the€decrease€of€his€returns€by€tax€burdens€imposed€on€theĻtransaction€by€the€licensee's€country.€€Furthermore,€each€party€should€look€into€whether€there€areĻany€governmental€approvals€that€are€required€before€entering€into€the€agreement.€€SomeĻcountries€require€governmental€approval€before€cross-boundary€payments€are€legally€effective.€ĻIt€would€be€best€for€the€transferor€to€include€such€an€assurance€by€the€transferee€in€theĻagreement.€€Š 4¬&4¬& ŠĢą „ ąą Ü ą5.ą0 4 ąRegistration€or€notification€of€international€agreements€was€created€through€antitrust€concepts,Š m   Šsuch€as€in€the€European€countries,€although€a€national€standardized€treatment€of€the€registrationĻor€notification€is€not€possible.€€When€an€agreement€is€registered,€it€is€sent€to€the€appropriateĻagency€and€is€reviewed€with€reference€to€applicable€antitrust€laws.€€Some€countries€requireĻinternational€agreements€be€recorded.€€Recordation€of€an€agreement€may€be€beneficial€to€aĻtransferee€to€put€third€parties€on€notice€of€the€agreement.€€Moreover,€in€some€countries,Ļrecordation€is€required€before€the€agreement€is€valid€and€enforceable€in€local€courts.Š 4¬&4¬& ŠĢą „ ąą Ü ą6.ą0 4 ąA€U.S.€person€will€most€likely€favor€U.S.€law€when€drafting€international€agreements,€but€U.S.Š õ% Šlaw€may€not€be€the€best€choice€when€licensing€or€selling€intellectual€property.€€If€the€property€isĻused€and€located€in€the€transferee's€country,€it€may€be€best€to€select€the€transferee's€country€asĻthe€choice€of€law.€€Another€option€may€be€to€have€certain€laws€apply€depending€on€certainĻcriteria.€€However,€a€side€consideration€is€to€anticipate€whether€the€country's€government€or€lawsĻmay€change,€thereby€changing€the€status€of€the€parties€or€some€part€of€the€agreement.€€AlthoughĻgovernmental€action€or€changes€in€the€law€are€difficult€to€foresee,€clauses€to€deal€with€suchĻchanges€should€be€addressed€in€the€agreement.€€For€example,€a€termination€clause€may€beĻincluded€to€determine€the€status€of€the€parties€in€such€circumstances.Š 4¬&4¬& ŠĢą „ ąą Ü ą7.ą0 4 ąEach€country€has€its€own€arbitration€laws€and€should€be€researched€accordingly.€€Moreover,€eachŠ O Šcountry€has€its€own€language,€and€the€agreement€will€most€likely€be€translated€into€eachĻlanguage.€€Due€to€the€inherent€differences€in€translation€between€languages,€agreements€mayĻhave€subtle€differences.€€One€option€might€be€to€have€the€final€agreement€drafted€in€a€neutralĻlanguage€chosen€by€all€parties€or€have€both€agreements€represent€the€final€agreement,€whichĻwould€require€the€skill€of€bilingual€counsels.Š 4¬&4¬& ŠĢą „ ąą0 Ü ą8.ą04ܬ&ܬ&ąFinally,€words€have€a€variety€of€meaning€to€each€person€within€each€country.€€Thus,€it€is€best€toŠ Ö!& Šdefine€important€terms,€no€matter€how€simple,€since€it€may€impact€the€grant€provided€for€in€theĻagreement.€€For€example,€a€utility€model€patent€may€differ€in€expiration€dates€for€each€country,Ļor€the€foreign€country€may€provide€for€more€than€one€method€to€protect€an€invention.€€Thus,€it€isĻbest€to€define€the€necessary€terms€in€agreement.Š 4¬&4¬& ŠĢą „ ąB.ą0 Ü ąINTERNATIONAL€€VENTURINGм&ģ#,ܬ&ܬ& ŠĢą „ ąą Ü ą1.ą0 4 ąA€joint€venture,€depending€upon€how€it€is€structured,€can€result€in€constructive€ownership€pathsŠ ^(Ž%. Šbetween€the€joint€venturers€to€yield€a€controlled€corporation€and€unexpected€tax€results.€€DueĻconsideration€should€be€given€to€control€and€to€the€formal€requirements€for€the€joint€ventureĻvehicle€and€whether€it€will€be€treated€as€a€corporation,€partnership,€LLC€or€other€entity€underĻU.S.€Law.Š 4¬&4¬& ŠĢą „ ąą Ü ą2.ą0 4 ą€In€closing,€there€is€one€thing€you€should€never€do€internationally,€and€that€is€to€transfer€a€patentŠ D-t*4 Šinto€a€foreign€venture,€particularly€a€corporation€in€exchange€for€stock.€€Domestically,€under€IRCŠ .E+5 Ššš351,€when€assets€are€placed€into€a€corporation,€there€is€no€tax€recognition€on€the€theory€that€theĻproperty€is€merely€changing€form,€and€that€its€risk€of€loss,€etc.,€has€not€diminished.€€As€such,Ļappreciated€property,€property€subject€to€liability,€and€the€like€can€be€placed€into€a€corporation€inĻexchange€for€stock€with€no€tax€consequences€to€the€contributor/shareholder.€€However,€underĻIRC€šš367,€any€transaction€described€in€IRC€šš332€(liquidation€of€subsidiaries),€šš315€(corporateĻformation),€šššš354€&€361€(corporate€reorganizations),€and€šš356€(additional€consideration€to€orĻfrom€a€corporation),€and€any€transaction€where€the€property€involved€is€an€intangible€results€inĻthe€following:Š 4¬&4¬& Šą „ ąą Ü ąą 4 ą(1)ą0 Œ ąThe€transferor€of€the€patent€is€treated€as€having€sold€the€patent€for€contingent€paymentsŠ X ˆ Šbased€upon€the€productivity€and€use€of€the€patent,€andŠ Œ ¬&Œ ¬& Šą „ ąą Ü ąą0 4 ą(2)ą0Œ 4¬&4¬&ąThe€transferor€of€the€patent€is€treated€as€receiving€amounts€annually€which€areŠ ś *  Šcommensurate€with€the€income€attributable€to€the€intangible€(whether€any€money€isĻactually€received€or€not),€andŠ Œ ¬&Œ ¬& Šą „ ąą Ü ąą 4 ą(3)ą0 Œ ąThe€amounts€deemed€received€by€the€transferor€are€U.S.€source€income.Šm  Œ ¬&Œ ¬& ŠĢĢą „ ąą Ü ą3.ą0 4 ą€The€worst€scenario€might€involve€a€patent€having€a€fair€market€value€of€$5,000,000€and€inŠ ą  Šwhich€the€inventor€or€inventor-corporation€had€a€basis€of€$100,000.€€If€the€monopoly€on€theĻprocess€or€product€could€be€used€to€generate€$1,000,000€of€royalty€per€year€for€20€years,€theĻpatent€transferor€will€be€forcibly€imputed€to€have€an€income€of€$1,000,000€per€year€for€20€years,Ļdespite€the€fact€that€the€patent€has€a€fair€market€value€of€only€$5,000,000.€To€add€insult€to€injury,Ļall€of€the€forced€income€from€the€transaction€is€U.S.€source€income,€rather€than€foreign€sourceĻincome.Š 4¬&4¬& ŠĢą „ ąą Ü ą4.ą0 4 ąIf€the€patent€were€simply€licensed€to€the€foreign€joint€venture€corporation,€it€would€probablyŠ h˜ Šexperience€a€low€foreign€tax€rate€of€about€10€%,€generate€100%€foreign€source€income,€andĻtherefore€provide€an€effective€device€for€soaking€up,€or€blending,€foreign€tax€credits.€€IfĻsignificant€capital€is€needed€to€set€up€manufacturing€operations,€it€should€be€borrowed€abroad.€ĻThe€negative€impact€of€using€patents€as€seed€capital€for€foreign€corporations€is€so€severe€that€anyĻinterest€charges€or€other€impact€of€alternate€financing€is€acceptable.Š 4¬&4¬& ŠĢą „ ąC.ą0 Ü ąPRACTICAL€SURVIVAL€STEPSŠOܬ&ܬ& ŠĢą „ ąą Ü ą1.ą0 4 ąPATENTSŠĮń!4¬&4¬& Šą „ ąĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąMake€certain€that€you€have€absolutely€completed€your€design€to€the€maximumŠ c“# Šmanufacturing€advantage.€€This€insures€that€(1)€your€design€is€set€to€be€manufactured€atĻthe€lowest€possible€cost€to€yield€the€maximum€profit,€which,€in€turn,€will€give€you,€withĻan€allowed€patent,€the€best€combinational€competitive€advantage;€(2)€no€changes€will€beĻmade€to€the€design€after€the€patent€is€filed€(because€if€your€patent€protects€a€sub-optimalĻversion€that€is€located€at€a€less€than€optimal€profitable€area,€and€if€the€claims€allowed€areĻnot€broad€enough€to€clearly€encompass€the€optimum,€you€effectively€have€no€patentĻprotection€and€a€copy€of€your€product€as€an€infringing€product€which€(brushes(€the€outerĻlimits€of€your€patent€-€because€your€patent€is€not€centered€on€your€product€-€is€moreĻlikely€to€invite€an€infringer€to€chance€litigation).€€If€you€are€not€technically€skilledĻenough€to€finish€your€product€to€this€stage,€we€can€provide€you€with€a€completeĻnon-disclosure€agreement€to€enable€you€to€approach€a€reputable€engineering€house€toĻcomplete€the€design.€€Remember€that€one€who€helps€on€the€invention€becomes€anĻinventor,€so€the€non-disclosure€agreement€will€also€include€a€clause€which€states€thatĻownership€of€the€aspects€invented€by€the€engineering€firm€are€yours.€€With€engineeringĻfirms€which€also€manufacture,€make€certain€you€have€included€the€clause€whichĻmandates€that€they€(will€never€do€business€even€relating€to€the€invention€with€anyoneĻelse.(€€When€a€manufacturing€firm€produces€their€(simple(€non-disclosure€agreement,€doĻnot€even€think€about€signing€it!€€The€vast€majority€of€these€are€set€a€short€timer€on€theŠ .E+5 Šwaiver€of€your€rights.€€Remember€that€you€are€paying€them€to€work€for€you!€Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąApply€for€a€patent€as€fully€as€possible,€with€as€many€embodiments€as€possible,€as€manyŠ r¢ Šclaims€as€can€be€supported,€and€as€many€range€equivalents€as€can€be€articulated.€€Keep€inĻmind€what€your€needs€are€and€match€them€with€the€practitioner€preparing€yourĻapplication.€€Large€law€firms€are€for€litigating€and€usually€charge€companies€fees€ofĻsignificant€magnitude.€€Choose€a€practitioner€with€a€technical€background€which€is€notĻmismatched€with€your€technology.€€If€you€have€a€chemical€case,€go€to€a€practitioner€withĻa€background€in€chemistry€and€chemical€engineering.€€If€you€have€an€electrical€case,€goĻto€a€practitioner€with€a€background€in€electrical€engineering.€€Most€practitioners€willĻsuffice€for€a€simple€mechanical€case.€€I€acquired€a€masterššs€degree€in€both€electrical€andĻchemical€engineering€so€that€I€would€be€enabled€for€the€most€technical€of€understandingĻfor€the€vast€majority€of€the€time.€€However,€I€know€my€limitations€too--€if€someone€cameĻto€me€with€a€complex€gene€splicing€patent,€I€would€send€them€to€someone€with€a€Ph.D.€inĻBiochemistry,€and€there€are€more€than€a€few€of€those€type€practitioners€around.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąJust€before€and€right€after€you€file€your€patent,€your€operating€plan€should€be€so€detailedŠ ą  Šthat€you€do€not€care€whether€you€license€your€invention€or€not€because€both€paths€shouldĻhave€an€abundant€amount€of€net€present€value.€€If€you€do€license,€make€certain€you€useĻthe€tax€principles€discussed€above€to€create€a€sale€and€to€lessen€your€tax€to€the€15%Ļcapital€gains€rate.€€Further,€do€not€retain€so€many€rights€that€the€IRS€would€rule€a€š šnon„¼salešš€had€occurred.€€Finally,€be€sure€to€use€the€rule€in€the€Associated€Patentees€case€toĻboost€your€royalty€by€at€least€12%€in€todayššs€economy€(and€perhaps€up€to€50%€by€notĻonly€reducing€the€tax€burden€of€the€payor€by€eliminating€his€need€to€capitalize,€but€alsoĻin€reducing€his€operating€risk€by€only€having€to€pay€for€units€of€production€from€whichĻhe€benefits).€€I€acquired€an€LL.M.€in€taxation€primarily€so€that€I€could€provide€additionalĻguidance€to€my€patent€clients€who€are€just€starting€on€their€first€project.€€By€insuring€thatĻthe€correct€steps€are€taken€at€the€outset,€money€can€be€saved€later€on,€especially€taxĻdollars.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąWithin€one€year,€apply€to€all€foreign€countries€where€you€might€have€a€chance€toŠ N~ Šestablish€a€market,€or€apply€to€all€non-Patent€Cooperation€Treaty€countries€where€youĻmight€establish€a€market€in€conjunction€with€the€filing€of€a€Patent€Cooperation€TreatyĻ(PCT)€application,€followed€by€a€Chapter€II€application€6€months€later€only€if€you€areĻinterested€in€the€three€to€four€countries€for€which€Chapter€II€is€an€issue.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąWhen€the€patent€issues,€you€should€immediately€place€the€patent€number€on€all€articlesŠ 4 d$ Šdirectly€related€to€the€patent.€€As€you€make€patentable€improvements,€and€typically€atĻintervals€of€not€more€than€one€year,€usually€from€the€anniversary€date€of€your€patentĻapplication€filing€date,€file€updated€continuation-in-part€patent€applications.€€If€filed€justĻbefore€your€1-year€anniversary€date,€use€the€continuation-in-part€as€your€foreignĻapplication€to€insure€that€your€foreign€filing€has€your€most€up€to€date€inventiveĻimprovements.€€If€all€of€your€claims€are€allowed€in€the€U.S.,€consider€parallel€prosecutionĻin€which€you€allow€the€claims€initially€found€to€be€patentable,€and€file€a€continuationĻcase€to€pursue€and€argue€over€broader€claims€not€made€in€the€first€filing.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ą2.ą0 4 ąTRADEMARKSŠ^(Ž%.4¬&4¬& ŠĢą „ ąą Ü ąą 4 ą(a)ą0 Œ ąChoose€a€name€for€your€product€or€service€which€is:€(1)€not€descriptive,€(2)€notŠ *0'0 Šsuggestive€(test:€if€you€disclosed€the€mark€to€a€stranger€and€they€would€be€unable€toĻguess€what€goods€and/or€services€the€mark€describes,€you€may€have€a€good€mark),€(3)€notĻa€geographic€or€place€name,€(4)€not€a€government€symbol,€flag,€coat€of€arms,€etc.,€(5)€notĻa€dictionary€word.€€Keep€in€mind€that€the€primary€object€of€the€game€is€not€to€be€(cute(,Ļ(catchy(€or€(sexy(,€but€to€choose€a€vessel€in€which€you€can€easily€accumulate€goodwillŠ .E+5 Šwith€the€goal€of€making€extra€money€on€the€sale€of€your€business€(especially€at€the€15%Ļcapital€gains€rate).€€Goodwill€is€virtually€always€assigned€to€the€trademark,€so€if€you€haveĻa€weak€or€non-protectable€mark,€no€buyer€is€going€to€pay€you€full€value€for€yourĻbusiness,€products,€or€services.€€This€is€about€putting€money€in€your€pocket€at€the€end€ofĻyour€work€life;€this€is€not€about€seeing€how€much€money€you€can€spend€arguing€with€andĻlitigating€against€other€holders€of€cheesy€trademark€names.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(b)ą0 Œ ąIdeally,€you€will€want€to€trademark€the€name€by€itself,€the€logo€by€itself,€and€whereŠ ‡· Špossible,€you€should€separate€the€name€from€the€logo€on€the€goods.€€Name-logoĻcombinations€are€very€weak,€and€it€is€better€to€use€a€regular€trademark€to€fully€protect€theĻname€(sequence€of€alphabetic€letters)€and€a€second€mark€to€protect€the€logo€by€itself,Ļeven€if€another€name€(or€no€name)€is€used€in€conjunction€with€it.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(c)ą0 Œ ąAvoid€differential€capitalization,€it€weakens€the€mark,€and€where€combinations€of€wordsŠ m   Šor€parts€of€words€are€used€it€(telegraphs(€the€pronunciation€and€meaning.€€For€example,ĻTreeExam€is€the€same€as€TREE€EXAM,€and€would€be€descriptive€for€a€tree€surgeonššsĻservices.€€€However,€it€is€unclear€whether€the€word€TREEEXAM€is€š štree€examšš€orĻš štreeex€amšš,€or€simply€š štreeexamšš.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(d)ą0 Œ ąBeware€of€letting€marketing€and€advertising€companies€choose€your€mark.€€AlthoughŠ Sƒ Šthey€may€provide€good€marketing€and€ad€copy€for€what€you€pay€them,€it€has€been€ourĻexperience€that€they€are€adept€at€finding€obscure€marks€owned€by€other€people.€€In€oneĻcase,€on€the€recommendation€of€a€marketing€company,€we€did€3€full€searches;€every€oneĻturned€up€an€obscure€record€which€would€have€cost€the€adopter€thousands€of€dollars€toĻlitigate.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(e)ą0 Œ ąLitigation€in€trademark€is€never€a€good€thing€for€a€new€adopter€of€a€mark€becauseŠ  : Ševeryone€else€in€the€world€has€greater€rights€than€you€do.€€You€are€creating€a€vessel€toĻhold€good€will€dollars.€€At€the€end€of€the€day,€when€you€cash€out,€no€one€cares€what€colorĻyour€š šgoodwill€bankšš€was.€€Additionally,€the€mark€is€NOT€where€you€identify€theĻproduct.€€The€box€or€brochure€has€plenty€of€open€space€for€that.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(f)ą0 Œ ąWe€spend€the€bulk€of€our€trademark€time€urging€potential€new€registrants€not€to€make€theŠ š   Šabove€mistakes.€€Often,€the€telephone€questioner€will€be€held€in€the€death€grip€of€anĻobsession€about€someone€elseššs€mark€or€a€descriptive€mark.€€The€former€is€like€facing€aĻwell€armed€gangster€while€naked,€while€the€latter€is€like€putting€your€money€and€effortsĻinto€a€bank€where€the€back€end€already€has€a€big€hole€blown€in€it€--€your€depositsĻprobably€will€not€be€available€when€you€try€to€make€a€withdrawal.Š Œ ¬&Œ ¬& ŠĢą „ ąą Ü ąą 4 ą(g)ą0 Œ ąRemember,€when€you€are€starting€out,€you€are€the€little€guy€and€you€have€to€carve€a€highŠ §"×' Šquality€niche€for€yourself.€€The€product€and€quality€you€put€into€your€product€or€serviceĻdrives€the€good€will.€€Even€a€goofy€name€will€eventually€take€on€the€mantle€of€qualityĻyou€instill€in€the€product€or€service.€€But€even€the€catchiest,€sexiest€name€in€the€worldĻcanššt€save€a€poorly€maintained€product.Ō#†¼F ¼XXW:#ŌŠė%#+Œ ¬&Œ ¬& ŠŅŠ,ŅĢń!>ńŌ‡XW:X¼¼F ŌŌ#†¼F ¼XXW:g”#Ōń!>ńĢĢĢŠ Œ*¼'0 ŠŃTRPŲ'3 Letter Landscape3Ų'Ų'3 Letter Landscape’3Ų'TŃŃ7€W:XXdéXXdé7ќń)>ńŃ€%³/Ńń)>ń›ą@Ø Ø 6öąINTELLECTUAL€PROPERTY€TAX€TREATMENT€TABLEˆŠ Š Šą@CCöąCurt€Harrington,€Harrington€&€Harrington,€Suite€250,€6300€State€University€Drive,€Long€Beach,€CA€90815;€(562)€594„9784ˆĢŌ*wƒ  ddd Xdd Xdd X,Ą0,Ą0wŌŌ,dd ŌŌ,§ dd ŌŌ,« dd ŌŌ,¦dd ŌŌ+  ŌŠ  øč „„ŠProperty€TypeŠ 'L „„'ŠWrite€Off€MethodŠ 'L „„'ŠCapital€GainŠ L Šņ ņCommentsó óŠ  L ŠPatent€or€TradeĻSecretŠ  µå ŠExpense€Immediately€šš174Š  Įń  ŠInst.€ņ ņlong€term€(15%)ó óŠ Įń  ŠCapital€gains€underĻšš1235€for€inventors€andĻholders€(€or€outsideĻšš1235€if€held€>12€mos.)Š  • Å ŠBest€possible€treatment.€€šš174Ļexpense€is€NOT€RELATED€to€theĻpatent€asset,€so€ņ ņno€recaptureó ó.€SaleŠ ©Ł Šoutside€šš1235€has€relaxed€buyerĻownership€percentage€rules.Š  • Å ŠCopyrightĢGeneral„Š  - ]  ŠCapitalize€Identifiable€Projects:Ģ(1)€15€year€write€off€if€acquired€inĻa€business€(šš197).€€(2)€otherwiseĻwrite€off€over€useful€life.Š  E  ŠNot€available€to€creatorĻor€creator€employer;€OkĻto€others€if€held€for€>1Ļyr.(15%)Š  E  ŠWhere€you€create€or€employ€someoneĻto€create€a€copyrighted€work,€you€areĻthe€author€and€the€sale€will€beĻordinary€income.€(Except€music)Š  E ! ŠSoftware,€nonĻPatentableŠ  ­Ż# ŠIf€held€in€trade€or€business€for€theĻproduction€of€income€(šš167(a))€okĻto€depreciate€over€36€months,Ļstraight€line,€typically€an€off„the„¼shelf€sale.€Specialty€software€notĻheld€for€production€of€income,Ļdepreciate€over€the€shorter€ofĻcopyright€life€or€useful€life.Š  e•+ ŠNo€capital€gains€inĻhands€of€creator€orĻcreatorššs€employer.ĢIf€purchased,€owner€hasĻfragmentation€byĻmedium€right€to€sell€offĻdifferent€media€portionsĻand€keep€othersŠ  e•3 ŠIf€truly€non„patentable,€you€shouldĻregister€within€3€months€ofĻpublication€in€order€to€get€valuableĻlitigation€rights€such€as€statutoryĻminimum€damages€and€attorney€fees.Š  ‰¹8 ŠPatentableĻSoftwareŠ  ż-: ŠExpense€under€šš174Š   9; ŠSame€as€for€PatentsŠ   9< ŠIRS€may€want€to€characterize€asĻsoftware,€but€should€be€patent,Ļespecially€if€patent€application€exists.Š  ń!? ŠTrademarksŠ  •Å@ ŠCap.€acquisition€&€costs€ofĻdefending.€€Amortize€over€15Ļyears€if€acquired€after€9/9/93€(withĻsome€piece€of€€business)Š  q”D ŠCapital€gains€if€held€forĻmore€than€one€year.Š  ‰¹F ŠSale€of€trademark€name€without€moreĻis€an€abandonment,€everyĻpurchase/sale€should€includeĻsomething€else€from€the€business.Š q”J  ŠĢŠ „!ÕK Šą@]]>öąPATENT€FEDERAL€TAX€CHARTˆĢą@CCöąCurt€Harrington,€Harrington€&€Harrington,€Suite€250,€6300€State€University€Drive,€Long€Beach,€CA€90815;€(562)€594„9784ˆĢŌ*ˆƒ# dddd § dd « dd ¦dd  ,Ą0,Ą0ˆŌŌ, dd ŌŌ,dd ŌŌ,« dd ŌŌ,édd ŌŌ,` dd ŌŌ,4dd ŌŌ+  ŌŠ  øč ŠŠ  L ŠHold€for€IncomeĻProductionŠ  @ ŠLicense,€NonĻExclusivelyŠ  @ ŠLicenseĻExclusively(butĻnot€a€sale)Š  4  ŠSale€by€ExclusiveĻLicense,€Lump€sumŠ  @  ŠSale€by€ExclusiveĻLic.ń!>ń›ń!>ń€ProductivityĻBased€*Š  4 ŠOrdinaryĻIncomeŠ  œ Ģ ŠOrdinary€IncomeĻafter€depreciationĻof€patent€(35%)Š   Ą ŠOrdinary€Income,Ļdepreciate€if€purchasedĢ(35%)Š   Ą ŠOrdinary€IncomeĻafter€depreciationĻ(35%)Š   Ą ŠNoneŠ  ØŲ ŠNoneŠ  ØŲ ŠSelfĻEmplmt.ĻTaxŠ  L  ŠIf€Matššl€Particip.Ļ12.4%€to€limit;Ģ2.9%€unlimitedŠ  L " ŠIf€Matššl€Particip.€12.4%Ļto€limit;Ģ2.9%€unlimitedŠ  L % ŠNo,€If€no€MaterialĻParticipationŠ  ( X ' ŠNoneŠ  4 d ( ŠNoneŠ  4 d ) ŠCapitalĻGainsŠ  “ä + ŠNoneŠ  Ąš , ŠNoneŠ  Ąš - ŠNoneŠ  Ąš . Š(15%)€under€šš1235€Ļ(15%€if€held€>€1yrĻoutside€of€šš1235Š  ØŲ1 Šń!>ńœń!>ń(15%)ń!>ń›ń!>ń€under€šš1235€Ļń!>ńœń!>ń(15%ń!>ń›ń!>ń€if€held€>€1yrĻoutside€of€šš1235Š  ØŲ4 ŠAddedĻcosts€toĻbuyerŠ  4d7 ŠBuyer€ExpensesĻProducts€BoughtĻfor€re„sale.Š  4d: Š€Buyer€ExpensesĻRoyalty€paid.Š  @p< ŠBuyer€ExpensesĻRoyalty€paid.Š  @p> ŠCapitalization€Cost€ofĻroyalty€paid,ņ ņ€addsŠ @p@ Šń!>ńœń!>ń(10%)ń!>ń›ń!>ń€to€buyers€costó óŠ  8hA ŠUnder€ņņAssociatedŠ L|B ŠPatenteesóó,€buyerŠ @pC Šexpenses€royaltyĻpd.Š  (XE ŠTotal€FedĻTax/CostŠ  ĄšG „„Š38„40%Š 'ĢüH „„'Š38„40%Š 'ĢüI „„'Š35%Š 'ĢüJ „„'Š15%Š 'ĢüK „„'Šń!>ńœń!>ń15%ń!>ń›ń!>ńŠ ĢüL ŠCommentŠ  d”M ŠThis€is€the€onlyĻcase€whereĻcorporateĻownership€of€aĻpatent€€isĻacceptableŠ  (XS ŠOwner€is€š šin€businessššĻand€is€responsible€forĻpolicing€the€market,€andĻbringing€suit.€MaterialĻParticipation€is€easy€toĻestablish€by€IRSŠ  (XY ŠPassive€activity,Ļesp€where€LicenseeĻmust€police,€sue,Ļetc.€Not€a€saleĻwhere€significantĻrights€retainedŠ  (X_ ŠAt€5.5%€interest€rate,€aĻlump€sum€paymentĻincreases€licenseeĻproject€cost€by€ń!>ńœń!>ń10%.ń!>ń›ń!>ń€ĻSome/all€could€haveĻgone€to€licensor.Š  (Xe ŠLicensor€can€stillĻhold€title,€but€has€toĻlicense€substantiallyĻall€rights€for€fullĻterm€of€patent.Š 4dj  Š*Other€Advantages:€Where€the€license€gives€up€enough€of€the€ownerššs€rights€to€be€considered€a€sale,€the€patent€need€not€beĻassigned,€and€the€inventor€owner€keeps€title€and€is€thus€more€secure€if€there€is€a€breach€by€the€licensee.Š \!Œk ŠŃ%³/)ŃŃTRY3Ų' LetterPŲ'3 Letter Landscape3Ų' LetterŲ'3 Letter LandscapeTŃŃ  ќĢń!>ńŅ,XŅń!>ń›Ņ,ŠŅŃšŠŃŃ,ŠŃń!>ńœ›œń!>ńń">ńĢń">ńń!>ń›œń!>ńń">ńŌ‡XW:X¼¼F ŌŠ  , Šń">ńą@µ µ 1ģąņ ņņņCurtis€L.€Harringtonóóó óˆŠ  ō ŠŅą,ŅŅą,ŅÓøŽfęÓņ ņń%>ńń#>ńŌ‡XW:X¼¼F Ōń#>ńń%>ńń&>ńń%>ńŌ‡ŠćŃ Š¼¼F Ōń%>ńń&>ńń'>ńŌ‡ŠćŃ Š¼¼F Ōń'>ńOfficeó ó:€ą  ąHarrington€&€Harrington;€€6300€State€University€Drive,€€Suite€250,€€Long€Beach,€CAŠ Ö Šą 8 ąą  ą90815;€€€Tel.€(562)€594„9784;€€Fax€(562)€594„4414Ģą 8 ąą  ącurt@patentax.com€ņ ņPATENTAXņņššó óóóą   ąń$>ńą ų ąń$>ńą P ąhttp://www.patentax.comŠ ¹ ŠÓfføŽÓĢņ ņÓšŁffÓSpecialtyó ó:ą  ąHigh€Technology€Patent€/€Trademark€/€Intellectual€Property€Law€&€TaxationŠ śĪ ŠÓffšŁÓĢÓšŁffÓņ ņEducationó ó:ą  ąņ ņB.S.€ó óChemistry€„€Auburn€University€(1974)Š 6  Šą 8 ąą  ąņ ņM.€S.€Electrical€Engineeringó 󀄀California€State€University€Long€Beach€(1990)Š  ā  Šą 8 ąą  ąņ ņM.S.€Chemical€Engineeringó 󀄀Georgia€Institute€of€Technology€(1977)Š ę ŗ  Šą 8 ąą  ąņ ņJ.D.ó 󀄀University€of€Houston€School€of€Law€(1983)Š ¾ ’  Šą 8 ąą  ąņ ņM.B.A.ó 󀄀University€of€Oklahoma€(1985)Š – j  Šą 8 ąą  ąņ ņLL.M.€ó óņņTaxationó󀄀University€of€San€Diego€School€of€Law€(1997)Š n B  ŠÓffšŁÓĢÓšŁffÓņ ņAdmittedó óą  ąSupreme€Courts€of€California,€Arizona,€Texas,€&€NevadaŠ Ŗ ~  Šņ ņto€Practiceó ó:€ą0  ąU.S.€Supreme€Court;ą š ąą H ąU.S.€District€Court,€Central€District€of€CaliforniaŠ‚V ų%ų% Šą 8 ąą  ąInternal€Revenue€Service€ą š ąU.S.€Patent€and€Trademark€OfficeŠ Z. Šą 8 ąą  ąU.S.€Court€of€Appeals€for€the€Federal,€Fifth€&€Ninth€CircuitsĢą 8 ąą  ąCalifornia€Department€of€Real€Estate€„€BrokerĢą 8 ąą  ąLos€Angeles€County€California€EMT„BasicĢą 8 ąą  ąU.S.€Tax€Courtą ˜ ąą š ąą H ąFCC„Commercial€&€Amateur€ExtraŠ ®‚ Šą 8 ąą  ąCertified€by€The€State€Bar€of€California€Board€of€Legal€Specialization:€TaxationĢÓffšŁÓĢÓšŁffÓņ ņLanguagesó óą0  ąJapanese€Language€Proficiency€Examination,€Approved€by€Japan€Foundation,€Level€4;Š ¼ ŠKanji€Proficiency€Exam€of€the€Japan€Kanji€Aptitude€Testing€Foundation,€passed€Level€7,Ļrecognized€by€the€Japan€Ministry€of€Education,€mastery€of€640€kanji;€some€technicalĻRussian€reading€ability.Š ų%ų% ŠÓffšŁÓĢÓšŁffÓņ ņPatentsó óą  ąPrepared€and€prosecuted€more€than€100€patents,€in€the€electrical€andŠ wK Šņ ņPreparedó óą0  ąchemical€technologies;€specialty€areas€include€optics,€fiber€optics,€cryogenicsŠ O# Šelectromagnetics,€natural€gas€processing€and€computers,€&€trademark€and€copyrightĻpreparation€and€prosecution.€€Patents€include:€Chemical:€4,957,634;€4,851,077;€Electrical:Ļ4,876,892;€4,833,351;€4,837,525;€Mechanical:€4,879,895;€4,906,199;€and€Optical:Ļ4,919,512;€4,898,468.Š ų%ų% ŠÓffšŁÓĢÓšŁffÓņ ņLitigationó óą0  ąAssociate€counsel€in€patent€matters,€trade€secret€litigation;€Judge€pro€tem,€Long€BeachŠ ß³$ ŠMunicipal€Court;€Superior€Court€Mediation€program,€Long€Beach;€Attorney„Client€feeĻDispute€Arbitrator,€Long€Beach€Bar€Association;€Patent€Panel,€American€ArbitrationĻAssociation.Š ų%ų% ŠÓffšŁÓĢÓšŁffÓņ ņTeachingó óą0  ąAdjunct€Law€Professor,€ņņGolden€Gate€University€School€of€Lawóó,€LL.M.€Taxation€Program;Š š!n ) ŠņņGeorgia€Institute€of€Technologyó󀄀previously€taught€heat€and€mass€transfer€laboratories,€andŠ r"F!* Šanalog€and€digital€computer€laboratory.Š ų%ų% ŠÓffšŁÓĢÓšŁffÓņ ņMember:ó óą0  ąń">ńŌ#†¼F ¼XXW:!“#Ōń">ńń#>ńŌ‡XW:X¼¼F Ōń#>ńState€bars€of€California,€Arizona,€Texas€and€Nevada;€Vice€Chair€of€the€California€Board€ofŠ €$T#- ŠLegal€Specialization€Taxation€Advisory€Committee€(member€2006„2011).€Fellow,€NationalĻTax€Practice€Institute;€€€ņ ņFormer€Membershipsó ó:€Long€Beach€Bar€Association€(Board€ofŠ -&%/ ŠGovernors,€1994„95);€Orange€County€Bar€Association,€Taxation€Section,€(Co„ChairĻTechnology€Law€Section€1996);€Orange€County€Chapter€of€California€Society€of€EnrolledĻAgents€„€President€2003„2004;€California€Bar€Association:€CEB€committee€(1999„2000);ĻIncome€&€Other€Tax€subcommittee€(Chair€2000„2002);€Taxation€Section€ExecutiveĻCommittee€(2002„2005).ń#>ńŌ#†¼F ¼XXW:·Ć#ŌŌ‡XW:X¼¼F Ōń#>ńń&>ńŠ’#f",°1°1 Šń%>ńŌ#†¼F ¼ ŠŠćѵ#ŌŌ‡XW:X¼¼F Ōń%>ńń&>ńń#>ńŌ#†¼F ¼XXW:ŠĘ#ŌŌ‡XW:X¼¼F Ōń#>ńń&>ńŠ °1°1 Šń&>ńń(>ńŠ’#f",°1°1 Šń(>ńń#>ńŌ#†¼F ¼XXW:ėĘ#Ōń#>ńń!>ń›ń!>ńń&>ńń#>ńŌ#†¼F ¼XXW:ØĒ#Ōń#>ńń&>ńń'>ńŌ#†¼F ¼ ŠŠćѰ±#Ōń'>ń