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Robert W. Wood, Esq.1
Wood LLP, San Francisco, CA
verdict against Samsung is only the latest episode
of the patent slug-fest between the two tech giants. Apple
accused Samsung of violating smartphone patents, though to a
smaller extent, Apple was found to have infringed Samsung patents
too. While $119.6 million is nothing to sneeze at, it's a tiny
fraction of the $2.2 billion Apple sought. In 2012, a different
jury ordered Samsung to pay Apple $930 million, but Samsung has
It isn't just companies like Apple and Samsung that engage
these high-stakes IP fights. Even little guys, mom & pop
companies and inventors can get embroiled too, as plaintiff or
defendant. From initial filing, licensing, litigation and sale,
billions of dollars turn on patents, and that means
If Apple ever
collects its millions, it is ordinary income, and
if Samsung ever pays, it's deductible. But smaller companies often
worry whether their patent recovery is capital gain taxed at lower
rates. For individuals and pass-through entities (S corporations,
partnerships and limited liability companies) the difference is
One way patent recoveries can be
capital gain is via §1235 of
the tax code. It says a qualifying holder's transfer of all
substantial rights to a patent is long term capital gain.
Amazingly, no one-year holding period is required. Payments over
time or continent on the patent's productivity qualify too.
payments for infringement can qualify. However, there
must be a transfer of all rights to the patent. Also, the transfer
must be by holders who are individual inventors or who acquired
their interest from unrelated individual inventors before the
patent was reduced to practice.
if you don't qualify for §1235? Capital gain is still
possible. Say a non-professional inventor tinkers evenings and
invents something. The resulting patent is a capital asset, while
professional inventors earn ordinary income. That leads to
For example, in
Lockhart v. Commissioner, 258 F.2d 343
(3d Cir. 1958), an inventor with 37 patents over 19 years was ruled
a professional. In contrast, in Kucera v. Commissioner, 10
T.C.M. 303 (1951), an inventor with 21 inventions and several
patents was not a professional so was entitled to capital gain. In
fact, §1235 was enacted to eliminate these
Yet outside of §1235, the distinction
professionals and amateurs is still relevant. Capital gain
should be possible if a patent is a capital asset, it is held for
more than one year and the settlement agreement
sells the patent. The holding period begins when the
patent has been "reduced to practice," defined as a demonstration
that the idea works. Ideally, the settlement agreement will
explicitly transfer all rights to the patent.
transfer of anything less is a license. Thus, where rights are
retained, a key question is whether they have substantial value. It
also helps if the payor records the payment as for the purchase of
patent rights. If the payor reports the payment as "royalties paid"
without mentioning a transfer of patent rights, it sounds
One piece of advice? If you're
hoping to qualify for capital
gain treatment, get some advice before you sign.
Another? Don't get into a fight with Apple or Samsung.
For more information, in the Tax Management Portfolios,
Reddy, 558 T.M., Intellectual Property: Exploitation and
Disposition, Reddy, 557 T.M., Intellectual Property:
Acquisition, Development and Ownership, and in Tax
Practice Series, see ¶1720, Transfers of Patents, Know-How,
Franchises, Trademarks and Trade Names.
© 2014 Robert W. Wood
Originally published by Forbes.com.
1 Robert W. Wood is a tax lawyer with a
practice (www.WoodLLP.com). The author of more than 30 books
including Taxation of Damage Awards & Settlement
Payments (4th Ed. 2009 with 2012 Supplement,
www.TaxInstitute.com), he can be reached at Wood@WoodLLP.com.
This discussion is not intended as legal advice, and cannot be
relied upon for any purpose without the services of a qualified
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