United States: Thinking Of Selling Your Intellectual Property? A Few Days Could Make A World Of Difference To Your Bottom Line

Last Updated: January 4 2018
Article by Withers LLP

A provision of the US House of Representatives proposed Bill for the "Tax Cuts and Jobs Act" is expected to take effect on January 1, 2018 and will have major implications on the sale of intellectual property. Take action by the end of the year if (1) you hold the rights to a self-created patent, invention, model or design, secret formula or process; or (2) you are the creator of musical compositions, or hold the copyright of a musical composition that was created by your personal efforts; and (3) you are looking to monetize the asset in the near future.

The corresponding legislation passed by the US Senate does not have a similar provision, so this print is subject to joint conference discussions. Unfortunately, resolution may come too late to leave sufficient time to take actions.

New laws that could affect your disposition of intellectual property as certain self-created property no longer to be treated as a capital asset

Current law:

Currently, a self-created patent, invention, model or design (whether or not patented), or secret formula or process is treated as a capital asset. Thus, any gain or loss recognized as a result of a sale, exchange, or other disposition of the property is taxed at the capital gains rate, a rate more favorable than ordinary income tax rates, provided an asset is held for more than a year. In addition, a creator of musical compositions or a taxpayer who holds a copyright in musical works created by their personal efforts may also elect to treat that property as a capital asset.1

Prior to the actual commercial use of a patent, both an individual who creates a patent and an unrelated individual who acquires a patent from its creator may treat any gains on the transfer of the patent as long term capital gains. In order to qualify, the transfer must be of substantially all of the rights to the patent and cannot be by gift, inheritance, or devise.

Proposed tax reform:

In the House of Representative's version of the Tax Cuts and Jobs Act (H.R. 1), any gain or loss from the disposition of a self-created patent, invention, model or design, or secret formula or process will be treated as an ordinary asset and subject to ordinary rather than capital tax rates. However, creators of musical compositions and copyrights in musical works will continue to be able to elect to treat such self-created property as capital assets.

Furthermore, the rule under IRC Section 1235, which allows creators of patents or those who have acquired the patent from its creator to treat the transfer of the patent as a capital asset, would be repealed. As such, any transfer of a patent by the creator will be taxed according to ordinary income tax rates.

What does this mean for me?

If the House Bill is enacted, as of January 1, 2018, any gain or loss recognized as a result of a disposition of such self-created property will be taxed at the ordinary income tax rates, which could result in a tax of up to 39.6% (compared to a tax of up to 20% for assets subject to long term capital gain rates). While corporations do not benefit from reduced capital gains rates, trusts do. Depending on the tax status of their owners, income flowing through tax transparent entities (including S Corporations, LLCs, LPs, and other partnership type vehicles) may also benefit from reduced capital gains rates.

The January 1, 2018 deadline for the proposed provision leaves a limited window of time for taxpayers who wish to benefit from the existing law to do so. Any sales of intellectual property that would benefit from the law currently in place should be undertaken before year end.

For example, Fred Watson is the creator and patent holder of a new gene therapy that has not yet gone to market. Fred is considering selling the patent to a pharmaceutical company. If Fred sells the patent on December 31, 2017 for $10 million, the patent will be considered a capital asset and taxed at long term capital gain rates. In this case, Fred would pay up to US$2 million in taxes on the US$10 million sale. If Fred sells the patent on January 1, 2018, Fred would pay up to US$3.96 million on the same transaction; a difference of $1.96 million..

How does this reconcile with the Senate Bill from December 1?

The Senate is silent on this issue. While the House could pass the Senate's Tax Bill and send it to the President for signature, the current climate makes this unlikely. Lawmakers are expected to negotiate and reconcile the differences between the two bills and have the final legislation to the President for signature by year end.

Current ordinary & capital rates for taxpayers married filing jointly:

The following table illustrates the different tax rates a person considering selling a self-created patent, invention, model or design (whether or not patented), or secret formula or process starting in 2018 will incur if the proposed law explained above is enacted. For example, a person is in the highest income bracket will pay a 20% tax on the sale of a patent if the sale takes place before January 1, 2018. However, if the sale takes place on January 1, 2018 the person will be taxed at a 39.6% rate (provided the proposed law is passed).


[1] Generally, copyrights, literary, musical, or artistic compositions are not treated as capital assets and any gain or loss recognized will be taxed as ordinary income. IRC Section 1221.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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