Thursday June 8, 2023
Article of the Month
Donations of Intellectual Property Part II
A charitable gift of an IP asset can provide a donor with tax benefits. However, the legal complexities that surround these types of gifts necessitate a deeper understanding of these assets prior to making a charitable contribution. As such, it is crucial that advisors have a firm grasp on how these gifts operate to best serve their clients' needs and objectives.
This article series will provide practical information on the tax deductions available for these types of intangible assets, their valuation and their methods for transfer. Part one of this article series provided an overview of charitable gifts of copyrights. This second part of the series will review gifts of trademarks and patents. By understanding the rules that come with gifts of IP assets, advisors can be prepared to guide their clients toward a strategy that will maximize their tax benefits and fulfill their client's charitable goals.
A trademark is a word, phrase, symbol or design that identifies and distinguishes the source of a particular good or service. Common examples include company names, logos, taglines and product names. However, a trademark could also be a particular shape, sound, color or scent that is used to identify or distinguish a particular commodity. Some trademarks are registered with the United States Patent and Trademark Office (USPTO), while others are not. Once registered, the trademark will need to be renewed every ten years. Both registered and unregistered trademarks reflect the right to the legitimate use of the mark, but only a registered trademark gives the owner the exclusive right to use the mark nationwide or in connection with the goods and services listed in the registration.
A patent is an intangible property right that protects an invention. A patent gives its owner the right to exclude others from making, using, distributing or selling a product that includes the patented invention or concept.
There are three types of patents: utility, design and plant patents. Individuals have to apply for a patent through the USPTO. A utility patent, the most common type, is granted to an individual who discovers or invents "any new and useful process, machine, article of manufacture or composition of matter, or any new and useful improvement thereof." 35 U.S.C. Sec. 101. Design patents are granted to an individual who invents "a new, original and ornamental design for an article of manufacture." 35 U.S.C. Sec. 171. Plant patents may be granted to an individual who "invents or discovers and asexually reproduces a distinct and new variety of plant." 35 U.S.C. Sec.161.
The United States Patent and Trademark Office is the federal agency that grants U.S. patents to inventors. While utility and plant patents are valid for a term of up to 20 years, design patents have a shorter 15-year term. Patent terms are generally not renewable.
Charitable Contributions to Charity
Trademarks are generally transferred to charity via an assignment contract that is recorded with the USPTO. Chapter 500 of the Trademark Manual of Examining Procedure contains the rules applicable to trademark transfers. The Trademark Manual of Examining Procedure is available on the USPTO website.
Patents are also transferred by an assignment contract recorded with the USPTO. The document that transfers a patent should be notarized and include, among other things, the patent number, date the document is executed and the names of the parties giving and receiving the interest. If a patent assignment is not recorded within three months, it will not protect the transferee against a subsequent purchase of the patent unless the assignment document is recorded prior to the subsequent purchase. There are specific rules applicable to the transfer of patents and more information about their transfer can be found in Chapter 300 of the Manual of Patent Examining Procedure.
Valuation for Charitable Contributions of Intellectual Property
Ordinary Income Property
Copyrights and patents are considered capital assets if acquired by purchase or inheritance. However, copyrights and patents are not capital assets if the taxpayer created the IP or it is received by an individual as a gift from the IP creator. Sec. 170(e)(1)(B). A donor who makes a charitable gift of an ordinary income asset is entitled to a deduction that is equal to the lesser of the property's cost basis or fair market value. Sec. 170(e)(1). IP given as a gift from the IP creator carries over the basis and character from the donor. Sec. 1221(a)(3). Trademarks are not subject to Sec. 1221(a)(3). Unless a trademark is depreciated in a trade or business, it will be considered a capital asset, even in the hands of the trademark creator. PLR 199944045.
Example – Gift of Patent by CreatorCapital Asset – Qualified Donee Income (QDI)
Mary developed and patented a bird-protection device for wind turbines. Her cost basis is $100,000 and the value is $1,000,000. She gave the patent to her local food bank. Because she created the patent through her personal efforts and the fair market value is greater than the basis, under Sec. 1221(a)(3) Mary qualifies for a charitable deduction for her basis of $100,000. For gifts of IP that are greater than $500, donors must fill out and include Form 8283 on his or her tax return. Donors must also fulfill the requirements for noncash gifts valued over $250, which require the donor to obtain a contemporaneous written acknowledgement (CWA) that complies with Reg. 1.170A-13(f) and Reg. 1.170A-16(d)(1)(i). Because the IP is valued over $5,000, Mary must obtain a qualified appraisal prepared by a qualified appraiser. Reg. 1.170A-16(d)(1)(ii).
Copyrights, trademarks and patents that are appreciated capital assets may be gifted to charity and qualify for a deduction for the lesser of the cost basis or fair market value plus a percentage of qualified donee income (QDI). Sec. 170(m)(3). If the donor informs the nonprofit of the intent to take a QDI deduction, the income produced by the charity's use of the IP will produce QDI. Notice 2005-41. Per Sec. 170(m)(8)(B), the donor must provide written notice at the time of the donation electing treatment as a qualified intellectual property contribution under Sec. 170(m)(8) and Sec. 6050L. Qualified IP includes copyrights, trademarks and patents. Sec. 170(m)(9), Sec. 170(e)(1)(B)(iii). If the IP is valued over $5,000, the donor must also obtain a qualified appraisal prepared by a qualified appraiser. Reg. 1.170A-16(d)(1)(ii). The net income is then reported by the nonprofit on IRS Form 8899 each year. The donor may deduct QDI (initially reduced by the basis) amounts for up to 10 years. Sec. 170(m)(5). For short tax years, a 12-year sliding scale may be used to cover a partial first and final year where the deduction is 100% of QDI in year one, 100% in year two and declines by 10% each year to 10% in years 11 and 12. Sec. 170(m)(7), Sec.170(m)(10)(D)(i). A donor is unable to claim a deduction for any QDI accrued after the legal lifespan of the IP asset expires. Sec. 170(m)(6).
Trademarks – Capital Assets
Trademarks are considered capital assets under Section 1221. The owner of a trademark who gives his or her entire interest in that trademark to a qualified charity will generally be entitled to claim an income tax deduction. However, if the charitable contribution is a partial interest, the charitable income tax deduction will not be permitted. So long as the donor gives his or her entire interest to a qualified charity, he or she receives an income tax deduction for the lesser of the cost basis or the fair market value of the trademark.
The fair market value of a trademark is determined by an appraiser and is typically based upon the value of goodwill. Goodwill relates to the inherent value of the trademark, which is based on reputation, the loyalty of the customer base associated with the trademark and the public recognition of the trademark.
If the donor "retains any significant power, right or continuing interest with respect to the subject matter of the trademark," no deduction is allowed when transferring the trademark to charity. PLR 199944045. The term "significant power, right, or continuing interest" includes, but is not limited to the list outlined in Sec. 1253(a).
Example – Gift of Partial Interest in a TrademarkPatents – Capital Assets
Tallulah owns a trademark. She wants to give the trademark to her alma mater but retain the right to prescribe the standard of quality of products or services sold under that trademark. She learns that if she retains this right, she will not receive an income tax deduction for the transfer of the trademark to her alma mater. She decides not to retain that right when making her donation to maximize her charitable deduction.
A patent is considered a capital asset if it was purchased or inherited by the taxpayer. The fair market value of a patent is determined by a qualified appraiser and is generally based upon the income stream that the patent is expected to generate. The income stream that a patent will generate often relates to whether the patent is current or obsolete, the kind of patent, restrictions on the use or transferability and the remaining duration of the patent.
The owner of a capital asset patent who gives his entire interest, or an undivided percentage that represents the owner's entire interest in a patent, to a qualified charity is not barred by the partial interest rules to claim an income tax deduction. Rev. Rul. 58-260. The appreciated patent gift qualifies for a deduction for cost basis plus a percentage of QDI. Sec. 170(m)(3).
Example – Gift of Entire Interest in Patent
Two years ago, Kate purchased a patent for $400,000 for a device used to polish gems and other valuable stones. The utility patent has 16 years left of its legal life. Kate is so appreciative of the education that she received at her local college that she wants to share the benefits of her patent with the college. She gifts her entire interest in the patent (including the right to all royalties the patent will generate) to the college. Because she gave her entire interest in the patent, Kate is entitled to a deduction for her cost basis plus QDI.
As soon as Kate's patented gem polishing machine went into production, it was in great demand from jewelers around the world. Experts are predicting continued demand for the device and are projecting that Kate's patent could be worth more than $5 million.
Kate's initial deduction for the patent is limited to the lesser of her cost basis or its fair market value. Based upon a qualified appraisal, she is allowed to take a deduction of $400,000, which is her total cost basis. She notifies her local college at the time of the contribution that she is electing treatment as a qualified intellectual property and plans to deduct any QDI. Her local college licenses the patent, receives QDI and files IRS Form 8899. Since Kate will be filing a return for a short taxable year, Kate's deductions are qualified over 12 years, to account for a partial first and final year. She reports no deductions after 12 years.
Date of Contribution Applicable Percentage QDI Kate's Deduction 1st 100 $0 $400,000 (basis) 2nd 100 $200,000 $0 (Not over basis) 3rd 90 $200,000 $0 (Not over basis) 4th 80 $250,000 $200,000 5th 70 $250,000 $175,000 6th 60 $300,000 $180,000 7th 50 $300,000 $150,000 8th 40 $350,000 $140,000 9th 30 $350,000 $105,000 10th 20 $400,000 $80,000 11th 10 $400,000 $40,000 12th 10 $400,000 $40,000 Total Deduction $1,510,000
Patents – Gift of Partial Interest
Due to the partial interest rule in Sec. 170(f)(3), an owner who gives less than their entire interest in a patent is not allowed to claim a tax deduction. A donor gives less than their entire interest in a patent if the owner retains the right to license the patent to others, manufactures or uses any product that is covered by the patent or places conditions on the gift, which, if triggered, may result in ownership of the patent reverting to the donor. Rev. Rul. 2003-28.
Example – Gift of Partial Interest in a Patent
Eddie has developed several inventions, including a product that reduces the heat emitted from stage lights. The invention is popular in theatres and playhouses because actors like the way the product reduces heat generated by the lights on stage. Eddie has patented the invention but has not yet found a company willing to manufacture it.
Eddie is a patron of the arts and really enjoys attending performances at the local community musical theatre, a qualified public charity. Eddie grants the theatre a non-exclusive license to use his invention. Eddie's grant of a license is not deductible because he retained a substantial right in the patent. Eddie retained ownership in the patent, the right to grant further licenses and a right to any future income from the patent.
Gifts of trademarks and patents to a qualified charity could offer attractive tax-planning advantages to donors as well as provide a long-lasting legacy. While there are many rules to follow when it comes to donations of intellectual property, a donation of intellectual property can offer donors a great opportunity to fulfill their philanthropic goals and ensure that the intellectual property is enjoyed for years to come. Donors should work closely with their professional advisors to ensure that they understand the tax deduction rules and realize the full tax benefits of the gift.
Donations of Intellectual Property Part I
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