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Patent Holders: Give Up Control before Royalty Income can be Treated as Capital Gains

Saul Brenner, CPA, J.D., LL.M. 07.07.2015 | eVisor

Patent holders must give up control of a transferred patent to treat the royalty income as capital gains. The Tax Court recently agreed with a 1975 decision by the U.S. Court of Claims that the retention of control by a holder over an unrelated corporation can defeat capital gain treatment under Section 12351.

In the matter, a couple transferred patents to a corporation owned jointly with a relative and family friend. Their attorney advised that they could not control that corporation directly, and that stock ownership had to be less than 25% of the total outstanding stock.  Accordingly, the couple's stock ownership in the corporation was limited to 24%.  The couple then reported royalty income they received from the corporation in exchange for the transfer of the patents as capital gain.  Nevertheless, the IRS determined that the royalty payments did not qualify for capital gain treatment and the Tax Court agreed.

In order for the transfer of a patent to qualify as a sale or exchange, the owner must transfer "all substantial rights."  The Tax Court agreed with the Court of Claims that the circumstances in the matter were not credible enough to assert that the corporation was not controlled by the couple.

1 Cooper v. Commissioner, 143 T.C. No. 10, Docket No. 17284-12, Filed September 23, 2014

Questions? Contact your Berdon advisor or Saul Brenner at 212.331.7630 | sbrenner@berdonllp.com

 

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