Checks

							TRANSITION FROM IDEA TO
PROFITABLE PROTECTED
PRODUCTS      MEDTRADE-SPRING
May 6, 2008                   Long Beach
PATENTAX®
Curtis L. Harrington          Kathy E. Harrington
Harrington & Harrington       Harrington & Harrington
Suite 250                     355 South Mt. Carmel Rd
6300 State University Drive   McDonough, GA 30253
Long Beach, CA 90815          (770) 914-1413
(562) 594-9784                kathy@patentax.com
curt@patentax.com             http://www.patentax.com
http://www.patentax.com
Disclaimer – Educational Only

 This Power Point Presentation is Educational Only
  and no part of this presentation can be considered
  as federal or state tax advice, opinion, or position
  and is not intended or written to be used, and may
  not be used, for the purpose of (i) avoiding tax-
  related penalties under the internal revenue Code
  or (ii) promoting, marketing or recommending to
  another party any tax-related matters addressed
  herein, nor (iii) constituting guidance on any tax or
  intellectual property matter.
Overall Simplified Procedure

 FINISH THE PRODUCT COMPLETELY
   What does this mean?
    You have full blueprints, circuitry, etc
    You have a fully developed profitability
     spreadsheet
    You have included the correct number and
     complexity of product options you will offer
Overall Simplified Procedure

 FINISH THE PRODUCT COMPLETELY
   What will finishing do for me?
    If later conditions suggest a change in
     direction, you won’t know how to change or
     what to change unless you are completely
     familiar with your product’s operating
     capabilities.
Overall Simplified Procedure

 FINISH THE PRODUCT COMPLETELY
   What will finishing do for me?
    If your competitors see that you will never
     leave the “design room” it’s a clear indication
     that you will never be able to compete. It
     detracts from your apparent readiness to enter
     the market.
Overall Simplified Procedure

 FINISH THE PRODUCT COMPLETELY
   What will finishing do for me?
    It “forces” you to think beyond the product.
     For every problem, you should be able to
     anticipate 10 problems. For every potential
     capability, you should be able to think of 10
     more. This process makes you “master” the
     your product.
Overall Simplified Procedure

 FINISH THE PRODUCT COMPLETELY
   What will finishing do for me?

    It will let you know whether you have a
     product you can make for $1 and sell for $100;
     instead of the other way around.
Overall Simplified Procedure

 FINISH THE PRODUCT COMPLETELY
   If the industry is fast changing, and if you don’t
    finish the first version, you won’t have a chance
    to get to a second version

   If the industry is not fast changing, you will have
    other things to do than trying to change the
    product when you have to worry about logistics,
    making deals with distributors, production, and
    servicing the product
Bogus Problems & Excuses

 BUT ISN’T THE CONCEPT GOOD
  ENOUGH?

   NO

   Concepts are only good for TIME TRAVEL and
    ANTI-GRAVITY machines
Bogus Problems & Excuses

 BUT ISN’T THE CONCEPT GOOD
  ENOUGH?

   NO

   There is the misconception that every industry
    has a Daddy Warbucks JUST WAITING to throw
    his arms around you and say “Oh My, I’ve been
    waiting for someone like you all my life”
Bogus Problems & Excuses

 BUT ISN’T THE CONCEPT GOOD
  ENOUGH?

   NO

   Look at yourself as one of your potential
    customers:
   “When is the last time you went out and bought a
    concept?”
Bogus Problems & Excuses

 I have a CONCEPT for a new SATELLITE
  CHEMICAL LASER, but I’m a secretary, and
  I DON’T KNOW THE DETAILS.

   STOP! You don’t have an invention, you have a
    mystical dream.

   If you don’t know how to build it, you are in
    trouble.
Bogus Problems & Excuses

 I know, I can PAY someone to take care of
  the DETAILS!

   STOP! YOU are the BOSS, YOU are supposed
    to know how to build it.

   No one will put the Quality and Care into the
    project if YOU are not involved. Others will
    simply take your money and do little.
Bogus Problems & Excuses

 I know, I can PAY someone to take care of
  the DETAILS!

   STOP! WHO are you going to trust to work for
    you?

   WHAT if you live in a jurisdiction where you
    “HELPER” will end up either owning the product
    or blocking your enforcement of your rights?
Bogus Problems & Excuses

 I know, I can PAY someone to take care of
  the DETAILS!

   STOP! WHO are you going to trust to work for
    you?

   WHAT is your relationship to those who are
    supposed to be helping you? Are your
    confidentiality agreements in place?
Bogus Problems & Excuses

 I know, I can PAY someone to take care of
  the DETAILS!

  HAS your office instituted the proper procedures
   and controls so that you can raise the issue of
   TRADE SECRET theft?

   IF YOU DON’T TREAT IT LIKE A TRADE
    SECRET, ITS NOT A TRADE SECRET!
Techniques for Moving Forward


 1. Do your homework on the product:

 Get onto the Internet, make a list of all similar
  products, and their sales price. (This will give
  some idea of what your price point might be)
Techniques for Moving Forward


 1. Do your homework on the product:

 Make a list of products which may not
  directly compete, but which may be “an
  alternative” in order to get an idea of the size
  of the potential market.
Techniques for Moving Forward


 1. Do your homework on the product:

 Take to account any Safety Considerations,
  dangers in purchase or use. Look to see if
  Insurance companies charge a premium
  related to this product or offer a discount. (Ex:
  Good=smoke detector Bad=skateboard
Techniques for Moving Forward


 1. Do your homework on the product:

 Get a quote from a commercial insurance
  company on product liability for production
  and ask for some data points on their most
  risky and least risky products.
Techniques for Moving Forward


 1. Do your homework on the product:

 If the product has ANY relationship to
  government, begin to explore the possibility
  of getting some government endorsements or
  approval. Don’t be dissuaded by the “we
  don’t endorse” statement.
Techniques for Moving Forward


 1. Do your homework on the product:

 Along the same lines, is a monopoly possible?
  State & Federal use can be protected by either
  patents, or by standards which your product
  meets where others fail.
Techniques for Moving Forward


 1. Do your homework on the product:

 Take a careful look at product differentiation
  between a deluxe version and a standard
  version.
 Carefully weigh the options for mix and
  match of features
Techniques for Moving Forward


 1. Do your homework on the product:

 Be aware that the design for the “high speed”
  manufactured version will differ from a
  manually constructed version. The high speed
  version will usually have the most profit, so
  your design emphasis and other protections
  should focus on this version.
Techniques for Moving Forward


 1. Do your homework on the product:

 Explore the transition from a low volume
  labor intensive start to manufacturing and an
  eventually to high speed and high volume.
Techniques for Moving Forward


 1. Do your homework on the product:

 Get ready to file a patent because:

   (a) Sale of the patent is a muniment of title which
    can support capital gains.
Techniques for Moving Forward


 1. Do your homework on the product:

 Get ready to file a patent because:

   (b) The patent application may be considered
    “insurance AGAINST success”.
Techniques for Moving Forward


 1. Do your homework on the product:

 Get ready to file a patent because:

   (b) You have no idea what will result from the
    patent application, no idea whether the product
    will “take off” and no idea what your competitors
    will do.
Techniques for Moving Forward


 1. Do your homework on the product:

 Get ready to file a patent because:

   (c) Your competitors have no idea as to the level
    of protection you will get.
Techniques for Moving Forward


 1. Do your homework on the product:

 Get ready to file a patent because:

   (d) It marks a point in time when you should
    consider ALL variants on the product, including
    FUTURE variants. Including them in the filing
    will constitute a “defensive publication.”
Techniques for Moving Forward


 1. Do your homework on the product:

 While patent is being written, prepare (but
  don’t send) a marketing packet which has:

   (a) Long story, Short Story, Medium Story

   (b) Photos, drawings, video demonstration
Techniques for Moving Forward

 1. Do your homework on the product:

 While patent is being written, find ALL of the
  TRADE PUBLICATIONS which have any relation
  to your product and prepare mailing labels:

   (a) Also possibly secure a web site for upload of all your
    articles and marketing materials (but leave it empty)

   (b) Collect follow up phone numbers to contact these
    publishers. (never send anything until patent is filed
Techniques for Moving Forward

 1. Do your homework on the product:

 FINISH THE PRODUCT IN FINAL-FINAL
  FORM

   (a) Hint: You should know the manufacturing cost at
    different production levels “to the penny”

   (b) And you should know (a) for each version
Techniques for Moving Forward


 1. Do your homework on the product:

 While patent is being written, find YOUR trade
  show which is from 3 – 5 months from patent filing:

   (a) Which you will attend, possibly exhibit

   (b) Note the other Exhibitors, your potential buyers
Techniques for Moving Forward

 1. Do your homework on the product:

 Don’t plan to produce the product?

 NEVER NEVER NEVER TELL THAT TO
  ANYONE.

   (a) No one will pay top dollar to someone who believes
    so little in their product that they refuse to make it.
Techniques for Moving Forward


 1. Do your homework on the product:

 Don’t plan to produce the product?

 YOU SHOULD EITHER MAKE A
  LIMITED NUMBER OR BE READY TO
  TAKE SOME “LONG TERM” ORDERS
  WHICH WON’T BIND YOU.
Techniques for Moving Forward


 1. Do your homework on the product:

 Why take orders?

 (a) It may be the only concrete method to
  guage customer acceptance.
Techniques for Moving Forward


 1. Do your homework on the product:

 Why take orders?

 (b) When you completely finish your product
  and know the actual production price, you will
  ideally be indifferent as to whether you make
  it or not.
Techniques for Moving Forward


 1. Lets do the math. Your product can be
  made for $4. You pay yourself $2, and sell to
  the wholesaler for $6. Wholesaler sells to
  outlet for $12, and outlet sells retail for $24.95
 (reflects a factor of 4)
Techniques for Moving Forward


 1. Lets do more math. Your product can be
  made for $4. You pay yourself $2, and sell to
  the wholesaler for $6. Wholesaler sells to
  outlet for $18, and outlet sells retail for $36.95
 (reflects a factor of 6)
Techniques for Moving Forward


 1. From this scenario you note two things:

 (a) First, your $2 gets doubled or tripled
  TWICE before the retail amount. (This is why
  the major retailers beat you down on price as
  it is a multiplier.
Techniques for Moving Forward


 1. From this scenario you note two things:

 (b) Second, your $2/unit is just the gross.
  You have expenses including (a) insurance,
  (b) physical overhead (c) sales costs, and once
  these are subtracted, you will pay Uncle Sam
  40% and the State of California 10%
Techniques for Moving Forward


 1. Without thinking about all this:

 (a) You wouldn’t know how much to sell for,
  even if someone did make an offer to buy.
 (b) You need to make an intelligent decision
  on manufacture/sell at each point along the
  way.
Techniques for Moving Forward


 1. Once you are happy with the content and
  coverage of the drafted patent (we will talk
  about the advantages later) you need to do
  several steps in rapid sequence:

 (a) Time the filing of the patent about 4
  months in advance of YOUR trade show.
Techniques for Moving Forward


 1. Once you are happy with the content and
  coverage of the drafted patent (we will talk
  about the advantages later) you need to do
  several steps in rapid sequence:

 (b) Purchase Patent Insurance as soon after
  you file the patent as possible.
Techniques for Moving Forward


 1. Once you are happy with the content and
  coverage of the drafted patent (we will talk
  about the advantages later) you need to do
  several steps in rapid sequence:

 (c) After you are CERTAIN that the patent
  has been filed, send out the press releases
  tauting your “NEW PRODUCT” to pick up as
  much free advertising as possible (worldwide)
Techniques for Moving Forward


 1. Once you are happy with the content and
  coverage of the drafted patent (we will talk
  about the advantages later) you need to do
  several steps in rapid sequence:

 (d) Start follow-up contact with publications,
  trade show personnel and others to make
  certain that you are “set for the show.”
Techniques for Moving Forward


 1. “Set For the Show” Means:

 (a) Your product is in the “new product” showcase

 (b) All of your follow-up calling, WORLD WIDE
  will give you the opportunity to schedule
  appointments or remind others you will meet with
  them
Techniques for Moving Forward


 “Meetings” include:

 (1) Foreign market representatives who want
  to buy or license the product

 (2) Domestic potential buyers

 (3) Your Domestic manufacturing customers
Techniques for Moving Forward

 “Reasons for Pulling everyone together at once:

 (1) Use your 1-year foreign patent right in most
  countries, to try to get interested people in the
  foreign jurisdictions who want to buy or license the
  product to compensate you early and use those
  funds to protect the product in those jurisdictions.

 (2) Domestic potential buyers will be competing
  with each other directly and can “bid up”
Techniques for Moving Forward


 Generally, as soon as the patent is filed, you
  should start selling –

 --Don’t wait for the trade show!!!!
A few words on Manufacturing


 Make sure you have an LLC/Corporate
  entity in place

 Make sure that you have commercial
  liability insurance
A few words on Manufacturing


 Make certain to follow rules on
  compensation for employees

 Remember than a single member LLC is
  a disregarded tax entity.
A few words on Manufacturing


 If you choose a corporation make
  CERTAIN that you observe the corporate
  formalities

 Be cognizant of your tax year, filing
  times, and worker’s comp insurance
  system
A few words on Manufacturing


 Keep copious records of EVERYTHING
  and save them for YEARS.

 If you have employees, adopt specific
  policies and keep them formally,
  preferably at the level of corporate
  formality
A few words on Manufacturing


 Continually evaluate the cash flow

 For several products, evaluate
  profitability and place efforts and cash
  where the best return is to to be obtained.
A few words on the Patent System


 Lets start with the biggest miconceptions
  on Patents
Biggest Misconceptions - Patents

 “If I have a patent I have the right to
  manufacture” – NO

 “I have to do a search” -NO (but you should
  spend $300,000 to be sure)

 “Can I get one of those great big
  INTERNATIONAL PATENTS”? NO
Biggest Misconceptions - Trademark

 “If other companies can pick stupid,
  descriptive names, I can too”- NO

 If my name isn’t descriptive, how will
  anyone know what my product is?
Biggest Misconceptions – Copyright

 “I made this clothing by hand, I want to
  copyright it”

 I want to copyright my idea!

 “Send them a really nasty letter, if they
  don’t like it, they can lump it”
Overview of Intellectual Property

   All Rights are NEGATIVE

   NO Positive rights to manufacture/sell

   Intellectual Property CAN be an asset
    which can attract CAPITAL GAINS
What is a Patent?
 Utility: 20 year (potential) certification relating to requests
  extending amortization periods

 Relating to (1) machine, (2) Process, (3) article of manufacture,
  (4) Composition of Matter, (5) non tuber (potato) plant

 Design: 14 year monopoly on the 3-Dimensional Design of a
  utilitarian item

 Seed Variety Registration under section 5, United States code
Why File for a Utility Patent

   Up to 35% U.S. Government subsidy (deductible)

   Instant (no holding period) Capital Gain - 15%

   Makes the Competition Think Twice

   Patent Insurance to stop infringers now available

   Good for Advertising and Prestige

   Utility one-year right to File
Why File for a Design Patent?

   Inexpensive (file-issue w/o argument < $2100)

   Your “Patent Pending” need not identify as design.

   New Look on old item qualifies

   Low Technology protection

   14 year life & NO maintenance fees

   Same Tax Treatment as Utility Patent!
Trade Secrets
 All patents start out as trade secrets as the information
  flows from the mind to some detectable indical

 Generally the same tax treatment as patents on sale

 Requires additional element in sales agreement to
  complete the sale, namely a “promise not to tell/exploit”

 Can be used for inventions/contributions smaller than
  patent & for aspects not captured in the patent
  application

 Criminal Statute for Thieves
Trademarks
 Most Mis-understood form of Intellectual Property

 Whereas Patents are a “two way” tax street,
  Trademarks are a “one way” tax street

 Trademark is much like a language-based
  “identification code” not for the goods and services,
  but for the --SOURCE-- of the goods & services.

 The idea is that a purveyor of goods and services
  will be motivated toward high quality where the
  public use the “trademark” to do more business
Trademarks (cont’d)
 A naked sale of a trademark is treated as an
  abandonment

 Since a trademark can last forever it has no
  defined life term

 Because it has an infinite life, any monies spent to
  create or defend it have to be capitalized (Result:
  you pay for trademarks with after tax money)

 Example: You spend $1,000,000 defending a
  trademark. (This costs you $1,450,000) (CA)
Trademarks (cont’d)
 Trademarks can assist a business entity in spinning off
  separate lines of business

 Trademarks attract Long Term Capital Gains and thus form
  the “holy grail” of business objectives, & enables business
  owners to harvest a lifetime of credit for superior goods
  and services

 Being forced to “change” your trademark is essentially the
  same as having to “start over” in business

 Picking a weak mark will cost potentially millions over the
  life of the business. Your Advertising dollars result in
  competitor sales.
Selecting a Trademark
 Objective is to MAXIMIZE goodwill value (especially when
  harvested at capital gains rates)

 Objective is to MINIMIZE litigation potential (buyers will not
  pay to buy litigation or constant problems with others

 Objective is to MAXIMIZE singlular association of CLIENT
  business with the trademark.

 RESIST the temptation to emulate others who chose poorly
Selecting a Trademark:               5 RULES
 Name of 6 or more characters which are NOT
  DESCRIPTIVE OF ANY ASPECT OF THE GOODS OR
  SERVICES

 Pick a name which is NOT IN THE DICTIONARY, a made-
  up word is preferable

 NOT A PERSON’S LAST NAME

 NOT A GEOGRAPHIC DESIGNATION

 NOT SCANDALOUS OR VULGAR
Trademark Observations
 You can get any mark, but if its descriptive you may end up
  paying millions each year to keep the name out of the public
  domain. Plus, a lawsuit could result

 The 5 Rules are really to maximize the “BUY LOW—SELL
  HIGH procedure. Ignoring them invokes the “BUY HIGH er
  than you should have and SELL LOWER than you could
  procedure.

 Special Procedure for writing off trademarks of acquired
  businesses over 15 years. This helps businesses who set out
  to acquire multiple businesses and helps sellers get a slightly
  higher price where the buyer can write off the purchase
  sooner
Trademark Observations (cont’d)
 Under the U.S. system you do not “own” the mark (it can be
  taken away from you) until AFTER FIVE YEARS AFTER
  REGISTRATION (typically about 7 years after you first apply)

 To cash in at the end of the day you need BOTH (1) a
  trademark which has the singular unique nature to capture
  MAXIMUM GOODWILL, as well as (2) decades of hard work
  in providing a high level of high quality goods and services.

 Sale of a business with a trademark is essentially where the
  Purchaser “becomes” the purchased entity.
Copyright Problems
 Not a Capital Asset in the hands of creator (except music)

 Therefore ordinary Income on first sale from creator

 Litigation Rule - losers pay winner’s Atty.. Fees (ordinary)

 Alternative Minimum Tax Potential Problem on Litigation (not
  compensation for personal injury, Attorney fees may not be
  deductible)

 Author’s decedents can take it back from owner
Copyright Advantages
 Only a minimum level of originality is required

 Inexpensive Registration

 Can be fragmented and sold in parts

 Capital gains for purchased copyrights held more than a year

 Long Term - Life of the author + 75 years (congress keeps extending it)

 Minimum statutory damages of up to $10k/copy

 Extended division of control of prohibited activities (copy, perform,
  distribute, display, etc.)

 Criminal Copyright statute helps deter copying
Patent Tax Specifics
 Deducting the Costs of Creation

 Maintaining Holder Status

 Attracting Capital Gains on Sale

 Considerations for Buyer / Licensees and Seller
  Licensors

 Avoiding Problems

 Examples
Patent Tax Deductions
 RESEARCH AND EXPERIMENTAL EXPENDITURES

 Internal Revenue Code Section 174:

  In General- A taxpayer may treat research or experimental
 expenditures which are paid or incurred by him during the
 taxable year in connection with his trade or business as
 expenses which are not chargeable to capital account. The
 expenditures so treated shall be allowed as a deduction

 The term "in connection with" is deliberately less stringent to
 distance the application of §174 from the requirement of
 having an ongoing business concern.
What May be Deducted?
 PATENT ATTORNEY FEES

 NON MARKETING RESEARCH

 Equipment, testing, experiments

 Remember: The value of these deduction is reflected against
  the taxpayers marginal income rate. A 35% marginal tax rate
  means that Uncle Sam is kicking in 35-cents for each dollar
  spent. States generally kick in their rate contribution.
Tax Credits
 IRC §41 gives taxpayers, typically large corporate taxpayers,
  a credit based upon either (a) a regular credit for qualified
  research expenditures which exceed some fixed base
  percentage of average annual gross receipts or (b) an
  incremental credit based upon current qualified research
  expenditures which exceed research intensity for a given
  base period. Although a percentage popularly stated with
  respect to this credit is “20%” there are other limitations to
  both credits which reduce the 20% value to a much lower
  figure.

 There are several alternatives (details are omitted for
  brevity) but to make matters worse, IRC §280C(c) disallows
  deduction of that portion of research expenses which are
  equivalent to the credit, while offering as an alternative the
  reduction of the credit. To make Tax Credits worth taking
  advantage of, significant dollars should have been spent on
Tax Credits (cont’d)
 (Compare Canada’s Federal 35% refundable tax credit for research by
  Canadian Controlled Private Corporations (Internal Revenue Act 127(10.1)),
  along with supporting refundable tax credits from the provinces: Ontario’s
  super allowance for example of from 125% up to 152.5%.

 The Pension Protection Act of 2006 (PPA) includes a “simplified” research
  credit alternative more likely to impact small inventors in 2007. The prior
  and still effective research expense credit (claimed on Form 6765) is the
  sum of: (1) 20% of any excess of qualified research expenses for the tax
  year over a base amount, (unless the taxpayer elects the traditional
  incremental credit, which would then replace this item); (2) The "university
  basic research credit," i.e., 20% of the basic research payments (to a
  university) determined under Code Sec. 41(e)(1)(A); and (3) 20% of the
  taxpayer's expenditures on qualified energy research by an energy research
  consortium. (Code Sec. 41(a)) .

 Independent companies perform full company audits and prepare tax
  credits for a percentage based fee (given the expansion of what is
Patent Tax Instant Capital Gains
 TREATMENT ON SALE

 Internal Revenue Code Section 1235:

 (a) GENERAL.- A transfer (other than by gift, inheritance, or
 devise) of property consisting of all substantial rights to a
 patent, or an undivided interest therein which includes a part
 of all such rights, by any holder shall be considered the sale
 or exchange of a capital asset held for more than 1 year,
 regardless of whether or not payments in consideration of
 such transfer are-
 (1) payable periodically over a period generally coterminous
 with the transferee’s use of the patent, or
 (2) contingent on the productivity, use, or disposition of the
 property transferred.
Comments on Section 1235
 Siblings are not treated as “related taxpayers”

 Cannot be used to compensate employees with capital gains

 This is an election to expense made in the first year of the
  project

 Capitalization only seems to make sense where the entity
  has carry forward losses against which capitalization could
  provide an offset

 Statute specifically includes “productivity based” sales
Comments on Section 1235 (cont’d)
 The statute includes, under some circumstances the ability to
  treat “investors” the same as inventors. (patents are usually
  so inexpensive that one would never take on investors for the
  cost of the patent only)

 Good candidates for “investment” include projects which
  have a long, costly, research lead time. Probably greater
  than $100,000 and more than a year.

 The statute “REDUCES” the percentage ownership for
  related taxpayers from 50% to 25% for the “inventive entity”
TRANSACTION SETS
 Selling a Patent, Trade Secret, Trademark or Copyright

 Buying a Patent, Trade Secret, Trademark or Copyright

 Optioning a Patent, Trade Secret, Trademark or Copyright

 Forming a Joint Venture, Partnership, LLC
 The statute “REDUCES” the percentage ownership for
  related taxpayers from 50% to 25% for the “inventive entity”
GENERAL LAW
PRINCIPLES
 When you buy an asset, you write it off over its useful life

 When you sell an asset, you must generally divest 100% of
  your ownership rights.

 Your ability to sell to a “related entity” is severely restricted
  with respect to deductions and gains.

 Most capital assets must be held for a year to attract long
  term capital gains

 The core of a license is a simple promise not to sue licensee
THE CASES OF INTEREST
For Taking Advantage of the Tax Benefits

 Green v. Commissioner, 83 T.C. 667 (1984

Prohibition on deducting project expenditures for “non-
  technically active” investment vehicles/partnerships, etc.

   In the Green case, the deductibility of research and
   development expenditures was denied where the invention
   was placed in a limited partnership which functioned only as
   a “vehicle for passively injecting risk capital into the
   development and commercialization of inventions.” Thus, an
   entity which seeks to claim a deduction should be set up to
   have a chance to enter the regular business.
THE CASES OF INTEREST
For Taking Advantage of the Tax Benefits

 Scoggins v. Commissioner 95-1 ustc 50,061; 46 F3D 950 (9th
  Cir).
Where a partnership kept the opportunity to enter business,
  money put into the partnership is deductible

   In Scoggins, the inventors formed a partnership to hold rights
   in the technology, and to pay for the research but only gave a
   corporation (who was a related taxpayer) doing the research a
   nonexclusive license. The issue in Scoggins is whether the
   partnership could take a deduction for the research
   expenditures passed through the corporation. Because of the
   limited interest granted, the partnership was still in the
   bussiness of exploiting the patent
THE CASES OF INTEREST
For Taking Advantage of the Tax Benefits

 Associated Patentees, Inc. 4 T.C. 979 (1945).

   Where the payments are dependent upon the patent’s use or
   production, it is considered that the payments are closely
   enough related to the value of the patent being used up that it
   is deductible in the year paid or accrued. This rule is from
   Associated Patentees, Inc. 4 T.C. 979 (1945), and as you can
   see it has survived for over half a century. The tremendous
   impact of this case is that it allows licensees who license
   based upon use, not to be forced to capitalize, but enabled to
   deduct on a use-rated basis, deducting as you go.
THE PRINCIPLES OF SALE
 A sale is the surrender of “substantially” all of the rights of
  ownership.

 A license can be a sale if it transfers:
    All rights to a whole patent for a whole nation
    All rights to 100% of the patent term
    No substantial rights retained


 “Subject to a right of payment” is not the retention of a
  substantial interest. Other retained details place the
  licensor/seller in a position to have “sale treatment” denied.
THE PRINCIPLES OF SALE (cont’d)
 Sale of a trade secret Requires More due to the nature of the
  right:
    A promise never to practice the secret (at minimum)
    A promise to never reveal the secret (or value would be destroyed)


 A license with a “failure to pay” clause can result in multiple
  sales.
    Licensor licenses to Licensee all rights subject to payment of annual
     minimum royalties and per-product royalties or else the equitable
     patent rights revert to the licensor.
    If Licensee does not pay, the licensor has the patent and can “sell” it
     again.
    Again, other conditions which give the licensee rights to regain the
     patent may cause a failure of “sale” treatment.
THE PRINCIPLES OF SALE (cont’d)
 Sale of a trademark Requires the inclusion of at least a bare
  indicia of ability for continuity of quality

    Trademark theory behind trademarks is that the buyer
     gets a chance to step into the shoes of the buyer. Sale of
     a naked name is so abhorrent to the trademark principles
     that the law forces it to be a forfeiture and abandonment of
     a mark. It doesn’t take much to support this bare indicia of
     continuity – a formula, a set of product specifications,
     something should be given along with the trademark.

    Further, the non-sale, license of a trademark requires that
     the trademark owner continue to exercise some control
     over the goods and services, like setting product and
     process standards.
GENERAL TAX RATES
 Income relating to an activity attracts:
      Ordinary Income rate – about 35% (ignoring deduction abatements)
      Self Employment Tax – 15% (ignore use of a corporation)($94,200)
      Social Security Medical – 3% Forever
      State Tax (California 10%)(Georgia 6%)(Texas, Nevada 0%)


 Passive ordinary income attracts:
    Ordinary Income rate – about 35% (ignoring deduction abatements)
    State Tax (California 10%)(Georgia 6%)(Texas, Nevada 0%)


 Long Term Capital Gains income attracts:
    Capital Gains rate of 15%
    State Tax (California 10%)(Georgia 6%)(Texas, Nevada 0%)
COST OF CAPITALIZATION
 Capitalization is an interest – free loan to the government of
  an amount of money equivalent to the non-expensible portion
  of a purchase or investment.

 Example: If a 1 million dollars is used to build a building at
  the first of the year, and 1 million dollars in rents are collected
  by the end of the year, there is a cash break-even.

 By not allowing expense treatment, the government forces
  tax to be paid on the 1 million dollars of say 35% ($350,000)
  but the taxpayer recovers this by depreciation over say 30
  years. The result is a loan to the government of $350,000
  which it pays back to you over 30 years at a zero interest
  rate.
COST OF RISK
 When a buyer purchses a patent outright, in addition to the
  cost of Capitalization, he has purchased a huge risk,
  including:

    Changes in Technology may be so radical that the value of the patent
     can become worthless overnight.

    Undiscovered references may be used to make the patent invalid.

    Inventor actions may impair patent enforceability.


 Thus, the sales price is lowered by both the cost of risk and
  the cost of capitalization. A buyer might pay an amount (if
  amortized over all units sold) of $1 if the patent were
  purchased, $1.10 if the patent costs weren’t capitalized, and
PATENT SALE OBJECTIVES - Seller
 Maintain Holder Status (to attract capital Gains on Sale)
    Case Law holds that a partnership can preserve holder status
        Holders include Inventors
        Holders include investors who invest in the invention before actual
         reduction to practice
    Given the limited liability from holding a patent, there is no reason to
     risk unusual forms of ownership (like an LLC) which are not yet
     established to preserve holder status


 Keep the patent in a position to enter business in all
  jurisdictions
    Some Exclusive Licensees are only interested in some country’s
     markets
    Be cognizant of the deadlines for entry into certain countries and the
     deadlines beyond which the country markets are abandoned.
PATENT SALE OBJECTIVES - Seller
 Capital Gains Treatment (15%) Tax Rate

 Avoid Any other taxes
    Reside in a state with no state income tax at the time of sale
    Avoid mixed agreements which include both sale provisions and
     personal services.
    If the sale involves a variety of factors don’t forget to agree to allocate
     reasonably the bulk of the sale to the items attracting lesser tax.


 Controlled risk sharing by requiring a large initial payment
  which may be stated in terms of advance royalties against
  production.
PATENT SALE OBJECTIVES - Seller
Control in the event of non-payment
    Use license/sale WITHOUT transferring title to eliminate having to
     bring suit if non-payment occurs.
    Set up a clear threshold as to when non-payment occurs (such as an
     annual minimum payment by a date and hour certain


 Maximize Royalty Sale rate by sharing risk with $/unit rate
    Keep some mechanism to verify the books of the producer
    Provide some indicia in the product of when made & by who to
     distinguish licensee cheating from infringing production
    Avoid complicated formulas which include returns or take account of
     other deductions. A lesser rate with no complication is easier to
     administer and is less inviting to litigation
PATENT SALE OBJECTIVES - Seller
 Avoid Mixing Capital Gains Income with Ordinary Expenses
    Expensing of items under section 174 should be used to offset
     ordinary income.


 Avoid Characterization of Inventions and Research as a
  “business of inventing” with patent “inventory”
    Results in non-expensing of patent procurement costs
    Results in “ordinary income” for patent “inventory sold”


 Avoid Investment or ownership of any interest in the buyer.
  Seller already gets instant capital gains. Investment in buyer
  not necessary
PATENT SALE OBJECTIVES - Seller
 If the seller wishes to capture the success of the buyer,
  consider a progressive chart in the license/sale agreement
  providing for increases in the per unit royalty over the life of
  the license / sale. If too aggressive, it could force the
  licensee to terminate the agreement and re-negotiate in
  future.

 If some business development activity is needed to
  “jumpstart” the product, process or service, insure that it is
  set up to allow:
    Further sale of the personal patent rights at capital gains rates.
    Absolute deductibility of any investment monies put into the business
     entity.


 Consider a configured license rate for “carrot & stick” to get
PATENT SALE OBJECTIVES - Seller
 Consider a shape configured license rate for “carrot & stick”
  to get the licensee buyer moving:

    Consider a reduced front-end royalty rate to cause the buyer to enter
     the market.

    Consider a yearly reduced royalty rate for yearly sales above a certain
     amount so that the buyer / licensee has an incentive to perform highly
     to reduce his average royalty rate.


 Require the buyer / licensee to prosecute infringers to
  maintain the value of the patent, or require the buyer /
  licensee to maintain patent insurance
PATENT SALE OBJECTIVES -
Buyer
 Deduction of all Royalty/Sale monies paid (moneys worth)

 Avoid Capitalization to the extent possible
    Any advance royalties should be against production
    Reasonable amounts for entering into contract should be
     administratively justified and minimized


 Don’t mix personal services contracts and technology
  purchase contracts
    You may be unable to work with the seller on a personal basis
    You may wish to Terminate the license & let the patent return to the
     licensor while still working with the Licensor
    Separate contracts will result in generally difficult to assail allocations
PATENT SALE OBJECTIVES -
Buyer
 If the Patent becomes Un-Economic maintain ability to:
    Terminate the license & return the patent to the Licensor/Seller
    Re-negotiate the patent (& repurchase) upon non-payment
    Consider filing a UCC financing statement with the patent office to
     insure that others know of your right to equitable ownership
    Each year do a sales projection before the minimum payment to make
     a clear decision as to whether the product will be continued the next
     year


 Ask for a reduced royalty rate for unit sales which exceed a
  high target to make up for having to overcome the
  momentum for high percentage market

 Maintain the control and responsibility for patent litigation
PATENT SALE OBJECTIVES -
Buyer
 If the invention is such that it is impossible or impractical for
  one licensee / purchaser to effectively take on the whole
  patent:
    Consider having an unrelated exploitation company set up to
     sublicense the patents on a non-sale basis while passing money back
     to the inventor on a sale basis

    Remember that section 1235 exempts siblings from “related taxpayer
     status” and that a sibling owned company would be “unrelated”.

    Be extremely wary of any sale – leaseback provision as certain types
     of sales / lease transactions are included on the IRS list of “listed
     transactions” Ask for a reduced royalty rate for unit sales which
     exceed a high target to make up for having to overcome the
     momentum for high percentage market
PATENT BUYERS & SELLERS
 Keep in mind that the Tax Law is littered with the dead bodies
  of “pretend inventors” with “pretend licenses” If the invention
  is not real and if the transaction is not reasonable, a real
  possibility exists that the IRS might re-write your deal to their
  liking, send a tax bill and possibly arrange for some relax
  time at “club fed”.

 Avoid putting a patent in any corporation or LLC unless you
  are ABSOLUTELY CERTAIN that you will not seek to sell it
  within a year. Consider carefully that even if the sale will
  occur in more than a year, the buyer may not want to buy
  your whole corporate organization.
PATENT BUYERS & SELLERS
 Use Options to maintain position and to avoid triggering a
  sale before both sides are ready.

 Short term licenses (not constituting a sale) should be kept to
  a minimum; only long enough to enable the parties to position
  themselves for sale. Short term licenses can be used in
  combination with options where testing or test marketing or
  other similar activities need to be accomplished.

 Make it CLEAR how both sides will treat SUBSEQUENT
  INVENTION by the inventor. Consider re-negotiation as well
  as option and right of first refusal.
SIMPLE EXAMPLE
 Seller invents Widget
 Seller moves to Las Vegas
 Seller licenses U.S. Buyer for the whole term of the patent for
  all of the United States as well as Japan based upon $3 per
  unit, with an advance royalty (against the unit rate) each year
  by midnight on January 5 (Objective Capital Gains to seller;
  Deductibility to buyer; No capitalization )
 Seller is free to apply for patents and sell the same patent in
  China, New Zealand, Australia and more, to other individuals
  who buy rights in whole countries (Capital Gains Result)
 If Licensee / buyer fails to pay, Seller / Licensor can sell the
  patent again to someone else.
PATENT TAX ADVANTAGES
 Top Tax Bracket Las Vegas Seller invents Widget on Friday
  and spends $10,000 to build it, improve it and apply for
  patent.

 Seller sells the patent on Monday for $10,000

 What did the seller make?
    Seller’s $10,000 investment is written off against ordinary income and
     is a government subsidy to seller of $3,500 causing seller to have
     actually spent $6,500 out of pocket
    The $10,000 sales price attracts capital gains of 15% or $1,500. Seller
     sends $1,500 to Federal government and keeps $8,500.
    Seller has invested the same amount as he received, yet makes
     $2000
Trademark Rules
 Self created trademarks are capitalized until sale.
 Any litigation to protect a mark is capitalized.
 If common mark is chosen, buyers will be confused.
 A common mark can result in increased sales for competitors
 Although a capital gain asset, trademarks should not be
  owned personally as ownership is per se the right to control
  and specify the nature and quality of the goods, and personal
  liability may (very likely) result
 The amount of goodwill a business CAN attract is directly
  proportional to the UNIQUENESS of the trademark. When it
  rains goodwill, is it better to have a barrel or a thimble?
SIMPLE Trademark EXAMPLE
 Seller selects non-descriptive, non-dictionary word mark
 Seller applies for trademark & passes easily due to
  uniqueness
 Seller works hard to maintain high quality product for 30
  years, never has any trademark lawsuits, & generates
  extreme goodwill.
 Trademark Capitalization account after 30 years includes (1)
  application cost ($950), incontestability filing ($650) & 3
  renewals (@ $850 each) totalling $2450.
 Seller moves to Las Vegas and decides to sell his California
  Business
 Seller Sells the business for cash attracting the capital gains
  rate (15%) and spends her evenings visiting the casinos on
  the strip
SELLING A BUSINESS
 Seller can sell or spin-off a business and insure time
  payments by retaining rights in any patents or trademarks,
  and can retain any rights in equipment by filing a UCC
  agreement.

 Beware the “type A Reorganization trap”.

    Often used to dupe inventors to form a corporation drop in a patent
     and merge with the buyer who is unwilling to pay money. Result can
     be a forced sale for the inventor, with tax bill even though no money
     was received.
    If splitting off a business by forming a subsidiary, the subsidiary should
     have continuity of on-going business, or a simple sale of assets of the
     corporation might result, destroying the objective of attracting capital
     gains personally for the seller.
TRADEMARK TAX Disadvantages
 Seller adopts common, descriptive trademark

 Seller makes $10,000 profit. Seller spent $10,000 defending
  a trademark lawsuit protecting his weak worthless trademark.

 Did seller break even? NO. He cannot deduct the $10,000
  paid to his trademark litigators. He must get up the next
  morning and borrow $3,500 from the bank to pay the taxes
  on the $10,000 of profit he now no longer has.

 Seller is not as seller, as he has no good will, a trademark
  that is less than worthless, a business bled dry by
  competitors he has carried with his advertising budget, and
  decidees to end it all. All of this simply because he chose a
COPYRIGHT TAX
 All copyrights (except for music and very recently) are NOT
  assets in the hands of the creator.

 Creation of non-music copyrights are then:
    A form of self employment (corporations or individuals)
    A creation of a set of inventory having no basis. (creators time is worth
     nothing)
    Activities done in your spare time since expenses relating to living are
     not business, but rather personal expenses


 Sale of your copyrights results in:
    Ordinary employment income to the Seller
    Potential Capital Gains to the Buyer who holds it for a year
COPYRIGHT TAX Disadvantages
 Writer is convinced that if he can sit in a Villa overlooking the
  Pacific Ocean he can write a $100,000 novel of a lifetime.
 Writer rents the villa for $100,000 (food included) and writes
  the novel of a lifetime. Writer finds a buyer to buy it for
  $100,000.

 Did writer break even? NO. He cannot deduct the cost of
  the Villa, he owes Uncle Sam the tax on the $100,000
  income including the ordinary rate, self-employment, social
  security portion AND his state taxes. Writer goes to the bank
  to borrow around $50,000. At this rate he won’t last long.
COPYRIGHT TAX Advantages
 Buyer finds a starving writer, an orphan with no relatives
  (because buyer remembers that Writer’s estate or children
  can claw back the copyright rights after 35 years on a non-
  work made for hire). Buyer pays the starving writer $1000 for
  a novel the Buyer knows is a sure hit for TV, movies, plays.

 The writer holds the copyright, publishes the book and makes
  $1,000,000 in book royalties, as ordinary passive income.

 Remembering that copyright rights can be fragmented, and 3
  years after he bought the copyright, he sells MGM the movie
  rights in perpetuity for $1,000,000 attracting capital gains.
INFRINGEMENT / FORCED SALE
 Litigation Results generally follow the nature of the asset:
    Copyright damages are ordinary, and probably passive unless the
     copyright owner is actively “in business” of buying and selling
     copyrights.
    Patent Damages for short term infringement are ordinary.
    Trademark Damages for trademark infringement are damages to the
     business and should be ordinary


 Where an infringement causes substantial damage to a
  patent or in some cases Trademark (including the underlying
  business), and particularly if the recovery is at or near the
  end of the asset, it may be a good move to pray for a judicial
  holding of “forced sale”. A holding of forced sale would
  bolster a position going forward to treat the recovery as
  attracting capital gains.
“Tax Avoidance” Defined

 “Tax avoidance” is not something that is
  wrong or unlawful

 “[o]ne who avoids tax does not conceal or
  misrepresent. He shapes events to reduce
  or eliminate tax liability and, upon the
  happening of the events, makes a complete
  disclosure.” Internal Revenue Manual
  9.1.3.3.2.1 (7/29/98)
Setting it up Right
 Remember that years often pass between “doing
  the deal” and “sitting down to look at the taxes.
  Tax effects should be considered BEFORE “doing
  the deal“

 Trying to go back and re-write “the deal“ years after
  it is done could smack of a tax “badge of fraud” and
  could attract no better treatment than had in the
  original deal; and could attract the attention of the
  Criminal Investigation Division if the magnitude of
  the difference between what was and what is
  attempted is big enough.
Overview of Intellectual Property

              ALL IP rights are NEGATIVE

          NO positive rights to manufacture/sell

        Some IP CAN qualify as asset that attracts
             CAPITAL GAINS tax treatment
PATENTS
        COMMON MISCONCEPTIONS:
    “A patent gives me the right to manufacture”
                  (NO it does not)

               “I have to do a search”
    (NO, but you should spend $300K to be sure)

“Let’s send them a really nasty letter, if they don’t like
                 it, they can lump it!”
     (WHOA! This can get you into big trouble…)
What is a Patent?
 Relates to (1) machine, (2) process, (3) article of manufacture,
  (4) composition of matter, (5) non-tuber plant

 Three kinds of patent:
    Utility:
       Covers function
       20 year potential
    Design
       Covers look of utilitarian item
       14 year potential
    Plant: 20 year potential
Why File for a Utility Patent?

   Up to 35% U.S. Government subsidy (deductibility)

   Instant capital gain tax rate of 15% (no holding period)

   Makes the competition think twice

   Patent insurance to stop infringers is now available

   Great for advertising and marketing

   Utility carries 1-year right to file foreign (design = 6 mo)
Why File for a Design Patent?

   Inexpensive (from filing to issue w/o argument <
    $2100)

   Your “Patent Pending” need not identify as design
    patent

   New look of old item qualifies!

   Low-tech protection

   NO maintenance fees
Patent Related Tax Deductions
 RESEARCH AND EXPERIMENTAL EXPENDITURES

 IRC §174 allows deduction for:

      Research or experimental expenditures

      Paid or incurred during the taxable year

      “In connection with” trade or business
What Else May be Deducted?

 PATENT ATTORNEY FEES!

 Non-marketing research

 Equipment, testing, experiments
CASES OF INTEREST –
Summary
For Taking Advantage of Patent Related Tax Benefits
 Green v. Commissioner, 83 T.C. 667 (1984


   NO DEDUCTION of project expenditures
   for “non-technically active” investment
   vehicles/partnerships, etc.
CASES OF INTEREST –
Summary
For Taking Advantage of Patent Related Tax Benefits
 Scoggins v. Commissioner , 95-1 USTC 50061; 46 F3D 950
  (9th Cir).


  Where a partnership keeps the
  opportunity to enter business, money put
  into the partnership is deductible.
CASES OF INTEREST –
Summary
For Taking Advantage of the Tax Benefits
 Associated Patentees, Inc. 4 T.C. 979 (1945).


  Where the payments are dependent
  upon the patent’s use or production, the
  payments are related to “using up” the
  patent and thus are deductible in the
  year paid or accrued.
What about Tax Credits?
 IRC §41 gives taxpayers, typically large corporate taxpayers,
  a credit based upon either

    a regular credit for qualified research expenditures which exceed a
     fixed base percentage of average annual gross receipts or
    an incremental credit based on current qualified research
     expenditures that exceed research intensity for a given base period.
    Percentage popularly stated with respect to this credit is 20% but
     there are other limitations that reduce the credit to a much lower
     figure.


 Bad news is that IRC §280C(c) disallows deduction of
  research expenses equivalent to the credit

    Alternative is reduction of credit!
    Significant dollars spent on R&D may make tax credit worthwhile
GENERAL LAW
PRINCIPLES
 Purchase of asset = write-off over useful life

 Sale of asset usually = giving up 100% ownership rights.

 Sale to related entity: restricted as to deductions and gains.

 Sale of capital asset: 1 year holding period for long-term
  capital gains treatment

 License = promise not to sue licensee
GENERAL TAX RATES
 Income relating to an activity:
      Ordinary Income tax rate – about 35%
      Self Employment Tax – about 15%
      Social Security Medical – 3% Forever
      State Tax (California 10%)(Georgia 6%)(Texas, Nevada 0%)


 Passive ordinary income:
    Ordinary Income rate – about 35%
    State Tax (California 10%)(Georgia 6%)(Texas, Nevada 0%)


 Long Term Capital Gains income:
    Capital Gains rate of 15%
    State Tax (California 10%)(Georgia 6%)(Texas, Nevada 0%)
COST OF CAPITALIZATION
 Capitalization:
    interest-free loan to the government
    amount = non-expensible portion of a
     purchase/investment

 Example:
    $1M used to build a building at the first of the year,
    $1M rent collected by end of the year = cash break even

    Disallowing expense forces 35% tax on the $1M to build
    TP recovers by depreciation over 27 years
    Result: ~$350K 27-year loan to government, 0% interest!
COST OF RISK
 Outright purchase of patent = capitalization cost + HUGE risk

    Patent could become worthless overnight.

    Patent could be invalidated.

    Patent enforceability could be compromised.

 Costs of risk + capitalization LOWER sales price!
 What’s the difference? A prospective buyer might pay
    $1M outright
    $1.10M if license structured to eliminate capitalization costs
    Possibly $3M with a pay-for-each-unit-produced arrangement
SALE OF PATENT
 Sale = surrender of “substantially” all ownership rights

 A license can be a sale IF it transfers:
    All rights to entire patent for an entire nation
    All rights to 100% of the patent term
    No substantial rights retained


 “Subject to right of payment” ≠ retention of substantial
  interest

 Other retained rights may = denial of sale treatment!
Instant Capital Gains
 TAX TREATMENT ON SALE OF A PATENT

 IRC §1235 treats as sale or exchange of a capital asset held
  for > 1 year:

      A transfer (but not by gift, inheritance or devise)
      Of ALL substantial patent rights (or undivided interest )
      By any HOLDER
      Regardless of whether payments are

         Periodic and associated with use OR
         Contingent on productivity, use, or disposition
SELLER OBJECTIVES
 Maintain HOLDER status
    Case law indicates that a partnership can preserve holder status
    Holders include:
       Inventors
       Investors who invest in the invention before actual RTP

    Limited liability from holding a patent!
    NO reason to risk unproven forms of ownership (like LLC)


 Keep patent in a position to enter business in all markets
    Sacrificing all substantial rights precludes 174 expensing
    Recall Green Case
    Hold back some jurisdictions for potential patent filings there
PATENT: SELLER OBJECTIVES
 Capital Gains Treatment (15% Tax Rate)

 Avoid any other taxes
    Reside in a state with no state income tax at the time of sale
    Avoid mixed agreements (sale provisions & personal services)
    Reasonably allocate bulk of sale to the items attracting lesser tax


 Control risk sharing
    Require large initial payment that can be stated in terms
     of advance royalties against production.
PATENT: SELLER OBJECTIVES
Maintain control in the event of non-payment
    License/sell WITHOUT transfer of title
    Clear threshold as to when non-payment occurs


 Maximize royalty rate by sharing risk with $/unit rate
    Keep mechanism to verify books of producer
    Provide indicia in the product to distinguish between licensee cheating
     and infringing production
    Avoid complicated formulas that include returns or take account of
     other deductions.
PATENT: SELLER OBJECTIVES
 Avoid Mixing Capital Gains Income with Ordinary Expenses
    Expense items under §174 to offset ordinary income


 Avoid characterization of inventions and research as a
  “business of inventing” with a patent “inventory”
    Results in non-expensing of patent procurement costs
    Results in “ordinary income” for patent “inventory sold”


 Avoid investment or ownership of any interest in the buyer
  (not necessary because seller already gets capital gains tax
  treatment)
PATENT: SELLER OBJECTIVES
 Capture success of buyer
    Consider progressive chart in the license/sale agreement
     providing for increases in per-unit royalty over the life of
     the license / sale. If aggressive, it could force the
     licensee to terminate the agreement and re-negotiate in
     future.

 Jumpstart product/process/service
    Insure business development activity is set up to allow:
       Further sale of personal patent rights at capital gains rates.
       Absolute deductibility of investment $ put into the business entity
PATENT: SELLER OBJECTIVES
 Consider shape configured license to get licensee buyer
  moving (carrot on a stick):

    Front-end royalty rate may cause buyer to hustle faster
    No royalty up front may motivate buyer to open market
    Yearly reduced royalty rate for annual sales above certain
     amount may give buyer/licensee incentive to perform to
     reduce average royalty rate.

 Require the buyer/licensee to prosecute infringers to maintain
  value of the patent or require the buyer/licensee to maintain
  patent insurance
PATENT: BUYER OBJECTIVES
 Deduction of all royalty/sale money paid (market value worth)

 Avoid capitalization to the extent possible
    Any advance royalties should be against production
    Reasonable amounts for entering into contract should be
     administratively justified and minimized


 Don’t mix PSCs & technology purchase contracts
    You may be unable to work with the seller on a personal basis
    You may want to terminate the license & allow the patent to return to
     the licensor while still working with the licensor
    Separate contracts will result in generally difficult to assail allocations
PATENT: BUYER OBJECTIVES
 If the Patent becomes uneconomic, maintain ability to:

      Terminate license & return patent to the Licensor/Seller
      Re-negotiate patent (& repurchase) upon non-payment
      Consider filing a UCC financing statement with the PTO
      Obtain yearly sales projection



 Maintain control and responsibility for patent litigation
PATENT: BUYER OBJECTIVES
 Impossible /impractical for one licensee / purchaser to
  effectively take on whole patent:

    Consider having an unrelated exploitation company set up to
     sublicense the patents on a non-sale basis while passing money back
     to the inventor (who gets cap gains) on a sale basis

    §1235 exempts siblings from “related taxpayer status” and that a
     sibling-owned company would be “unrelated”.

    Be wary of sale-leaseback provisions:
       Certain sales/lease transactions are IRS “listed transactions”
       Ask for reduced royalty rate for unit sales exceeding high target
PATENT: BUYERS & SELLERS
 Tax law littered with dead bodies of “pretend inventors” with
  “pretend licenses”
    If the invention is not real and the transaction is not
      reasonable, a real possibility exists that the IRS might re-
      write your deal to their liking, send a tax bill and possibly
      arrange for some R&R at “Club Fed”.

 Avoid putting a patent in any corporation or LLC unless you
  are ABSOLUTELY CERTAIN you will not seek to sell it within
  a year. Consider carefully that even if the sale will occur
  beyond a year, the buyer may not want to buy your whole
  corporate organization.
PATENT: BUYERS & SELLERS
 Use options

 Keep short term (non-sale) licenses to a minimum

 Clearly address treatment of SUBSEQUENT
  inventions
EXAMPLE
 Seller invents Widget, moves to Las Vegas
 Seller licenses U.S. Buyer
    whole patent for whole patent term
    all of the United States as well as Japan
    $3 per unit, advance royalty (against the unit rate)
    each year by midnight on January 5
   (Cap Gains to seller, deductibility to buyer, no capitalization )

 Seller can apply for patent and sell same patent in China,
  New Zealand, Australia, etc., to other individuals who buy
  rights in whole countries (and capital gains result)
 If any Licensee / buyer fails to pay, Seller / Licensor can sell
  the patent again to someone else.
PATENT TAX DREAM
 Top tax bracket (35%) Las Vegas Seller invents Widget on
  Friday, spends $10K to build, improve & apply for patent,
  sells patent on Monday for $10K

 How much did the seller make?
    $10K investment written off against ordinary income ($3.5K)
     (seller is only out of pocket $6.5K)
    The $10K sales price attracts capital gains rate of 15%. ($1.5K)
     (seller gets to keep $8.5K)
    Seller invested $10K, received $10K, but made 2K in the process!
    This is LEGAL! Successful inventors invest less and receive more!
Comments on §1235
 Siblings are not treated as “related taxpayers”

 Cannot be used to compensate employees with capital gains

 This is an election to expense made in the 1 st year of project

 Capitalization only make sense where the entity has carry
  forward losses against which an offset is possible

 Statute specifically includes “productivity based” sales
Comments on § 1235 (cont’d)
 May treat some investors as inventors

 Good candidates for investment may include
   Projects costing greater than $100K
   Lead time of greater than one year

 The statute “REDUCES” percentage ownership for
  related taxpayers from 50% to 25% for the “inventive
  entity”
Trade Secrets
 All patents start out as ideas or trade secrets

 Generally same capital gains tax treatment as patents on sale

 Sale of Trade Secret: sales agreement requires promise not to
  divulge/exploit to be considered a complete sale.

 May be used for inventions/contributions smaller than patent or
  for aspects of invention not captured in the patent application

 Criminal statute for Trade Secret thieves
SALE OF TRADE SECRET
 Sale of a trade secret requires at a minimum:
    A promise never to practice the secret
    A promise to never reveal the secret

 License with “failure to pay” clause can result in multiple
  sales
    Licensor licenses all rights subject to payment of annual minimum
     royalties & per-product royalties , else equitable rights revert to
     licensor.

    If Licensee does not pay, licensor has trade secret and can “sell” it
     again.

    Other conditions that give the licensee rights to regain the patent may
Trademark

          COMMON MISCONCEPTIONS:

“Other companies have descriptive TMs, why can’t I?”
   (NO, if other companies jumped off a cliff would
                        YOU?)

 “If my name isn’t descriptive, how will anyone know
                  what my product is?”
          (NO, that’s not the purpose of TM)
Trademarks
 Most misunderstood form of Intellectual Property

 Patents are a “2-way” tax street, TM is a “1-way” tax street

 TM is an “ID code” for the SOURCE of the goods & services,
  NOT for the goods themselves.

 Purveyor motivated toward higher quality goods and
  services where public uses the TM to do more business with
  purveyor
Trademarks (cont’d)
 A sale of a naked trademark (no goods/services) is treated
  as an abandonment

 A trademark can last forever - no defined life term

 Infinite life means money spent to create or defend a TM
  must be capitalized
  (Result: payment for TM with after-tax dollars! Not good.)

 Example: You spend $1M defending a trademark.
    It will cost you $1.45M in CA
    It will cost you $1.41M in GA
Trademarks (cont’d)
 TM can help spin off separate lines of business

 TM attracts long-term capital gains tax treatment

 Being forced to change a TM mid-stream is essentially the
  same as having to “start over” in business

 Picking a weak mark can potentially cost you millions over
  the life of the business - ad dollars spent on a weak mark
  boost competitor sales!
Trademark Principles
 Self-created TMs are capitalized until sale.
 Any litigation to protect TM is capitalized.
 If common TM is chosen buyers will be confused.
 A common TM can mean increased sales for competitors
 Although a capital asset, TMs should not be owned
  personally
    Per se right to control
    Per se right to specify the nature and quality of the goods
    Personal liability may (very likely) result
 Goodwill is directly proportional to TM UNIQUENESS
Trademark Strategy
 US TM Office grants weak marks EVERY DAY!

 The 5 Platinum Rules:
   Following them helps you to BUY LOW and SELL HIGH.
   Breaking them means you BUY HIGH and SELL LOW.


 15 year write-off for TM of acquired businesses
Trademark Strategy (cont’d)
 You do not own a TM until FIVE YEARS after
  REGISTRATION
    Incontestability at abut 7 years post-application in reality
    Until then the mark CAN BE TAKEN AWAY FROM YOU

 To cash in at the end of the day you need BOTH
    A TM which can capture MAXIMUM GOODWILL $$
    Decades of providing high quality goods & services.

 Purchaser of a business with a TM “becomes” the purchased
  entity
Selecting a Trademark
 Objective is to MAXIMIZE goodwill value (especially when
  harvested at capital gains tax rates)

 Objective is to MINIMIZE litigation potential (buyers will not
  pay for litigation and constant problems with others!)

 Objective is to MAXIMIZE singular association of CLIENT
  business with the TM.

 RESIST the temptation to emulate others who chose poorly!
5 PLATINUM RULES
 NOT DESCRIPTIVE

 NOT IN THE DICTIONARY

 NOT A PERSON’S LAST NAME

 NOT A GEOGRAPHIC DESIGNATION

 NOT SCANDALOUS OR VULGAR
TRADEMARK DREAM
 Seller selects non-descriptive, non-dictionary word mark
 Seller applies for TM & TM passes easily due to uniqueness
 Seller works hard to maintain high quality product for 30
  years, never has any TM lawsuits & generates extreme
  goodwill.
 TM capitalization account after 30 years includes:
    Application cost ($950)
    Incontestability filing ($650)
    3 renewals ($850 each), totaling $2,450.
 Seller moves to LV and sells his CA business
 Seller sells the business for cash, attracting the 15% capital
  gains rate
 Seller subsequently spends days lounging poolside in sunny
SALE OF TM
 Sale of a TM requires at least a bare indicia of ability to
  maintain continuity of quality

    TM theory: buyer may step into the shoes of the seller.

    “Bare indicia of continuity” is a low threshold

    Non-sale license of a TM requires that the TM owner
     continue to exercise some control over goods & services
TRADEMARK NIGHTMARE
 Seller adopts common, descriptive TM

 Seller makes $10K profit. Seller spent $10K
  defending a TM lawsuit to protect his worthless TM.

 Did seller break even? NO.
   Cannot deduct the $10K paid to his TM litigators
   Must come up with additional $3.5K for taxes on
     $10K profit!
Copyright

          COMMON MISCONCEPTIONS:
 “I made this clothing by hand, I want to copyright it”
               (NO, can’t CR clothing)

            I want to copyright my idea!
     (NO, there must be a tangible expression)
Copyright
 Minimum level of originality required
 Inexpensive Registration
 Can be fragmented and sold in parts
 Capital gains on sale of purchased CR held >1 year
 Long Term: life of the author + 75 years
 Minimum statutory damages of up to $10K/copy
 Extended division of control of prohibited activities
  (copy, perform, distribute, display, etc.)
 Criminal Copyright statute helps deter copying
Copyright Problems
 Self-created CR NOT capital asset in hands of
  creator (except music)

 Ordinary income on first sale from creator

 Litigation Rule - losers pays winner’s attorney fees

 Author’s decedents can take it back from owner
COPYRIGHT TAX
 CR (except for music very recently) is NOT asset in
  hands of the creator.
 Creation of non-music CRs are then:
    Form of active self employment
    No basis (creator’s time worthless)
    Activity in spare time - living expenses are not
     business expenses, they are personal expenses
 Sale of your CR results in:
    Ordinary employment income to Seller
    Capital gains to Buyer who holds it for a year
COPYRIGHT TAX DREAM
 Buyer finds a starving writer, an orphan with no relatives
  (writer’s estate or children can claw back the CR rights after
  35 years on a non work made for hire).

 Buyer pays starving writer $1K for a novel Buyer knows is a
  sure hit for TV, movies, plays.

 Writer holds CR, publishes the book and makes $1M in book
  royalties, ordinary passive income.

 Remembering that CR can be fragmented, and 3 years after
  he bought the CR, he sells MGM the movie rights in
  perpetuity for $1M attracting capital gains.
COPYRIGHT TAX NIGHTMARE
 Writer is convinced that if he can sit in a villa overlooking the
  Pacific he can write the novel of a lifetime.
 Writer rents a villa for $1M (food included) and does so.

 Buyer buys book for $1M
 Did writer break even? NO.
    cannot deduct the $1M cost of the villa
    Owes IRS tax on the $1M income, ordinary rate PLUS
     self-employment PLUS social security PLUS state taxes.
    Must come up with about $50,000.
Setting it up Right
 Tax implications should be considered
  BEFORE making IP decisions.

 Rewriting an IP deal years after it is done:
   tax “badge of fraud”
   Possibly no better tax treatment than the
    original deal
   could attract the attention of the Criminal
    Investigation Division if the magnitude of
    difference between the two deals is big
    enough.
“Tax Avoidance” Defined

 “Tax avoidance” is not wrong or unlawful

  “[o]ne who avoids tax does not conceal or
  misrepresent. He shapes events to reduce
      or eliminate tax liability and, upon the
  happening of the events, makes a complete
     disclosure.” Internal Revenue Manual
               9.1.3.3.2.1 (7/29/98)
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