If people sold cars the way they license intellectual property (IP), you might sell the car with the stipulation that it can only be driven east of the Mississippi, or it can’t be driven on highways. Interests in IP can be sliced, diced, and licensed in bits and pieces. Unless the holder of the IP is a tax-exempt institution (non-profit hospitals, universities, etc.) the licensor would prefer that the royalties be taxed at capital gain rates, which are lower than ordinary income rates.
Spiridon Spireas is a good illustration of how you should not license IP. In Spireas v. Commissioner, the taxpayer claimed the royalties were eligible for capital gains, and the Tax Court said no, the royalties are ordinary income. The Tax Court opines that the patent holder could have structured things differently, without really changing the substance of the arrangements, to achieve capital gain treatment. But they didn’t and they are bound by the documents they signed. “The Tax Court observed that Spireas and Hygrosol, in hindsight, might have structured the agreement differently to achieve capital gain treatment.”
The takeaway from this is that, when licensing IP, make sure your IP attorney is aware of the tax issues and has access to good tax advice. Sharkansky has the experience to offer guidance should an issue like this arise for you.
Written by Joe Shulman, CPA