Presentation on theme: "TRANSITION FROM IDEA TO PROFITABLE PROTECTED PRODUCTS"— Presentation transcript:
1TRANSITION FROM IDEA TO PROFITABLE PROTECTED PRODUCTS MEDTRADE-SPRINGLong BeachKathy E. HarringtonHarrington & Harrington355 South Mt. Carmel RdMcDonough, GA(770)May 6, 2008PATENTAX®Curtis L. HarringtonHarrington & HarringtonSuite 2506300 State University DriveLong Beach, CA 90815(562)
2Disclaimer – 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.
3Overall Simplified Procedure FINISH THE PRODUCT COMPLETELYWhat does this mean?You have full blueprints, circuitry, etcYou have a fully developed profitability spreadsheetYou have included the correct number and complexity of product options you will offer
4Overall Simplified Procedure FINISH THE PRODUCT COMPLETELYWhat 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.
5Overall Simplified Procedure FINISH THE PRODUCT COMPLETELYWhat 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.
6Overall Simplified Procedure FINISH THE PRODUCT COMPLETELYWhat 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.
7Overall Simplified Procedure FINISH THE PRODUCT COMPLETELYWhat 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.
8Overall Simplified Procedure FINISH THE PRODUCT COMPLETELYIf 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 versionIf 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
9Bogus Problems & Excuses BUT ISN’T THE CONCEPT GOOD ENOUGH?NOConcepts are only good for TIME TRAVEL and ANTI-GRAVITY machines
10Bogus Problems & Excuses BUT ISN’T THE CONCEPT GOOD ENOUGH?NOThere 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”
11Bogus Problems & Excuses BUT ISN’T THE CONCEPT GOOD ENOUGH?NOLook at yourself as one of your potential customers:“When is the last time you went out and bought a concept?”
12Bogus 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.
13Bogus 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.
14Bogus 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?
15Bogus 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?
16Bogus 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!
17Techniques 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)
18Techniques 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.
19Techniques 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
20Techniques 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.
21Techniques 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.
22Techniques 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.
23Techniques 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
24Techniques 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.
25Techniques 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.
26Techniques 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.
27Techniques 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”.
28Techniques 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.
29Techniques 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.
30Techniques 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.”
31Techniques 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
32Techniques 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
33Techniques 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
34Techniques 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
35Techniques 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.
36Techniques 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.
37Techniques 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.
38Techniques 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.
39Techniques 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)
40Techniques 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)
41Techniques 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.
42Techniques 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%
43Techniques 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.
44Techniques 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.
45Techniques 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.
46Techniques 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)
47Techniques 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.”
48Techniques 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
49Techniques 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
50Techniques 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”
51Techniques for Moving Forward Generally, as soon as the patent is filed, you should start selling –--Don’t wait for the trade show!!!!
52A few words on Manufacturing Make sure you have an LLC/Corporate entity in placeMake sure that you have commercial liability insurance
53A few words on Manufacturing Make certain to follow rules on compensation for employeesRemember than a single member LLC is a disregarded tax entity.
54A few words on Manufacturing If you choose a corporation make CERTAIN that you observe the corporate formalitiesBe cognizant of your tax year, filing times, and worker’s comp insurance system
55A 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
56A few words on Manufacturing Continually evaluate the cash flowFor several products, evaluate profitability and place efforts and cash where the best return is to to be obtained.
57A few words on the Patent System Lets start with the biggest miconceptions on Patents
58Biggest 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
59Biggest Misconceptions - Trademark “If other companies can pick stupid, descriptive names, I can too”- NOIf my name isn’t descriptive, how will anyone know what my product is?
60Biggest 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”
61Overview of Intellectual Property All Rights are NEGATIVENO Positive rights to manufacture/sellIntellectual Property CAN be an asset which can attract CAPITAL GAINS
62What is a Patent?Utility: 20 year (potential) certification relating to requests extending amortization periodsRelating to (1) machine, (2) Process, (3) article of manufacture, (4) Composition of Matter, (5) non tuber (potato) plantDesign: 14 year monopoly on the 3-Dimensional Design of a utilitarian itemSeed Variety Registration under section 5, United States code
63Why File for a Utility Patent Up to 35% U.S. Government subsidy (deductible)Instant (no holding period) Capital Gain - 15%Makes the Competition Think TwicePatent Insurance to stop infringers now availableGood for Advertising and PrestigeUtility one-year right to File
64Why 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 qualifiesLow Technology protection14 year life & NO maintenance feesSame Tax Treatment as Utility Patent!
65Trade SecretsAll patents start out as trade secrets as the information flows from the mind to some detectable indicalGenerally the same tax treatment as patents on saleRequires 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 applicationCriminal Statute for Thieves
66Trademarks Most Mis-understood form of Intellectual Property Whereas Patents are a “two way” tax street, Trademarks are a “one way” tax streetTrademark 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
67Trademarks (cont’d)A naked sale of a trademark is treated as an abandonmentSince a trademark can last forever it has no defined life termBecause 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)
68Trademarks (cont’d)Trademarks can assist a business entity in spinning off separate lines of businessTrademarks 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 servicesBeing forced to “change” your trademark is essentially the same as having to “start over” in businessPicking a weak mark will cost potentially millions over the life of the business. Your Advertising dollars result in competitor sales.
69Selecting a TrademarkObjective 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 othersObjective is to MAXIMIZE singlular association of CLIENT business with the trademark.RESIST the temptation to emulate others who chose poorly
70Selecting a Trademark: 5 RULES Name of 6 or more characters which are NOT DESCRIPTIVE OF ANY ASPECT OF THE GOODS OR SERVICESPick a name which is NOT IN THE DICTIONARY, a made- up word is preferableNOT A PERSON’S LAST NAMENOT A GEOGRAPHIC DESIGNATIONNOT SCANDALOUS OR VULGAR
71Trademark 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 resultThe 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
72Trademark 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.
73Copyright ProblemsNot a Capital Asset in the hands of creator (except music)Therefore ordinary Income on first sale from creatorLitigation 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
74Copyright Advantages Only a minimum level of originality is required Inexpensive RegistrationCan be fragmented and sold in partsCapital gains for purchased copyrights held more than a yearLong Term - Life of the author + 75 years (congress keeps extending it)Minimum statutory damages of up to $10k/copyExtended division of control of prohibited activities (copy, perform, distribute, display, etc.)Criminal Copyright statute helps deter copying
75Patent Tax Specifics Deducting the Costs of Creation Maintaining Holder StatusAttracting Capital Gains on SaleConsiderations for Buyer / Licensees and Seller LicensorsAvoiding ProblemsExamples
76Patent 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 deductionThe term "in connection with" is deliberately less stringent to distance the application of §174 from the requirement of having an ongoing business concern.
77What May be Deducted? PATENT ATTORNEY FEES NON MARKETING RESEARCH Equipment, testing, experimentsRemember: 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.
78Tax CreditsIRC §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 research.
79Tax 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 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 “research”)
80Patent Tax Instant Capital Gains TREATMENT ON SALEInternal 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.
81Comments on Section 1235Siblings are not treated as “related taxpayers”Cannot be used to compensate employees with capital gainsThis is an election to expense made in the first year of the projectCapitalization only seems to make sense where the entity has carry forward losses against which capitalization could provide an offsetStatute specifically includes “productivity based” sales
82Comments 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”
83TRANSACTION SETSSelling a Patent, Trade Secret, Trademark or CopyrightBuying a Patent, Trade Secret, Trademark or CopyrightOptioning a Patent, Trade Secret, Trademark or CopyrightForming a Joint Venture, Partnership, LLCThe statute “REDUCES” the percentage ownership for related taxpayers from 50% to 25% for the “inventive entity”
84GENERAL LAW PRINCIPLES When you buy an asset, you write it off over its useful lifeWhen 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 gainsThe core of a license is a simple promise not to sue licensee
85THE CASES OF INTEREST For Taking Advantage of the Tax Benefits Green v. Commissioner, 83 T.C. 667 (1984Prohibition 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.
86THE 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 deductibleIn 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
87THE 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.
88THE PRINCIPLES OF SALEA 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 nationAll rights to 100% of the patent termNo 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.
89THE 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.
90THE PRINCIPLES OF SALE (cont’d) Sale of a trademark Requires the inclusion of at least a bare indicia of ability for continuity of qualityTrademark 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.
91GENERAL 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% ForeverState Tax (California 10%)(Georgia 6%)(Texas, Nevada 0%)Passive ordinary income attracts:Long Term Capital Gains income attracts:Capital Gains rate of 15%
92COST 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.
93COST OF RISKWhen 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 perhaps $3 on a pay-for-each-unit-produced arrangement.
94PATENT SALE OBJECTIVES - Seller Maintain Holder Status (to attract capital Gains on Sale)Case Law holds that a partnership can preserve holder statusHolders include InventorsHolders include investors who invest in the invention before actual reduction to practiceGiven 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 statusKeep the patent in a position to enter business in all jurisdictionsSome Exclusive Licensees are only interested in some country’s marketsBe cognizant of the deadlines for entry into certain countries and the deadlines beyond which the country markets are abandoned.
95PATENT SALE OBJECTIVES - Seller Capital Gains Treatment (15%) Tax RateAvoid Any other taxesReside in a state with no state income tax at the time of saleAvoid 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.
96PATENT SALE OBJECTIVES - Seller Control in the event of non-paymentUse 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 certainMaximize Royalty Sale rate by sharing risk with $/unit rateKeep some mechanism to verify the books of the producerProvide some indicia in the product of when made & by who to distinguish licensee cheating from infringing productionAvoid 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
97PATENT SALE OBJECTIVES - Seller Avoid Mixing Capital Gains Income with Ordinary ExpensesExpensing 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 costsResults 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
98PATENT 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 the licensee buyer moving
99PATENT 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
100PATENT SALE OBJECTIVES - Buyer Deduction of all Royalty/Sale monies paid (moneys worth)Avoid Capitalization to the extent possibleAny advance royalties should be against productionReasonable amounts for entering into contract should be administratively justified and minimizedDon’t mix personal services contracts and technology purchase contractsYou may be unable to work with the seller on a personal basisYou may wish to Terminate the license & let the patent return to the licensor while still working with the LicensorSeparate contracts will result in generally difficult to assail allocations
101PATENT SALE OBJECTIVES - Buyer If the Patent becomes Un-Economic maintain ability to:Terminate the license & return the patent to the Licensor/SellerRe-negotiate the patent (& repurchase) upon non-paymentConsider filing a UCC financing statement with the patent office to insure that others know of your right to equitable ownershipEach year do a sales projection before the minimum payment to make a clear decision as to whether the product will be continued the next yearAsk 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 marketMaintain the control and responsibility for patent litigation
102PATENT 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 basisRemember 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
103PATENT 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.
104PATENT 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.
105SIMPLE 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.
106PATENT TAX ADVANTAGESTop 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 $10,000What 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 pocketThe $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 $2000Sucessful inventors invest much less and receive much more
107Trademark 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 competitorsAlthough 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) resultThe 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?
108SIMPLE Trademark EXAMPLE Seller selects non-descriptive, non-dictionary word markSeller applies for trademark & passes easily due to uniquenessSeller 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 BusinessSeller Sells the business for cash attracting the capital gains rate (15%) and spends her evenings visiting the casinos on the strip
109SELLING A BUSINESSSeller 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.
110TRADEMARK TAX Disadvantages Seller adopts common, descriptive trademarkSeller 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 bad trademark.
111COPYRIGHT TAXAll 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 expensesSale of your copyrights results in:Ordinary employment income to the SellerPotential Capital Gains to the Buyer who holds it for a year
112COPYRIGHT 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.
113COPYRIGHT 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.
114INFRINGEMENT / 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 ordinaryWhere 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.
115“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 (7/29/98)
116Setting it up RightRemember 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.
117Overview of Intellectual Property ALL IP rights are NEGATIVENO positive rights to manufacture/sellSome IP CAN qualify as asset that attracts CAPITAL GAINS tax treatment
118(WHOA! This can get you into big trouble…) PATENTSCOMMON 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…)
119What is a Patent?Relates to (1) machine, (2) process, (3) article of manufacture, (4) composition of matter, (5) non-tuber plantThree kinds of patent:Utility:Covers function20 year potentialDesignCovers look of utilitarian item14 year potentialPlant: 20 year potential
120Why 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 twicePatent insurance to stop infringers is now availableGreat for advertising and marketingUtility carries 1-year right to file foreign (design = 6 mo)
121Why File for a Design Patent? Inexpensive (from filing to issue w/o argument < $2100)Your “Patent Pending” need not identify as design patentNew look of old item qualifies!Low-tech protectionNO maintenance feesSame capital gains tax treatment as utility patent!
122Patent Related Tax Deductions RESEARCH AND EXPERIMENTAL EXPENDITURESIRC §174 allows deduction for:Research or experimental expendituresPaid or incurred during the taxable year“In connection with” trade or business
123What Else May be Deducted? PATENT ATTORNEY FEES!Non-marketing researchEquipment, testing, experiments
124CASES OF INTEREST – Summary For Taking Advantage of Patent Related Tax Benefits Green v. Commissioner, 83 T.C. 667 (1984NO DEDUCTION of project expenditures for “non-technically active” investment vehicles/partnerships, etc.
125CASES 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.
126CASES 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.
127What about Tax Credits?IRC §41 gives taxpayers, typically large corporate taxpayers, a credit based upon eithera regular credit for qualified research expenditures which exceed a fixed base percentage of average annual gross receipts oran 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 creditAlternative is reduction of credit!Significant dollars spent on R&D may make tax credit worthwhile
128GENERAL LAW PRINCIPLES Purchase of asset = write-off over useful lifeSale 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 treatmentLicense = promise not to sue licensee
129GENERAL TAX RATES Income relating to an activity: Ordinary Income tax rate – about 35%Self Employment Tax – about 15%Social Security Medical – 3% ForeverState Tax (California 10%)(Georgia 6%)(Texas, Nevada 0%)Passive ordinary income:Ordinary Income rate – about 35%Long Term Capital Gains income:Capital Gains rate of 15%
130COST OF CAPITALIZATION interest-free loan to the governmentamount = non-expensible portion of a purchase/investmentExample:$1M used to build a building at the first of the year,$1M rent collected by end of the year = cash break evenDisallowing expense forces 35% tax on the $1M to buildTP recovers by depreciation over 27 yearsResult: ~$350K 27-year loan to government, 0% interest!
131COST OF RISKOutright purchase of patent = capitalization cost + HUGE riskPatent 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 costsPossibly $3M with a pay-for-each-unit-produced arrangement
132SALE OF PATENTSale = surrender of “substantially” all ownership rightsA license can be a sale IF it transfers:All rights to entire patent for an entire nationAll rights to 100% of the patent termNo substantial rights retained“Subject to right of payment” ≠ retention of substantial interestOther retained rights may = denial of sale treatment!
133Instant 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 HOLDERRegardless of whether payments arePeriodic and associated with use ORContingent on productivity, use, or disposition
134SELLER OBJECTIVES Maintain HOLDER status Case law indicates that a partnership can preserve holder statusHolders include:InventorsInvestors who invest in the invention before actual RTPLimited 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 marketsSacrificing all substantial rights precludes 174 expensingRecall Green CaseHold back some jurisdictions for potential patent filings there
135PATENT: SELLER OBJECTIVES Capital Gains Treatment (15% Tax Rate)Avoid any other taxesReside in a state with no state income tax at the time of saleAvoid mixed agreements (sale provisions & personal services)Reasonably allocate bulk of sale to the items attracting lesser taxControl risk sharingRequire large initial payment that can be stated in terms of advance royalties against production.
136PATENT: SELLER OBJECTIVES Maintain control in the event of non-paymentLicense/sell WITHOUT transfer of titleClear threshold as to when non-payment occursMaximize royalty rate by sharing risk with $/unit rateKeep mechanism to verify books of producerProvide indicia in the product to distinguish between licensee cheating and infringing productionAvoid complicated formulas that include returns or take account of other deductions.
137PATENT: SELLER OBJECTIVES Avoid Mixing Capital Gains Income with Ordinary ExpensesExpense items under §174 to offset ordinary incomeAvoid characterization of inventions and research as a “business of inventing” with a patent “inventory”Results in non-expensing of patent procurement costsResults 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)
138PATENT: SELLER OBJECTIVES Capture success of buyerConsider 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/serviceInsure 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
139PATENT: SELLER OBJECTIVES Consider shape configured license to get licensee buyer moving (carrot on a stick):Front-end royalty rate may cause buyer to hustle fasterNo royalty up front may motivate buyer to open marketYearly 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
140PATENT: BUYER OBJECTIVES Deduction of all royalty/sale money paid (market value worth)Avoid capitalization to the extent possibleAny advance royalties should be against productionReasonable amounts for entering into contract should be administratively justified and minimizedDon’t mix PSCs & technology purchase contractsYou may be unable to work with the seller on a personal basisYou may want to terminate the license & allow the patent to return to the licensor while still working with the licensorSeparate contracts will result in generally difficult to assail allocations
141PATENT: BUYER OBJECTIVES If the Patent becomes uneconomic, maintain ability to:Terminate license & return patent to the Licensor/SellerRe-negotiate patent (& repurchase) upon non-paymentConsider filing a UCC financing statement with the PTOObtain yearly sales projectionMaintain control and responsibility for patent litigation
142PATENT: 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
143PATENT: 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.
144PATENT: BUYERS & SELLERS Use optionsKeep short term (non-sale) licenses to a minimumClearly address treatment of SUBSEQUENT inventions
145EXAMPLE Seller invents Widget, moves to Las Vegas Seller licenses U.S. Buyerwhole patent for whole patent termall 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.
146PATENT TAX DREAMTop tax bracket (35%) Las Vegas Seller invents Widget on Friday, spends $10K to build, improve & apply for patent, sells patent on Monday for $10KHow 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!
147Comments on §1235 Siblings are not treated as “related taxpayers” Cannot be used to compensate employees with capital gainsThis is an election to expense made in the 1st year of projectCapitalization only make sense where the entity has carry forward losses against which an offset is possibleStatute specifically includes “productivity based” sales
148Comments on § 1235 (cont’d) May treat some investors as inventors Good candidates for investment may includeProjects costing greater than $100KLead time of greater than one yearThe statute “REDUCES” percentage ownership for related taxpayers from 50% to 25% for the “inventive entity”
149Trade Secrets All patents start out as ideas or trade secrets Generally same capital gains tax treatment as patents on saleSale 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 applicationCriminal statute for Trade Secret thieves
150SALE OF TRADE SECRET Sale of a trade secret requires at a minimum: A promise never to practice the secretA promise to never reveal the secretLicense with “failure to pay” clause can result in multiple salesLicensor 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 cause a failure of “sale” treatment.
151Trademark 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)
152Trademarks Most misunderstood form of Intellectual Property Patents are a “2-way” tax street, TM is a “1-way” tax streetTM 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
153Trademarks (cont’d)A sale of a naked trademark (no goods/services) is treated as an abandonmentA trademark can last forever - no defined life termInfinite 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 CAIt will cost you $1.41M in GA
154Trademarks (cont’d) TM can help spin off separate lines of business TM attracts long-term capital gains tax treatmentBeing forced to change a TM mid-stream is essentially the same as having to “start over” in businessPicking a weak mark can potentially cost you millions over the life of the business - ad dollars spent on a weak mark boost competitor sales!
155Trademark 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 competitorsAlthough a capital asset, TMs should not be owned personallyPer se right to controlPer se right to specify the nature and quality of the goodsPersonal liability may (very likely) resultGoodwill is directly proportional to TM UNIQUENESS
156Trademark 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
157Trademark Strategy (cont’d) You do not own a TM until FIVE YEARS after REGISTRATIONIncontestability at abut 7 years post-application in realityUntil then the mark CAN BE TAKEN AWAY FROM YOUTo cash in at the end of the day you need BOTHA TM which can capture MAXIMUM GOODWILL $$Decades of providing high quality goods & services.Purchaser of a business with a TM “becomes” the purchased entity
158Selecting a TrademarkObjective 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!
1595 PLATINUM RULES NOT DESCRIPTIVE NOT IN THE DICTIONARY NOT A PERSON’S LAST NAMENOT A GEOGRAPHIC DESIGNATIONNOT SCANDALOUS OR VULGAR
160TRADEMARK DREAMSeller selects non-descriptive, non-dictionary word markSeller applies for TM & TM passes easily due to uniquenessSeller 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 businessSeller sells the business for cash, attracting the 15% capital gains rateSeller subsequently spends days lounging poolside in sunny LV
161SALE OF TMSale of a TM requires at least a bare indicia of ability to maintain continuity of qualityTM theory: buyer may step into the shoes of the seller.“Bare indicia of continuity” is a low thresholdNon-sale license of a TM requires that the TM owner continue to exercise some control over goods & services
162TRADEMARK 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 litigatorsMust come up with additional $3.5K for taxes on $10K profit!
163(NO, there must be a tangible expression) CopyrightCOMMON 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)
164Copyright Minimum level of originality required Inexpensive RegistrationCan be fragmented and sold in partsCapital gains on sale of purchased CR held >1 yearLong Term: life of the author + 75 yearsMinimum statutory damages of up to $10K/copyExtended division of control of prohibited activities (copy, perform, distribute, display, etc.)Criminal Copyright statute helps deter copying
165Copyright ProblemsSelf-created CR NOT capital asset in hands of creator (except music)Ordinary income on first sale from creatorLitigation Rule - losers pays winner’s attorney feesAuthor’s decedents can take it back from owner
166COPYRIGHT TAXCR (except for music very recently) is NOT asset in hands of the creator.Creation of non-music CRs are then:Form of active self employmentNo basis (creator’s time worthless)Activity in spare time - living expenses are not business expenses, they are personal expensesSale of your CR results in:Ordinary employment income to SellerCapital gains to Buyer who holds it for a year
167COPYRIGHT TAX DREAMBuyer 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.
168COPYRIGHT 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 $1MDid writer break even? NO.cannot deduct the $1M cost of the villaOwes IRS tax on the $1M income, ordinary rate PLUS self-employment PLUS social security PLUS state taxes.Must come up with about $50,000.
169Setting it up RightTax 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 dealcould attract the attention of the Criminal Investigation Division if the magnitude of difference between the two deals is big enough.
170“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 (7/29/98)
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