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TRANSITION FROM IDEA TO PROFITABLE PROTECTED PRODUCTS May 6, 2008 PATENTAX® Curtis L. Harrington Harrington & Harrington Suite 250 6300 State University.

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Presentation on theme: "TRANSITION FROM IDEA TO PROFITABLE PROTECTED PRODUCTS May 6, 2008 PATENTAX® Curtis L. Harrington Harrington & Harrington Suite 250 6300 State University."— Presentation transcript:

1 TRANSITION FROM IDEA TO PROFITABLE PROTECTED PRODUCTS May 6, 2008 PATENTAX® Curtis L. Harrington Harrington & Harrington Suite State University Drive Long Beach, CA (562) May 6, 2008 PATENTAX® Curtis L. Harrington Harrington & Harrington Suite State University Drive Long Beach, CA (562) MEDTRADE-SPRING Long Beach Kathy E. Harrington Harrington & Harrington 355 South Mt. Carmel Rd McDonough, GA (770) MEDTRADE-SPRING Long Beach Kathy E. Harrington Harrington & Harrington 355 South Mt. Carmel Rd McDonough, GA (770)

2 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.

3 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 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

4 Overall Simplified Procedure FINISH THE PRODUCT COMPLETELY What will finishing do for me? If later conditions suggest a change in direction, you wont know how to change or what to change unless you are completely familiar with your products operating capabilities. FINISH THE PRODUCT COMPLETELY What will finishing do for me? If later conditions suggest a change in direction, you wont know how to change or what to change unless you are completely familiar with your products operating capabilities.

5 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 its a clear indication that you will never be able to compete. It detracts from your apparent readiness to enter the market. FINISH THE PRODUCT COMPLETELY What will finishing do for me? If your competitors see that you will never leave the design room its a clear indication that you will never be able to compete. It detracts from your apparent readiness to enter the market.

6 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. 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.

7 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. 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.

8 Overall Simplified Procedure FINISH THE PRODUCT COMPLETELY If the industry is fast changing, and if you dont finish the first version, you wont 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 FINISH THE PRODUCT COMPLETELY If the industry is fast changing, and if you dont finish the first version, you wont 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

9 Bogus Problems & Excuses BUT ISNT THE CONCEPT GOOD ENOUGH? NO Concepts are only good for TIME TRAVEL and ANTI-GRAVITY machines BUT ISNT THE CONCEPT GOOD ENOUGH? NO Concepts are only good for TIME TRAVEL and ANTI-GRAVITY machines

10 Bogus Problems & Excuses BUT ISNT 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, Ive been waiting for someone like you all my life BUT ISNT 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, Ive been waiting for someone like you all my life

11 Bogus Problems & Excuses BUT ISNT 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? BUT ISNT 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?

12 Bogus Problems & Excuses I have a CONCEPT for a new SATELLITE CHEMICAL LASER, but Im a secretary, and I DONT KNOW THE DETAILS. STOP! You dont have an invention, you have a mystical dream. If you dont know how to build it, you are in trouble. I have a CONCEPT for a new SATELLITE CHEMICAL LASER, but Im a secretary, and I DONT KNOW THE DETAILS. STOP! You dont have an invention, you have a mystical dream. If you dont know how to build it, you are in trouble.

13 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. 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.

14 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? 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?

15 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? 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?

16 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 DONT TREAT IT LIKE A TRADE SECRET, ITS NOT A TRADE SECRET! 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 DONT TREAT IT LIKE A TRADE SECRET, ITS NOT A TRADE SECRET!

17 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) 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)

18 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. 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.

19 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 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

20 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. 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.

21 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. Dont be dissuaded by the we dont endorse statement. 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. Dont be dissuaded by the we dont endorse statement.

22 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. 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.

23 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 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

24 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. 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.

25 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. 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.

26 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. 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.

27 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. 1. Do your homework on the product: Get ready to file a patent because: (b) The patent application may be considered insurance AGAINST success.

28 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. 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.

29 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. 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.

30 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. 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.

31 Techniques for Moving Forward 1. Do your homework on the product: While patent is being written, prepare (but dont send) a marketing packet which has: (a) Long story, Short Story, Medium Story (b) Photos, drawings, video demonstration 1. Do your homework on the product: While patent is being written, prepare (but dont send) a marketing packet which has: (a) Long story, Short Story, Medium Story (b) Photos, drawings, video demonstration

32 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 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

33 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 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

34 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 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

35 Techniques for Moving Forward 1. Do your homework on the product: Dont 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. 1. Do your homework on the product: Dont 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.

36 Techniques for Moving Forward 1. Do your homework on the product: Dont plan to produce the product? YOU SHOULD EITHER MAKE A LIMITED NUMBER OR BE READY TO TAKE SOME LONG TERM ORDERS WHICH WONT BIND YOU. 1. Do your homework on the product: Dont plan to produce the product? YOU SHOULD EITHER MAKE A LIMITED NUMBER OR BE READY TO TAKE SOME LONG TERM ORDERS WHICH WONT BIND YOU.

37 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. 1. Do your homework on the product: Why take orders? (a) It may be the only concrete method to guage customer acceptance.

38 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. 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.

39 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) 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)

40 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) 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)

41 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. 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.

42 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% 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%

43 Techniques for Moving Forward 1. Without thinking about all this: (a)You wouldnt 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. 1. Without thinking about all this: (a)You wouldnt 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.

44 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. 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.

45 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. 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.

46 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) 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)

47 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. 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.

48 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 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

49 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 Meetings include: (1) Foreign market representatives who want to buy or license the product (2) Domestic potential buyers (3) Your Domestic manufacturing customers

50 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 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

51 Techniques for Moving Forward Generally, as soon as the patent is filed, you should start selling – --Dont wait for the trade show!!!! Generally, as soon as the patent is filed, you should start selling – --Dont wait for the trade show!!!!

52 A few words on Manufacturing Make sure you have an LLC/Corporate entity in place Make sure that you have commercial liability insurance Make sure you have an LLC/Corporate entity in place Make sure that you have commercial liability insurance

53 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. Make certain to follow rules on compensation for employees Remember than a single member LLC is a disregarded tax entity.

54 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 workers comp insurance system If you choose a corporation make CERTAIN that you observe the corporate formalities Be cognizant of your tax year, filing times, and workers comp insurance system

55 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 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

56 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. Continually evaluate the cash flow For several products, evaluate profitability and place efforts and cash where the best return is to to be obtained.

57 A few words on the Patent System Lets start with the biggest miconceptions on Patents

58 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 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

59 Biggest Misconceptions - Trademark If other companies can pick stupid, descriptive names, I can too- NO If my name isnt descriptive, how will anyone know what my product is? If other companies can pick stupid, descriptive names, I can too- NO If my name isnt descriptive, how will anyone know what my product is?

60 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 dont like it, they can lump it 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 dont like it, they can lump it

61 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 All Rights are NEGATIVE NO Positive rights to manufacture/sell Intellectual Property CAN be an asset which can attract CAPITAL GAINS

62 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 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

63 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 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

64 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! 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!

65 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 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

66 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 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

67 Trademarks (contd) 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) 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)

68 Trademarks (contd) 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. 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.

69 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 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

70 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 PERSONS LAST NAME NOT A GEOGRAPHIC DESIGNATION NOT SCANDALOUS OR VULGAR 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 PERSONS LAST NAME NOT A GEOGRAPHIC DESIGNATION NOT SCANDALOUS OR VULGAR

71 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 LOWSELL 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 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 LOWSELL 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

72 Trademark Observations (contd) 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. 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.

73 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 winners Atty.. Fees (ordinary) Alternative Minimum Tax Potential Problem on Litigation (not compensation for personal injury, Attorney fees may not be deductible) Authors decedents can take it back from owner Not a Capital Asset in the hands of creator (except music) Therefore ordinary Income on first sale from creator Litigation Rule - losers pay winners Atty.. Fees (ordinary) Alternative Minimum Tax Potential Problem on Litigation (not compensation for personal injury, Attorney fees may not be deductible) Authors decedents can take it back from owner

74 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 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

75 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 Deducting the Costs of Creation Maintaining Holder Status Attracting Capital Gains on Sale Considerations for Buyer / Licensees and Seller Licensors Avoiding Problems Examples

76 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. 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.

77 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. 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.

78 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 research. 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 research.

79 Tax Credits (contd) (Compare Canadas 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: Ontarios 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) (Compare Canadas 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: Ontarios 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)

80 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 transferees use of the patent, or (2) contingent on the productivity, use, or disposition of the property transferred. 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 transferees use of the patent, or (2) contingent on the productivity, use, or disposition of the property transferred.

81 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 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

82 Comments on Section 1235 (contd) 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 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

83 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 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

84 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 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

85 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. 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.

86 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 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

87 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 patents 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. Associated Patentees, Inc. 4 T.C. 979 (1945). Where the payments are dependent upon the patents 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.

88 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. 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.

89 THE PRINCIPLES OF SALE (contd) 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. 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.

90 THE PRINCIPLES OF SALE (contd) 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 doesnt 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. 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 doesnt 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.

91 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%) 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%)

92 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. 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.

93 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 werent capitalized, and perhaps $3 on a pay-for-each-unit-produced arrangement. 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 werent capitalized, and perhaps $3 on a pay-for-each-unit-produced arrangement.

94 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 countrys markets Be cognizant of the deadlines for entry into certain countries and the deadlines beyond which the country markets are abandoned. 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 countrys markets Be cognizant of the deadlines for entry into certain countries and the deadlines beyond which the country markets are abandoned.

95 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 dont 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. 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 dont 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.

96 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 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

97 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 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

98 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 the licensee buyer moving 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

99 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 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

100 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 Dont 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 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 Dont 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

101 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 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

102 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 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

103 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. 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.

104 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. 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.

105 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. 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.

106 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? Sellers $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 Sucessful inventors invest much less and receive much more 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? Sellers $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 Sucessful inventors invest much less and receive much more

107 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? 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?

108 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 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

109 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. 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.

110 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 bad trademark. 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 bad trademark.

111 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 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

112 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 wont last long. 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 wont last long.

113 COPYRIGHT TAX Advantages Buyer finds a starving writer, an orphan with no relatives (because buyer remembers that Writers 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. Buyer finds a starving writer, an orphan with no relatives (because buyer remembers that Writers 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.

114 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. 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.

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) 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)

116 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. 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.

117 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

118 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) Lets send them a really nasty letter, if they dont like it, they can lump it! (WHOA! This can get you into big trouble…)

119 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

120 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)

121 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 Same capital gains tax treatment as utility 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 Same capital gains tax treatment as utility patent!

122 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

123 What Else May be Deducted? PATENT ATTORNEY FEES! Non-marketing research Equipment, testing, experiments

124 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. Green v. Commissioner, 83 T.C. 667 (1984 NO DEDUCTION of project expenditures for non-technically active investment vehicles/partnerships, etc.

125 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. 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.

126 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 patents use or production, the payments are related to using up the patent and thus are deductible in the year paid or accrued. Associated Patentees, Inc. 4 T.C. 979 (1945). Where the payments are dependent upon the patents use or production, the payments are related to using up the patent and thus are deductible in the year paid or accrued.

127 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

128 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 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

129 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%) 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%)

130 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! 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!

131 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! Whats 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 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! Whats 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

132 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! 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!

133 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

134 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 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

135 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. 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.

136 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. 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.

137 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) 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)

138 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 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

139 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 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

140 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 Dont 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 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 Dont 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

141 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 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

142 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 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

143 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. 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.

144 PATENT: BUYERS & SELLERS Use options Keep short term (non-sale) licenses to a minimum Clearly address treatment of SUBSEQUENT inventions Use options Keep short term (non-sale) licenses to a minimum Clearly address treatment of SUBSEQUENT inventions

145 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. 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.

146 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! 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!

147 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

148 Comments on § 1235 (contd) 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

149 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

150 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 cause a failure of sale treatment. 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 cause a failure of sale treatment.

151 Trademark COMMON MISCONCEPTIONS: Other companies have descriptive TMs, why cant I? (NO, if other companies jumped off a cliff would YOU?) If my name isnt descriptive, how will anyone know what my product is? (NO, thats not the purpose of TM)

152 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

153 Trademarks (contd) 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 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

154 Trademarks (contd) 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!

155 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 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

156 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

157 Trademark Strategy (contd) 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

158 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!

159 5 PLATINUM RULES NOT DESCRIPTIVE NOT IN THE DICTIONARY NOT A PERSONS LAST NAME NOT A GEOGRAPHIC DESIGNATION NOT SCANDALOUS OR VULGAR

160 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 LV 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 LV

161 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 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

162 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! 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!

163 Copyright COMMON MISCONCEPTIONS: I made this clothing by hand, I want to copyright it (NO, cant CR clothing) I want to copyright my idea! (NO, there must be a tangible expression)

164 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

165 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 winners attorney fees Authors decedents can take it back from owner

166 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 (creators 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 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 (creators 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

167 COPYRIGHT TAX DREAM Buyer finds a starving writer, an orphan with no relatives (writers 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. Buyer finds a starving writer, an orphan with no relatives (writers 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.

168 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. 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.

169 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.

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)

171 WANT A COPY OF THIS POWER POINT? Please visit: And click on LIBRARY Please visit: And click on LIBRARY


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