Intellectual property is considered intangible property by the Internal Revenue Service (IRS). It can be gifted, assigned, sold, leased or even donated, just as any other type of property. If a business finds itself with a patent that doesn’t make sense for it to continue maintaining, that business may want to consider donating the patent to a qualifying charitable organization under Section 501(c)(3) of the Internal Revenue Service Code in exchange for a tax deduction.
It’s not uncommon for a business to develop an idea and create a patent but fail to use it to its fullest income-producing potential, for whatever reason. In that case, that business may want to consider determining the patent’s fair market value or its basis and take a deduction by donating it, according to Nicholas C. Tomlinson, an associate at Gambrell & Stolz LLP. “While it’s important to work with an attorney and accountant who are familiar with charitable contributions and patent donations, donating a patent can be a smart business move for many businesses,” he says.
Smart Business spoke with Tomlinson about patent donations and how businesses can benefit by donating a patent.
How are patent donations deductible under the Internal Revenue Code?
The IRS considers a patent to be property, and Section 170 of the code covers all charitable contributions, including patent donations. Congress established limits on intellectual property donations as part of the American Jobs Creation Act passed in 2004. There were concerns about abuse specifically in the area of patent donations so this was an attempt to crack down on those abuses. Companies and individuals are limited to using the lesser of either the fair market value or the basis both of which can be tricky to determine.
How can a business determine the value of a patent that might be donated?
Unfortunately, Congress didn’t address the area of determining value; however, the three accepted methods of evaluating patents are the same basic methods used to determine the value of any other property.
The first is the market method approach, which looks at what’s comparable on the market. This is inherently a challenge because, by nature, a patent is supposed to be unique and original so using the market approach raises questions about the validity of the patent itself. The second method is the income method, which takes into account the future income that the patent would produce from royalties or if the patent were sold.
The third is the cost approach, which is basically the cost of developing the patent.
What are the limits for the donations?
Section 170 of the IRS Code differentiates between corporations and individuals. A corporation may take a tax deduction for a donation up to 10 percent of its net taxable income. For individuals, that deduction can’t exceed 50 percent of the taxable income base. Many partnerships are LLCs, and their taxes are passed through the individuals so the individual limit would apply. Anything in excess of the 10 percent for corporations and 50 percent for individuals can be carried forward for five years.
What are some potential pitfalls of making a patent donation?
Because this is an area that has come under considerable IRS scrutiny, people looking to donate a patent should keep in mind that this type of transaction could lead to an audit, so it’s important to make sure everything is well documented. It’s also important to consider the costs involved with determining the value of the patent, as it can end up costing more than the value of the patent itself. Individuals looking to donate a patent must have a qualified appraisal done by an independent third party. An appraisal is also strongly recommended for corporations. The IRS closely scrutinizes these types of transactions, so you want to make sure to follow all of the proper procedures for determining a patent’s value. Someone should do the appraisal who is qualified to make the appraisal on that particular type of technology that the patent protects.
In addition to the tax benefits, are there any other advantages to donating patents?
While the tax benefits can be fairly substantial, depending on the value and the basis of the patent, there are other reasons why a business or individual might consider donating a patent. Patents can be costly to maintain due to yearly maintenance fees that can run into thousands of dollars. When a donation is made, the acquiring entity assumes the cost of the maintenance fees. Donating a patent also creates goodwill and promotes business relationships in the community.
NICHOLAS C. TOMLINSON is an associate at Gambrell & Stolz LLP where he practices in the areas of taxation, corporate law, trusts and estates, and employee benefits. Reach him at (404) 221-6537 or email@example.com.