One little-publicized part of the new tax law (Tax Cuts and Jobs Act of 2017) may negatively affect the value of some patents and other intellectual property. It does so by changing the tax treatment of income from sales of “patents, models and secret formulas or processes” from capital gains to ordinary income.
Prior to the amendment of Tax Code Section 1221(a)(3), income from sales of (1) “patents, models and secret formulas or processes,” (2) held by the IP creator, (3) for more than one year, was taxed at the capital gains rate. This resulted in lower tax than the ordinary income tax rate that applied to other types of IP, such as copyrights, literary, musical, and artistic compositions. Congress has now taken this tax advantage away.
The change in the law affects those that sell or license IP in the “primary market” only —in other words, the original creators of the IP. It generally does not affect those that have paid to own the IP, including the IP creators’ employers.
There still remains an exception under Tax Code Section 1235 providing for lower tax on sales and licensing of all rights to patents, secret formulas and trade names (but only these types of IP). For other types of IP, adjustments in sale prices and license royalties will need to compensate for the higher tax under the new law.
Our tax and IP groups can help you assess the new law’s impact on these valuable assets.