It is often normal to hear from people how baffling they find the tax code. If you are reading this, you are probably heavily involved in a field other than taxes and wish to simplify the subject for your convenience.
There are several ways in which intellectual property is taxed, as well as examples of the broad effects of the new Jobs and Tax Relief Act and all related intellectual property.
Small Business and Intellectual Property
Before we dive fully into the topic, it is important to mention that depending on the nature of the charges, there are three ways a small business can handle expenses related to intellectual property.
Creating Intellectual Property in Capitalization Costs
Any business that produces intellectual property for its benefit cannot deduct the costs incurred. To develop copyright, trademark, or patent will be “capitalized” or combined to determine the “income tax basis” of the asset.
The starting point for calculating how much tax you will pay when you sell or exchange a particular item or how much you can write off for depreciation or amortization over the useful life of the asset is the income tax basis.
Consider, for example, that your company invests $50,000 in the design and registration with the USPTO of a trademark. An alternative instead of the $50,000 expense is deductible, and the tax basis of the trademark money is triggered.
This $50,000 is deducted from the acquisition price in the event of a subsequent trademark sale to compute the gain to be disclosed on the sale on the business income tax return.
Intellectual property used for business purposes
Any costs incurred to start a business are still not deductible if you have not yet started the trade or business in question. Instead, once the business is formally launched, there is the option to elect to amortize these “start-up expenses” over 15 years.
The process gives rise to an amortization deduction to offset the income earned. Once this basis is established for patents or copyrights, you can claim an amortization deduction with a useful life of 15 years. Your annual depreciation deduction reduces the income tax basis of the related asset by the same amount.
For example, if your company owns a patent with an income tax of 150. 000 and you elect to deduct $15,000 for amortization, the income tax on the patent will be reduced by 15,000 to 135,000, and so on each subsequent year until it is zero.
Only items with a short useful life can be amortized. The most typical examples of intellectual property are patents and copyrights. Trademarks are not amortizable. They do not have a limited useful life because they are often continuously renewable.
Experimentation and research
Can deduct general “research and experimentation” expenses instead of capitalizing on expenses incurred to establish or improve a specific asset. These expenses are intended to “eliminate uncertainty concerning the development or improvement of a product.”
In designing a new or improved type of bulletproof vest, for example, all costs invested would be capitalized into the income tax basis of the intellectual property related to the vest once the corporation knew the vest would work.
However, testing costs would still be deductible. All research and experimentation expenses must be spread over five years following the recently passed Jobs and Tax Reduction Act and will no longer be deductible.
Sales of intellectual property
Previously, intellectual property used in a business allowed for both ordinary loss treatment and long-term capital gain treatment if the asset was held for more than one year.
Thanks to the Jobs and Tax Relief Act, intellectual property is typically treated as an ordinary asset, even if used in a business. The only exception is the outright sale of a patent (or an undivided interest in all significant patent rights).
Taxpayers would distinguish between recapture of prior depreciation deductions and pure appreciation in value when IP used in a business had previously received long-term capital gains treatment.
Differentiating different types of licenses would also be essential for tax treatment before the Jobs and Tax Relief Act. A licensing arrangement incorporating intellectual property would normally be considered ordinary income rather than capital.
Taxpayers could claim sale treatment where an exclusive license would cover all substantial rights in the relevant intellectual property and look more like a sale. This sale versus license analysis is less important now that the new law has been changed.
The acquisition of IP
The asset’s cost is used as the purchaser’s income tax basis when a third-party purchase intellectual property. The buyer can amortize the asset over a useful life of 15 years if the item has a useful life.
The anti-abuse regulations prohibited amortization churning, where a taxpayer would sell intellectual property to a connected party and start the IP amortization schedule over again from scratch.
The IRS will be much less concerned about these anti-abuse provisions now that IP gain will be virtually routine. The math to beat depreciation won’t work for the taxpayer.
Buyers often want to approach business purchases as asset sales, which increases the intellectual property in the acquired company’s income tax basis.
The fact is that amortization of intellectual property and goodwill could result in significant deductions. However, sellers often choose the latter option because the fees and paperwork are usually more unpleasant in an equity transaction.
Writer and content creator interested in Entrepreneurship, Marketing, Jobs and landlord issues. I have a bachelor’s degree in Communication from the Andrés Bello Catholic University, VE, and I also studied at Chatham University, USA. In this blog I write and collect information of interest around agreements, property and mortgage.