Tax Research Paper

FACTS

John has inventions in mind.  He filed a provisional patent application with the US Patent and Trademark Office for one invention.  The other invention John filed a regular utility patent application for.  Both of these invention ideas can be seen as patent pending after filing.  Major manufacturing companies want to buy the patents from John.  These sales are assumed to meet all qualifications needed to be granted long-term capital gain treatment. 

ISSUES

1.     Do these sales of the provisional patent and the patent-in-progress qualify as sales of “patents” for long-term capital gain treatment?

2.     Are patents that are pending treated the same, in tax implications, as if it were an issued patent?

3.     Is a provisional patent able to be sold, with all of its substantial rights, to a third party, in this case a manufacturing company?

ANALYSIS

A Provisional patent is a “quick” patent that costs less money and is given the “patent pending” label for advertising and marketing within 24 hours of applying for the provisional patent.  It also has a useful life of only 12 months after applying for the patent before it is expired. 

Internal Revenue Code Section 1235 states that a "transfer" consisting of "all substantial rights" to a patent by any "holder" shall be considered the sale or exchange of a capital asset held for more than 1 year.  Section 1235 does not have a minimum holding period.  Therefore under code section 1235, it is understood that any patent, whether it be provisional or otherwise, would be treated as if it were a long-term capital gain at the time of sale or transfer. 

Section 1235 is used in the case of William W Taylor and Gene W. Taylor v. Commissioner, U.S. Tax Court.  In this case,  William & Gene Taylor had patent transfer agreements for their patented manhole cover. The other licensing agreements were to be taxed under ordinary income since the substantial rights had not been transferred to the manufacturing...