Article of the Month

Last month's featured article explained the benefits to charity and donors of the gift of copyrights. This month, we discuss the gift of another form of intellectual property – the gift of a patent. As with gifts of copyright, a patent makes an excellent gift to charity. However, there are some specific considerations that donors and charities must keep in mind.

What is a Patent?

A patent is an intangible property right that protects an invention. Intangible property differs from tangible property. Tangible property refers to physical property - something that can be touched or felt such as real estate, vehicles, money, furniture and works of physical art. Intangible property is property that has value but the property cannot be seen or touched. Patents are one kind of intangible property. Other kinds of intangible property include copyrights, trademarks, goodwill and brand recognition.

A patent gives its owner the right to exclude others from making, using, selling, offering for sale or selling an invention that includes the patented invention. In the United States, the United States Patent and Trademark Office (USPTO) grants patents to inventors after the inventor publicly discloses the invention by filing a patent application. Generally speaking, patents last for 20 years and are not renewable.

There are three kinds of patents: utility patents, design patents and plant patents. A utility patent is granted to anyone who discovers or invents "any new and useful process, machine, article of manufacture or composition of matter, or any new and useful improvement thereof." Design patents are granted to the inventor of any "new, original and ornamental design for an article of manufacture." Plant patents may be granted to anyone who invents or discovers and asexually reproduces a distinct and new variety of plant.

The protection of a patent is rooted in the United States Constitution and is among the enumerated powers granted to Congress:

To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.

Article I, Section 8, United States Constitution

Transferring Patents

Patents are generally transferred by way of an assignment contract, will or deed of gift that is subsequently recorded with the USPTO. There are specific rules applicable to the transfer of patents (more information about transfer can be found in Chapter 300 of the Manual of Patent Examining Procedure).

The document that transfers a patent should identify the patent by number and date and it should be notarized and recorded with the USPTO. If a patent assignment is not recorded within three months, it will not protect the transferee against a subsequent purchase of the patent unless the assignment document is recorded prior to the subsequent purchase.

Tax Treatment of Gifts of Patents

1. Deduction of Patents

The owner of a patent who gives his entire interest, or an undivided percentage of his entire interest, in a patent to a qualified charity is allowed to claim both an income tax and gift tax deduction for the contribution. Rev. Rul. 58-260.

Because of the partial interest rule (see GiftLaw Pro 1.1.5), an owner who gives less than his entire interest in a patent is not allowed to claim any tax deduction. A donor gives less than his entire interest in a patent if he retains the right to license the patent to others; manufactures or uses any product that is covered by the patent; or places conditions on the gift which, if triggered, may result in ownership of the patent reverting to the donor.

2. Initial Deduction Limits

Since June 3, 2004, gifts of patents have been subject to new appraisal rules to determine their value. See Section 882 of The American Jobs Creation Act of 2004 (P.L. 108-357). The initial charitable deduction for a patent is now the lesser of: (1) the taxpayer's basis in the patent; or (2) the fair market value of the patent. Since many inventors have a low cost basis in creating a patent, the deduction of a gift of patent may be limited. Rev. Rul. 2003-28.

3. Deduction for Income Generated from Patents

After a charity receives a gift of patent, the charity may license the patent and produce "Qualified Donee Income (QDI)." The donor may receive additional qualified charitable deductions for QDI in excess of his or her basis produced for up to 10 years after the gift year. The deduction starts at 100% of the QDI received each year and declines to 10% of the QDI in tax year 11. The percentage of the deduction varies with each passing year. The charity is required to track the QDI attributable to the patent gift and report that amount to the donor and the IRS to substantiate the donor's deduction. This is reported on Form 8899, Notice of Income From Donated Intellectual Property.

4. Valuation

Because patents are usually worth more than $5,000, the gift of a patent must be appraised in order to determine the fair market value and the amount of the allowable deduction for a gift of a patent. The fair market value of a patent is determined by a qualified appraiser and is generally based upon the income stream that the patent is expected to generate.

The income stream a patent will generate often relates to whether or not the patent is current or obsolete, the kind of patent (i.e., utility or design), whether there are any restrictions on the use or transferability of the patent, and the remaining duration of the patent. It is also important to know the donor's cost basis of the gift.

Examples of Gifts of Patents

1. Partial Gift of Patent

Tommy Edison has developed a number of inventions, including a product that reduces the heat emitted from light bulbs. The invention is popular in theatres and playhouses. Actors like the invention because it reduces heat generated by light bulbs on stage that can cause actors' make-up to run. Tommy has patented the invention but has not yet found a company willing to manufacture his invention.

Tommy is a patron of the arts and really enjoys attending performances at the Menlo Park Municipal Playhouse, a qualified charity. Tommy grants the Playhouse a non-exclusive license to use his invention. Tommy's grant of a license is not deductible because Tommy retained a substantial right in the patent (ownership in the patent and a right to future income from the patent). Rev. Rul. 2003-28.

2. Undivided Interest Gift of Patent

Carrie Granite has recently secured a patent for a device that will polish gems and other valuable stones. She is a proud alumna of Bedrock College, having earned her Masters of Geology there several years ago.

Carrie is so appreciative of the education she received at Bedrock that she wants to share the benefits of her patent with the college. She gifts her entire interest in the patent (including the right to all of the royalties the patent will generate) to the college. Because she gave her entire interest in the patent, Carrie is entitled to a deduction for the gift of her patent.

Carrie Granite's patented gem polishing machine is revolutionary and once the machine went into production it was in great demand from jewelers around the world. Experts are predicting continued demand for the device and are projecting that Carrie's patent is worth more than $10 million.

Assuming that Carrie spent $10,000 in developing various prototypes of the device before she was satisfied with the final invention, what is the maximum amount she can deduct as a result of her gift to Bedrock College?

Carrie's initial deduction for the patent is limited to the lesser of her cost-basis or its fair market value. In this case, she is allowed to take a deduction of $10,000 (her total cost basis) rather than the expected $10 million in fair market value.

3. Deduction for Income Producing Patent

Carrie Granite has developed a revolutionary gem polishing machine and patented her invention. As an alumna of Bedrock College, she has gifted the patent and the right to receive the royalties, which has a total fair market value of $10 million, to the college.

As experts predicted, there is great demand for the gem polishing machine that Carrie developed. As the owner of the patent, Bedrock College decided to license the patent to a third party who is now manufacturing and selling the machine. Bedrock's patent has generated significant income, nearly $800,000 in royalties, each year since Carrie first gifted the patent to the college. Is Carrie entitled to any additional deductions in regards to her gift of patent?

Yes. In addition to a deduction for the initial gift of patent, Carrie is able to take additional qualified charitable deductions for the income produced by the patent. In the year after the donation, Carrie was entitled to deduct the full amount of the income that the patent generated for Bedrock College (or QDI) or $800,000. The chart below shows the amount of the allowable deduction that Carrie is permitted to take over the following decade (assuming annual QDI of $800,000 per year).

Year	Deduction Percentage	Patent Revenue	Allowable Deduction
Gift Year		$0	$0
1	100%	$800,000	$800,000
2	90%	$800,000	$720,000
3	80%	$800,000	$640,000
4	70%	$800,000	$560,000
5	60%	$800,000	$480,000
6	50%	$800,000	$400,000
7	40%	$800,000	$320,000
8	30%	$800,000	$240,000
9	20%	$800,000	$160,000
10	10%	$800,000	$80,000

Bedrock College is required to track the annual amount of the QDI attributable to Carrie's gift of patent and report that amount to Carrie and the Internal Revenue Service each year to substantiate her gift. The college would file IRS Form 8899, Notice of Income from Donated Intellectual Property, each year.