by Steve McDaniel and Jon Hurt
Technology Litigators
Since many of you like to take the xtension to file taxes these days (we did), and you have a little time
to prepare for next April, now is a good
time as any to apply the “early bird gets
the worm” strategy should any of the following issues ring a warning bell in the
back of your mind. Sure, we are not accountants or tax attorneys, so don’t take
anything we say here as tax advice. That
being said, trade secrets can have tax consequences that you may want to discuss
with your honest-to-Pete tax advisor.
Are trade secrets taxable proper-
ty? Short answer, yes. What, did you
think the IRS is going to miss a chance
to bleed you? But like most things
tax related, the specifics are somewhat
buried in the forest of dead trees that
make up the current tax code. Under
26 U.S. Code § 170 “Charitable, etc.,
contributions and gifts” various in-
tellectual properties including trade
secrets are recognized as tax related as-
sets: “(e) Certain contributions of ordi-
nary income and capital gain property
… (1) General rule … The amount of
any charitable contribution of property
otherwise taken into account under this
section shall be reduced by the sum of -
… (A) the amount of gain which would
not have been long-term capital gain
(determined without regard to section
1221(b)( 3)) if the property contributed
had been sold by the taxpayer at its fair
market value (determined at the time of
the contribution), and (B) in the case
of a charitable contribution - … (iii)
of any patent, copyright (other than a
copyright described in section 1221(a)
( 3) or 1231(b)(1)C)), trademark, trade
name, trade secret, know-how, software
(other than software described in sec-
tion 197(e)( 3)A((ii)), or similar prop-
erty, or applications or registrations
of such property, or … the amount of
gain which would have been long-term
capital gain if the property contributed
had been sold by the taxpayer at its fair
market value (determined at the time of
such contribution).” Whew! And, we
thought patent law was indecipherable!
From the convoluted verbosity
above, you can see why you are going
to need a joint sit down with your tax
advisor and your attorney to figure out
the best joint tax and legal positioning
to take on your trade secrets and other
intellectual property. But it seems that
you can get some type of tax benefit for
giving trade secrets, “know how” and
other IP assets away as a charitable
contribution. Big whoop. Most people
want to make money from their trade
secrets rather than give them away.
And honestly, can anyone think of a
charity that would want or use a trade
secret from the paint and coatings in-
dustry? If you do, please contact us and
we will be sure that our not-for-profit
entity has been set up to receive them!
Another issue that arises is the dif-
ference between a trade secret and
know-how. The IRS has generally
long viewed know-how as existing
based on a trade secret status, as hav-
ing or including a secret process or
formula that is not necessarily patent-
able, and that it can be duplicated by
an employee that leaves the company.
Know-how in this view falls under
the trade secret umbrella and the pro-
ceeds from the sale of know-how can
be taxed as a capital gain. In regards to
trade secrets, any benefit of the capital
gains rate may be lost if the IRS rules
that the confidential information did not
classify as a trade secret (i.e., property),
such as not being protected by adequate
secrecy (hint, hint . . . . see previous iPaint
articles). However, the subject of know-
how has produced differing opinions
between courts and the IRS in various
cases. In some court rulings non-secret
information (e.g., manuals, easily re-
versed engineered processes) was viewed
as know-how and still taxable as prop-
erty in the sale of a business. The tax
issues with trade secrets and know-how
gets even more complicated when your
business is international, another topic
to raise during the sit-down with your
advisors.
Given the treatment of trade secrets
and other IP as property, there may be
several ways to categorize R&D costs
of their development for reducing your
tax bill. The sit-down topics include the
research and development (R&D) deduction or the R&D tax credit (if it is currently renewed – the tax code is always
changing). For example, based on the
Death, Taxes, Trade Secrets and Other Certainties
