What Type of Asset is Intellectual Property?
We all know that physical items that you buy can be (and usually are) taxed. And that income can be taxed (also usually is depending on your state). So, there is a tax on physical items, known as tangible assets, and then there is income tax, but how does a tax on the idea of something work?
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Intellectual property, whether that be a patent, trademark, or copyright are collectively known as intangible assets. This essentially means that they are the opposite of a physical item, that it is an asset in nature or in mind. For purposes of the IRS, when you pay taxes on intellectual property, you are paying taxes on an intangible asset. If you make any income off intellectual property or transfer intellectual property rights to another individual or entity you are subject to taxation. This blog post aims to clear some of the additional nuances associated with filing taxes on intellectual property.
Reporting Earned Taxes
When you receive an income or any monetary amount on intellectual property, it is taxed as supplemental income in the form of royalties. You may have heard the phrase “royalties” before in describing how a musician gets paid for their new song, and that is exactly what this is. Whether it’s a new song, movie, drug, medical device, or anything else, the income made from intellectual property is taxed as a royalty. Generally, filing the tax itself is fairly easy, as it only requires one form, or two if you are also paying royalties to other individuals or entities. Below I will cover both when royalties are only paid out to one individual/business, or when they are shared.
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Forms Used
In order to report royalties earned from intellectual property, up to two forms must be filed with the IRS: Form 1090 Schedule E and Form 1099-Misc.
Form 1090 Schedule E is used in our case to report any income made from royalties. This should be filed separately from the taxes of the business/company and should only include income made from the relevant patent/trademark/copyright. Below I provide a general breakdown on how to fill in the form:
Box 4A: Enter income earned from royalties
Boxes 5-20: Enter any expenses incurred from obtaining the intellectual property
Form 1099-Misc. should only be filed if you are also paying intellectual property rights to another, whether that be another entity or individual. If you are paying intellectual property rights in excess of $600 to another, enter the amount in box 2.
Tax Breaks
In the case of medical or scientific research, In the case of research, the IRS and United States government can provide some amount of tax breaks for research. I will go over what is likely to be most relevant, the small business tax break for research.
Small Business Tax Break
The IRS has a program in place for small businesses that can provide up to $250,000 in tax relief. In order to initially qualify a business will need to provide a gross receipt from no longer than five years ago that shows expenses of under $5 million.
In order to potentially receive the tax deduction, you will need to file two additional forms with the IRS to determine whether you qualify and how much you qualify for. These two forms are the Form 6765, Credit for Increasing Research Activities, also known as the Credit For R&D Form, and the Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. To qualify for this, a company must show that they are actively engaged in the research and development of new technologies, chemicals, medical devices, etc., and are doing so to continue overall economic growth in the United States. The bar to pass is overall relatively low, so as long as you are a company that is actively engaged in the research and development of new things in a scientific capacity, and you are engaged in the economy, which you would be as a business.
In Form 6765, you report all expenses associated with the research you are conducting, which includes supplies, wages, rent for tangible property, virtually anything that is not the actual facility itself. In Form 8974, you state which year from the past five years you wish to receive the reduction from.
Key Note on the Tax Break
Make sure when filing these two forms, you also file the relevant Forms 941, Employer’s Quarterly Federal Tax Return for the year which you are requesting a retroactive tax break from. The Form 941 should be readily available within your company’s records, as it is filed quarterly for small businesses with employees.
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Remarks
While everything I have laid out here might seem clear cut, it is not always so. This should serve as a starting point for businesses who are starting to earn an income in their intellectual property. As you continue to grow, I would always advise to speak with a tax attorney who is an expert on these more niche matters. Furthermore, if you wish you maximize your chances on the tax break described above, I would highly advise speaking to a tax attorney who is involved with companies engaged in research and development.
Sources:
1. http://publications.ruchelaw.com/news/2017-05/tax-101-IP.pdf
2. https://www.pli.edu/catalog/publications/treatise/taxation-of-intellectual-property
3. https://grr.com/publications/an-introduction-to-the-tax-treatment-of-intellectual-property-including-the-impact-of-the-tax-cuts-and-jobs-act/
4. https://www.vedderprice.com/-/media/files/vedder-thinking/publications/2003/08/vedder-price-adds-new-ip-lawyer/files/ip-strategies/fileattachment/ip-strategies.pdf
5. https://smallbusiness.chron.com/taxes-vs-intangibles-10577.html
6. https://www.irs.gov/businesses/small-businesses-self-employed/qualified-small-business-payroll-tax-credit-for-increasing-research-activities
7. https://www.investopedia.com/terms/i/intangibleasset.asp#:~:text=An%20intangible%20asset%20is%20an,vehicles%2C%20equipment%2C%20and%20inventory.
8. https://www.irs.gov/businesses/small-businesses-self-employed/intangibles
9. https://www.irs.gov/forms-pubs/about-schedule-e-form-1040
10. https://smallbusiness.chron.com/report-patent-income-tax-return-42663.html
11. https://www.irs.gov/pub/irs-tege/eotopicb99.pdf
12. https://www.businessnewsdaily.com/2683-research-development-tax-credits.html
13. https://www.armaninollp.com/articles/r-d-tax-credit-guide-how-claiming-can-save-business-250000-a-year/