Understanding the taxation of intellectual property is important if you plan to develop your own intellectual properties or if you plan to invest in those that others have created.

The Internal Revenue Code places certain "non-favorable" treatments on intellectual properties the creator may offer for sale, such as:  

  • Literary works  
  • Music compositions  
  • Artistic compositions  
  • Video games  
  • Television shows
  • Movies  
  • Books

Other types of intellectual property that may be included in a general type of intangible assets may also be treated as capital assets when the creator offers them for sale. These properties can be subject to special regulations regarding the product's useful life, which specify how to amortize the cost associated with an intangible asset. Some examples of intellectual properties that may fall under this category include:  

  • Trade secrets
  • Formulas  
  • Operational knowledge  
  • Techniques, methods, or processes related to secrecy

Understanding Legal Implications

Gaining an understanding of the legal and tax implications associated with intellectual property can be quite an intimidating task. Many large companies have experts at their disposal to account for the sale and the ownership of intellectual property properly. 

However, most individuals rarely have the necessary understanding of the legal implications of intellectual property, despite the fact that the latter plays an important role in the United States economy.

As a consequence, creators and their tax advisors, should they have any, are usually not as familiar with the tax issues that apply to their specific professions as they could be. Adequate planning and reporting of income gained from intellectual property can have a rather significant effect on a creative person's tax liabilities. The way in which intellectual properties are treated for the purpose of taxation is normally determined by:

  • Considering the property's nature.
  • How a person came to be in possession of it.

There are a number of factors that determine whether the cost associated with developing an intellectual property might have to be reported on the creator's personal taxes, being rendered ineligible for deduction or amortization, and if the property is eligible to be immediately expensed. 

Some of these factors include:  

  • The purpose of the intellectual property  
  • The nature of its development  
  • The intellectual property's useful life

It may be possible to determine the eligibility for amortization of the cost associated with purchasing an intellectual property by using the income forecast method.

Aligning Business Strategy and Tax Planning for Intellectual Property

Today, many companies are looking for new ways to increase their profits and revenues with continuing to manage costs and cash flow effectively. This makes developing an effective tax plan for intellectual property a good idea. Properly handling intellectual properties is a great way to help companies:

  • Generate high value 
  • Address the risks associated with taxation and manage them effectively

Failing to address these issues properly can potentially lead to higher tax burdens on a global level. It could also limit the company's ability to effectively make important decisions after taxation. 

Most business leaders do not have the time it takes to consider intellectual property as a critical business issue properly. They are often much too involved in the company's real-life situations, which can determine the company's failure or success.

How Should the Creator of Intellectual Property Expect to Be Treated?

The following types of intellectual property will not be eligible for treatment as capital gain in the event the property is sold:  

  • Self-created copyrights  
  • Literary works  
  • Music compositions  
  • Artistic compositions

The Tax Court, for example, has determined that the concept of a television show is not eligible for such treatment.

Intellectual property that has been purchased is usually eligible to receive treatment as a capital asset when it has been sold. This is unless the owner possesses the intellectual property for the primary intention of selling it to customers in the regular course of daily business. A couple of examples of these situations can include:  

When the copyright and the software are purchased, it can be considered as a capital gain. However, the sale of the copyright, along with the code behind the software, would not be considered as a capital gain.

If you need help with the taxation of intellectual property, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.