Donation of Intellectual Property: What Does it Look Like?

Donation of Intellectual Property: What Does it Look Like?

Article posted in Intangible Personal Property on 15 December 2014| comments
audience: National Publication, Dennis Walsh, CPA | last updated: 20 January 2015


Dennis Walsh examines the challenging subject of gifts of intellectual property.

by Dennis Walsh, CPA

Prior to 2004, Congress became increasingly interested in the valuation of charitable contributions of intellectual property rights.  As noted in a report by the Joint Committee on Taxation1, methodologies existed to appraise intellectual property, but the actual value of such property was difficult to determine, as it is speculative in nature and depends on various future events. 

High values claimed for contributions frequently resulted in a significant tax benefit to donors, but little or no actual benefit to the charities, as many donations of patents, copyrights, software, and other forms of intellectual property assets later turned out to be worthless or produced far less revenue than projected based on the appraisals performed.  Congress felt that looking at results based on the actual revenue generated from such property, instead of predictions, would provide a more accurate measure of the value eligible for a charitable income tax deduction.

This four-part series explains opportunities for the charitable transfer of intellectual property assets, identifies practical issues for donors and donee organizations, and illustrates the potential cumulative tax benefits from particular intellectual property asset donations.  A case study of two scenarios involving the donation of a trademark to a charity will also be presented.

What is intellectual property?

Intellectual property (IP) refers to creations of the mind - inventions, literary and artistic works, symbols, names, images, and designs used in commerce.  IP is divided into two categories:  industrial property, which includes patents, utility models, trademarks, industrial designs and geographical indications of source; and copyright, which includes literary and artistic works. 2

In the federal tax law context, intellectual property is a variant of intangible property.  Due to the diverse and evolving nature of IP, the Internal Revenue Code does not provide an all-inclusive definition of assets within this class.  Rather, the Code and other guidance lists common forms of IP along with a catch-all provision for the inclusion of similar types of assets not specifically listed. 

In particular, Internal Revenue Manual (IRM) guidance provides examples of intangible property that may also be classified as intellectual property depending on specific asset characteristics.  The IRM states that intangible property includes, but is not limited to:

  • Computer software
  • Patents, inventions, formulae, processes, designs, patterns, trade secrets, or know-how
  • Copyrights and literary, musical, or artistic compositions
  • Trademarks, trade names, or brand names
  • Franchises, licenses, or contracts
  • Methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data
  • Other similar items

An item is considered similar if it derives its value not from physical attributes, but from its intellectual content or other intangible properties. 3

Added in 2004, Internal Revenue Code Section 170(e)(1)(B)(iii) provides that for purposes of this charitable contribution provision, qualified intellectual property is any:

  • Patent
  • Copyright (other than as described in Section 1221(a)(3) or 1231(b)(1)(C)) 4
  • Trademark
  • Trade name
  • Trade secret
  • Know-how
  • Software (other than as described in Section 197(e)(3)(A)(i)) 5
  • Similar property and applications or registrations of such property (emphasis added)

2004 changes

Congressional concern over inflated deductions of corporate patents in particular was addressed by the enactment of Section 170(e)(1)(B)(iii) in October 2004, which added the donation of IP as a situation where the deductible amount of a charitable contribution of property must be reduced by any long-term capital gain that would be realized if the property were sold at its fair market value at the time of the contribution.

This provision effectively limits a deduction for the contribution of qualified intellectual property that would otherwise be eligible for a fair market value deduction to the lesser of fair market value or the donor’s adjusted basis.  Thus, for a contribution of such property made after 2004, a donor receives no deduction for any excess of fair market value over basis.

Congress recognized that a cost basis limitation would be a disincentive to charitable gifts of valuable, income-producing IP, since many owners of such assets will have little or no basis as a result of having previously deducted developmental costs as ordinary and necessary business expenses (Section 162), research and experimental expenditures (Section 174), or as amortization under Section 197 in the case of an intellectual asset acquired and held in connection with a trade or business.

In addition, qualified creative expenses of free-lance writers, photographers, and artists, as defined in Section 263A(h)(2), are exempt from the uniform capitalization rules and are typically deducted in the year incurred under Section 162.  Also, no increase in basis is allowable for the value of a developer’s time for a self-created asset.

To help remedy the basis disincentive, the 2004 amendments created a new Section 170(m), authorizing a donor of qualified intellectual property to a charity, other than a private non-operating foundation, to deduct a percentage of annual net income produced by the asset for up to ten years, based on a sliding percentage scale.

To be eligible for future charitable deductions, the donor must provide notice to the donee organization at the time of the donation that includes: 6

  1. The name, address, and taxpayer identification number of the donor
  2. A description of the qualified intellectual property in sufficient detail to identify the property
  3. The date of the contribution
  4. A statement that the donor intends to treat the contribution as a qualified intellectual property contribution for purposes of §§ 170(m) and 6050L

An annual return must then be made by the donee organization for any taxable year in which the donee receives or accrues net income from the property. 7  The return is made to the Internal Revenue Service on Form 8899, Notice of Income from Donated Intellectual Property, and is due 30 days after the end of the donee’s tax year.  Form 8899 must be filed and a copy provided to the donor for any tax year of the donee organization that includes any portion of the ten-year period beginning with the date of the contribution. 8

But Form 8899 is not provided for any part of a year after the date of the expiration of the legal life of the property, if occurring prior to the tenth anniversary of the date of the contribution. 9  Also, if the qualified intellectual property fails to produce net income for the donee’s tax year, the donee is not required to file Form 8899. 

To determine the Section 170(m) additional deduction for a particular year, the donor multiplies the amount of qualified donee income reported on Form 8899 by the applicable percentage shown in the table below.  However, the additional deduction for any year is allowable only to the extent that the aggregate amount of net income from the property since donation, as adjusted by the annual percentage limitations, exceeds the amount of any deduction allowable to the donor for the initial contribution of the property. 10

Tax Year Deductible Percentage
1 100%
2 100%
3 90%
4 80%
5 70%
6 60%
7 50%
8 40%
9 30%
10 20%
11 10%
12 10%

Although the allowable period of additional contributions is ten years, the potential for a donee to have a fiscal year other than the calendar year, combined with the possibility of an additional short tax year resulting from a donee’s change in accounting period, requires that the table provide for twelve separate taxable years.

As pointed out by the joint committee and reflected by the decreasing percentages, the further in time from the date of a gift, the more likely it will be that the value inuring to the charity from its use of the property is attributable to value added by the charity since the time of the contribution.

With this foundation in place, in Part II we’ll look at some specific examples of an IP donation and introduce techniques for the valuation of IP assets.  We’ll also discuss issues surrounding the determination of qualified donee income and reporting by the donee organization.

Click the links below to read more:

Part 2
Part 3
Part 4

  • 2. World Intellectual Property Organization (WIPO) Publication 943, 2013
  • 3. IRM (07-01-2006)
  • 4. A copyright described in IRC § 1221(a)(3) or § 1231(b)(1)(C) is a copyright held by a taxpayer whose personal efforts created the property, or in whose hands the basis of the property is determined, for purposes of determining gain from a sale or exchange, in whole or in part by reference to the basis of the property in the hands of a taxpayer whose personal efforts created the property
  • 5. Software described in IRC § 197(e)(3)(A)(i)) is software readily available for purchase by the general public, subject to a nonexclusive license, that has not been substantially modified
  • 6. IRC § 170(m)(8)(B)
  • 7. Treas. Reg. § 1.6050L–2(a)
  • 8. IRC § 170(m)(5)
  • 9. IRC § 170(m)(6)
  • 10. IRC § 170(m)(2), (7)

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