Patent Attorney and Founder
When you go to sell things that you own, it doesn’t always get taxed the same way. There’s ordinary income and there’s capital gain or loss, capital income. And that’s just a surface approach, but the thing that gets people’s attention is that the top capital gains rate is 20 percent, whereas the top ordinary income tax rate before net investment income is 37. Net investment income tax is 3.8 for the highest earners. So, we’re looking at almost a 20 difference in tax for what you earn on your self-created and tangible.
Here’s what they need to know. In 2017, a law that was extremely comprehensive was passed, the Tax Cuts and Jobs Act. It took effect January 1 of 2018, but many people still aren’t aware of a tremendous change that was made at that time. It’s this: self-created intangibles, secret processes, other ideas for running a business are no longer capital assets under Section 1221(a)(3). It exempts any self-created intangible from being a capital asset. The result of that is that if you create something, or you create something while working for a company, and then that company wants to sell that asset, it will not get capital gain treatment. It will be at the ordinary income rate for that entity or that person. And that’s huge news, and it sounds pretty terrible to all of us.
So, it was in one of these circumstances where my client was asking me, “What are the ways that I can get around this, Miss Tax Attorney? Don’t you, let’s see, NYU LLM at work?” And so, the answer is that we have to travel back in time to when the client meets with you, JD or Matt or Karen. And at that time, there needs to be a serious look at patenting the idea. Obviously, all of you and many people watching want to patent their ideas for many reasons, but for tax purposes, there is an excellent reason.
Section 1235 of the code allows you to get capital gains treatment when you sell substantially all of the rights to a patent. And that is now an exception to the general rule that self-created intangibles are ordinary.