United States: New Restrictions (and New Opportunities) in Donating Trademarks, Copyrights and Other Intellectual Property

Article by Richard F. Riley, Jr. and Terri W. Cammarano*

Congress has radically changed the rules for deducting charitable contributions of copyrights, trademarks, patents and other intellectual property. The new rules apply to donations made on or after June 3, 2004. This article explains the new rules, and considers some strategies for making use of them.

Previously, charitable contributions of intellectual property interests, such as trademarks, copyrights and patents, were treated the same as donations of any other type of property. A deduction was generally available for the full fair market value of the intellectual property or intellectual property rights donated. So long as the taxpayer's entire right to the intellectual property – or a fractional undivided interest in all rights held by the taxpayer – was donated to charity, the only tax issue in almost every case came down to valuation: determining, usually by means of an independent appraisal, the true fair market value of the donated trademark, copyright or patent or the rights therein. In a previous article, we described these charitable deduction rules, and surveyed case law and expert commentary on how to determine the value of donated intellectual property.¹

New Law – Initial Deduction Limited to Basis, But Additional Deductions Available in Post-donation Years

As part of the American Jobs Creation Act of 2004,² Congress amended section 170 of the Internal Revenue Code to place trademarks, copyrights, patents, trade secrets, software, and other intellectual property into a category of charitable donations for which no deduction is allowed for the amount of short-term or long-term capital gain that the taxpayer would have received if the taxpayer had sold the property.³In other words, the initial charitable contribution deduction is limited to the lesser of the taxpayer's basis in the intellectual property, or the fair market value of the intellectual property.

The basis of donated intellectual property may be relatively easy to determine in the case of copyrights, trademarks, patents and other intellectual property which are purchased by the taxpayer from a third party, but computing the basis in self-created trademarks, patents and other types of intellectual property may involve difficult issues of allocating research and development expenses and other internal costs.

The severe restriction imposed by the above rule, limiting the initial deduction to no more than the taxpayer's basis in the intellectual property, is moderated by an intriguing new rule for which there is no equivalent in prior law on charitable contributions. Under the new law, the contributing taxpayer is allowed an additional deduction – over and above the initial deduction (which, as noted above, is limited to the property's basis) – in the taxable year of the donation and for each of the next nine years (ten years altogether), equal to a specified percentage of the income earned by the donee charity with respect the donated intellectual property in each year of such ten-year period ⁴ In other words, to the extent the charity earns royalties or other income with respect to the donated intellectual property, a portion of such amounts is allowed as a deduction to the original contributor over a ten-year period.

Specific restrictions on the contributor's deduction for the donee charity's income derived from the donated property are as follows. First, the deduction for any income earned by the charity in the year of the contribution is allowed only to the extent such income exceeds the amount of the initial deduction for the donation itself.⁵ Second, the contributor's deduction is limited to a declining percentage of the charity's income from the property over the ten-year period beginning with the year of the contribution, determined according to the following table ⁶

(The table provides percentages for a twelve-year period, to allow for the fact that the contributor and the donee charity may have different taxable years. The contributor gets the deduction for income received by the donee during each taxable year of the donee that ends "within or with" the taxable year of the contributor).⁷

Third, the additional deduction for income received by the donee charity is not available in the case of intellectual property donated to private foundations (except private operating foundations).⁸

In order to know how much to deduct, contributors will be informed of the amount of income earned by the donee charity under new information reporting requirements.⁹ Charities that receive contributions of intellectual property subject to the deduction rules described above are required to file annual information returns (Form 1099) with the IRS, identifying the contributor and the date of the contribution, describing the donated intellectual property, and showing the amount of royalties or other income derived from the property with respect to which a deduction may be available to the contributor under the rules and restrictions described above.¹⁰ A copy of the information return must be provided to the contributor.¹¹

Congressional Intent and Taxpayer Strategy Considerations

The legislative history of the Jobs Act states that, in enacting the new restrictions on charitable contributions of intellectual property, Congress was concerned about two things. One was the inherent difficulty of determining the fair market value of these types of intangible properties. In the view of Congress, these valuation uncertainties may have given rise to questionable deductions.¹² The second concern was that charities receiving donated intellectual property, even if the property had substantial value, may not have had the expertise to exploit the property, and ended up "stuck" with intangible property that had little or no real economic benefit to them or no meaningful use within the context of the charity's mission.¹³

In light of these concerns, the rules discussed in this article should provide a powerful incentive for owners of intellectual property to assure that they donate property that is likely to generate real monetary value to the charity in the form of a stream of royalties or other income. Because the initial charitable contribution deduction is severely limited, the real tax benefit of the donation will come in the post-contribution years when deductions are available for a portion of the donee charity's income derived from the property.

In response to these new tax incentives, businesses and other taxpayers will want to survey their intellectual property inventory, and consider what intellectual property interests may be surplus to business needs while still having the ability to generate a royalty stream in the hands of a holder such as a charitable organization. These intellectual properties may be suitable for a donation. A donation in these circumstances may be a way for the donor to create or strengthen a relationship with a university, art museum, theater group, research institute, or other charitable donee, while creating a tax benefit at the same time – with the deduction now tied to the charity's reported income amounts, avoiding the uncertainties inherent in determining fair market value at the time of contribution.

Donors will need to conduct some due diligence on prospective donees of intellectual property, to ensure that the donee has the desire and capacity to exploit the intellectual property in the near future. For example, a written agreement with a donee might require the donee to, for example, honor existing royalty contracts or pursue a particular business plan with respect to the use of the intellectual property. If the charity fails to follow through, the donor might have a claim against the charity for the amount of the deductions that could have been taken had the charity honored its commitments. In these and other ways, the new intellectual property donation rules may significantly impact the relationship between donors and charitable donees.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.