Tax Reform will Harm Inventors, High Tech Start-ups

HR 1, the Tax Cuts and Jobs Act, passed the House of Representatives on November 16, 2017 by a vote of 227-205. Within HR 1 is a provision to change 26 U.S.C. 1221(a), 26 U.S.C.1231(b)(1) and 26 U.S. Code § 1235,), which address the way patents are treated from a tax perspective. See Tax Bill Proposes Repeal of Capital Gains Treatment for PatentsCurrently, patents are treated like other property in that when a patent is sold, profit from the sale is taxed at a long -term capital gains rate. In effect, the changes to patent tax treatment contained within HR 1 changes the nature of a patent into something other than a property right such that when a patent is sold it will be considered income for tax purposes. This proposed change would dramatically increase the taxes paid to the government, perhaps doubling the amount of taxes paid.

Despite being named “the Tax Cuts and Jobs Act”, HR 1 is yet another blow in a long string of incredible damage to patent rights and investment in the earliest stages of commercializing new technologies. This proposed change to U.S. tax law will prove to be devastating to independent investors and startups seeking investment, which means it will be unquestionably harmful to job creation. What this means, of course, is that the Tax Cut and Jobs Act is another wildly misnamed Act, much like the Orwellian named America Invents Act that destroyed inventing in America through the creation of the Patent Trial and Appeal Board.

More disturbing than the harmful effects the proposed changes would have – this signals a continuing approach toward patent rights as not being a property right, which contradicts the Patent Act and centuries of precedent. Indeed, the government’s destruction of the once great U.S. patent system is built upon a simple, yet scary philosophy: Where it matters, no one in government actually considers a patent to be a property right. If a patent is not a property right, a patent can be treated however the political winds blow (or political money flows). And that is exactly what has happened. So why not tax it more?

Independent inventors and startups rely on the benefits of current tax treatment of long term capital gains to help justify the financial risks they take when bringing inventions to market or otherwise licensing to others the use of their new technologies. § 1221, § 1231 and § 1235 accomplish this by providing long term capital gain tax treatment for the patents of inventors and their investors. Why would Congress want to change this and further make an already risky endeavor even more risky and less financially rewarding?

Changing these regulations to treat patents sales as income will significantly devalue patents on both ends of early stage innovation. It increases the cost of inventing by taxing the fruits of inventing activity. While market sizes for inventions vary depending on the invention, the market value for any particular invention is finite. That means that any given patent only has one value. Increasing tax on the patent directly lowers the profit potential for the inventor. Lowering profit has the effect of increasing the risk that the invention will not bring enough profit to become worthwhile, which will cause many inventors to walk away, and investors to discriminate even more than they already are doing. Can America afford to further discourage inventors and investors? With China doing the exact opposite the prospect of Congress enacting further disincentives is surreal.

But that’s not all the damage. The finite value of the market for a patent does not change when the patent is sold. The market value is the same, so increasing tax means that investors who buy the patent will receive less profit because the profit is eaten by higher taxes. So the purchasing investor must overcome lower profit due to higher taxes by driving down the purchase price of the patent. That means the inventor and the inventor’s investors will get even less, which negatively effects the profit/risk equation from the onset of the inventing cycle. This means there will be less inventing, which again seems surreal given China in recent years has been adopting policies to do the exact opposite.

All three branches of government have already made significant changes to the patent system that make it difficult, if not almost impossible, to earn a living solely as an inventor. This philosophically flies in the face of the purpose of the patent system and the choices made by the Founding Fathers, who consciously chose to have a patent system affordable by real people, not just large corporations. Today it seems that our leaders are doing whatever they can to disadvantage individuals, pursuing a policy fundamentally and diametrically opposed to the choices made over 200 years ago, and pursued until very recently.

Unfortunately, Congress is poised to deal another blow by removing one of the most important financial incentives – the incentive to even try in the first place. To do so would further devalue U.S. patents, and further change the corresponding risk-reward calculus, to the point of making the “business of inventing” in the U.S. untenable for individual inventors from a financial perspective.

The good news, however, is that the Senate’s pending tax legislation does not include this same provision. So there is hope that when the bills are reconciled, the House changes to § 1221, § 1231 and § 1235 may not make it into the final bill. So as this plays out we will see if Congress wants to levy yet another blow to our nation’s startup and job creation engine.


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3 comments so far.

  • [Avatar for Lost In Norway]
    Lost In Norway
    December 4, 2017 04:48 am

    At some point those in power are going to realize that patents are private rights… Right? Please tell me I am right. I am not sure how much more of this farce I can take.

  • [Avatar for Cris Phelps]
    Cris Phelps
    December 2, 2017 09:53 am

    I enjoyed reading your article, but found it bit misleading, like a salesman selling through fear, uncertainty and doubt. The house bill is the only item you could reference as a fact at the time of your article, so I understand the “tone”. However, your last paragraph leaves the door open to follow up or amended article including what the Senate does by stating they don’t include the same language, regarding patents.

    Ironically, the Senate bill passed this morning (Dec 2) shortly after your article published (Nov 30). Even though there are no real details in the Senate version of the tax plan and what finally gets to POTUS desk is anyone’s guess, I look forward to your follow up article including the Senate version, now that it is available for inclusion.

    DISCLAIMER – I have no patents, so I am only an observer.

  • [Avatar for angry dude]
    angry dude
    November 30, 2017 10:13 am

    I don’t quite get it

    patent assets can be sold as part of entire company sale – real or shell company
    how can you assign a percentage value to patent assets vs other company’s assets like trade secreted know-how, copyrighted software code etc ???
    especially if they deal with same technology
    no one can