The Taxman, Technology Litigation And Cavalier Settlement Structures

• Published date: 28 February 2024
• Law Firm: Gray Reed & McGraw LLP
• Author: Mr Brian A. Clark, CPA and Joshua D. Smeltzer

Intellectual property ("IP") is hugely important to businesses. Given that importance, IP owners must occasionally litigate against the unauthorized use of their technology. The costs of such litigation and appurtenant settlements implicate a host of federal income tax issues. Some IP litigants do not consider those tax issues at all, while others aggressively overplay their hand. This post provides insights regarding federal income tax issues related to IP (mainly patent¹) litigation and settlements so that companies can know when they might have a tax issue and seek appropriate advice.

Tax Principles Regarding Patent Litigation Expenses

One of the difficulties with IP litigation is that no particular provision of the Internal Revenue Code (the "Code")² controls. As such, taxpayers might consider the general business deduction statute (' 162), production of income deduction (' 212) and general capitalization rule (' 263). The use of a particular Code Section is functionally determined by the "origin-of-the-claim" test set forth in United States v. Gilmore.³ The origin-of-the-claim test is unfortunately not objective and the filer's intent for filing the suit is not dispositive as to federal income tax consequences. In a patent case, litigants must distinguish between issues relating to ownership or title of the patent versus costs related to infringement of the patent. Ownership costs are typically capitalized which is a result facially confirmed by regulation:

Defense Or Perfection Of Title To Intangible Property'

In General. '

A taxpayer must...