Royalties received in exchange for patent rights can be treated as a long-term capital gain. Is there a way such a gain can also be deemed exempt from NIIT?

[hlevine284]

There is an IRS Technical Advice Memorandum dated Aug.8, 2002 and released Dec 6, 2002 in which IRS ruled that the royalty payments should be treated as long-term capital gain under Section 1235. A number of cases are cited in that TAM. However, most of what is written about IRC 1235 and similar fact patterns occurred prior to 2014 and therefore prior to the existence of the Net Investment Income Tax (NIIT). This raises a new question about the taxation of royalty payments afforded long-term capital gain treatment under IRC 1235 - is the gain subject to NIIT, or conversely, is there an argument that can be made that the gain is exempt from NIIT under the theory that the gain was derived in the ordinary course of a non-passive trade or business. Can the inventor be deemed to be in the business of inventing patentable property such that the capital gain from such property would qualify as exempt from NIIT.

I am seeking support for making such an argument or any argument that would enable a capital gain under IRC 1235 to be deemed exempt from NIIT.

[Zbucklyo · Accepted solution]

I don't see it.  According to what I read, royalty income from patents is subject to the NIIT.

According to PWC, patent income is considered portfolio income and therefore subject to NIIT.

https://www.pwc.com/us/en/washington-national-tax/newsletters/private-company-services-tax/assets/pw...

Other sources seem to indicate the same thing.  From my view, you are trying to have your cake and eat it too.  If the royalty income is afforded LTCG treatment, why wouldn't it be subject to the NIIT?  However, you can either consult a tax professional with a background in the tax treatment of intellectual property, or elect to not pay the NIIT on such income, be audited by the IRS, and take the case to the Tax Court.

[B711]

How do I get long term capital gain treatment for my patent income that is reported in Box 2 of my 1099 as royalties?

[DaveF1006]

Usually long-term capital gains is usually related to a sale of property, if you receive income on this royalty each and every year, this is considered ordinary income that is not subject to capital gains consideration, unless this is a transfer of a patent.  If so, Certain transfers of patents by inventors are still taxed at long-term capital gains rates..