Royalties from related party are ordinary income.The Second Circuit Court of Appeals affirmed the Tax Court's decision that an individual's receipt of patent royalties was ordinary income, not long-term capital gain Long-term capital gain A profit on the sale of a security or mutual fund share that has been held for more than one year. , because the payments were made in exchange for patent rights transferred to a related corporation. Nathaniel Garfield was a limited partner in a partnership that was majority owner of a corporation. In 1969, his general partner, Thomas McSherry, fried a patent application for an expansible fastener and the same day assigned the related patent rights to the partnership. Subsequently, the partnership transferred the patent rights to the corporation, which paid royalties to Garfield and McSherry The IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. in 2004 notified Garfield of deficiencies in returns for 2000 through 2002 stemming from more than $800,000 in royalties for the three years that it said Garfield erroneously characterized as long-term capital gain. Garfield pointed to section 1235(a), which provides that a property transfer of all substantial rights to a patent is treated as a sale or exchange of a long-term capital asset. However, the Tax Court rejected this argument because under subsection subsection Noun any of the smaller parts into which a section may be divided Noun 1. subsection - a section of a section; a part of a part; i.e. (d), the treatment is not available if the transfer was between a corporation and a related party--in the case of patent rights, a more-than-25% owner. Garfield held a 36% interest in the corporation and, before that, the partnership had held a 74% interest. Alternatively, Garfield argued that the patent was a capital asset and that the royalty payments were long-term capital gains under sections 1221 and 1222. The counts rejected this argument also, on the basis that Garfield did not hold any patent right for more than one year as required. In addition, the courts upheld a 20% substantial underpayment penalty Underpayment Penalty A tax penalty enacted on an individual for not paying enough of his or her total estimated tax and withholding. If an individual has an underpayment of estimated tax, they may be required to pay a penalty (on Form 2210). under section 6662(a). The Tax Court said that grounds for an exception for reasonable cause and acting in good faith were not evident where Garfield and his wife "do not contend that they followed, or even sought, the advice of a tax professional." The Second Circuit upheld the penalty while acknowledging the returns were signed by a law firm. * Nathaniel H. Garfield v. Commissioner, TC Memo 2006-267, aff'd, 102 AFTR AFTR American Federal Tax Reports (Prentice-Hall) AFTR Americans For Tax Reform AFTR Air Force Training Ribbon AFTR Air Force Training Record AFTR atrophy, fasciculation, tremor, rigidity AFTR Atomic Frequency Time Reference 2d 2008-5803 (2d Cir. 2008) By Jean T. Wells, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , J.D., assistant professor of accounting, Howard University Howard University, at Washington, D.C.; coeducational; with federal support. It was founded in 1867 by Gen. Oliver O. Howard of the Freedmen's Bureau, to provide education for newly emancipated slaves. A normal and preparatory department was opened the same year. , Washington, D. C. |
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