HR 1 passed by House is another blow to patent right as it would change the nature of a patent into something other than a property right—so that when a patent is sold, it would be considered income for tax purposes.

HR 1, the Tax Cuts and Jobs Act that was recently passed by the House of Representatives on a 227-205 vote, has an ominous provision to change laws that address the way patents are treated from a tax perspective.

Currently, 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, shifts in patent tax treatment contained within HR 1 change the nature of a patent into something other than a property right—so that when a patent is sold, it will be considered income for tax purposes. This proposed change would dramatically increase taxes paid to the government, perhaps doubling it.

The November 16 vote is 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 devastating to independent investors and start-ups seeking investment, which means it will unquestionably harm job creation.

The Tax Cut and Jobs Act is another wildly misnamed act, much like the Orwellian-named America Invents Act that devastated inventing in America through the creation of the Patent Trial and Appeal Board.

On a broader level, the act signals a continuing approach toward patent rights as not being a property right, which contradicts the U.S. Patent Act and centuries of precedent. 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?

Adding even more risk

Independent inventors and start-ups 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 when licensing to others the use of their new technologies. Internal Revenue Code sections 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 patent 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.

Although 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.

Bad domino effects

But that’s not all of 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 the 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 receive even less money, negatively affecting the profit/risk equation from the onset of the inventing cycle. This means there will be less inventing.
All three branches of government have 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 early in our country’s history and pursued until very recently.

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 United States untenable for individual inventors from a financial perspective.

The good news is that the Senate’s tax legislation, passed on December 2, does not include this same provision. So there is hope that when the bills are reconciled, the House’s changes to Sections 1221, 1231 and 1235 may not make it into the final bill. As this plays out, we will see whether Congress wants to levy another blow to our nation’s start-up and job creation engine.