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How to Report Patent Income on a Tax Return

written by: Ty Wingfoot•edited by: Jean Scheid•updated: 7/4/2011

If your business earns patent royalties, it would be essential for you to determine how to report a patent income on a tax return. The article discusses in detail the tax treatment of patent income.

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    Patent income is the income generated from an exclusive right to an invention. A patent’s life is usually twenty years from application. When the patent expires, others are no longer prohibited from copying the invention.

    How to Report Patent Income on a Tax Return

    Patent income may not necessarily be tax-free. There are instances that patent income is taxable. The income derived from patents may be subject to business and occupation (B&O) tax. To determine if patent income is taxable, one must first determine if the earnings are categorized as business or non-business.

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    Business Income

    To determine how to report patent income on a tax return one should segregate business income from non-business income. The B&O tax applies to income generated from patent royalties and patent sales if the said income is considered regular, recurrent, and an ongoing part of business activities. Examples of taxable patent income are the following:

    If the inventor earns patent royalties for the right to use a patented process or to manufacture a patented product.

    If the income is from the sale of a patent by the inventor.

    If an investment firm generate patent royalties from patents and other intangible assets (such as copyrights) it owns for investment purposes.

    In these instances, the patent income is considered an ongoing part of the business operations because it is necessary to continue the business.

    Another consideration is to determine where the owner resides. B&O tax applies to patent income if the owner lives or has a commercial residence in Washington.

    Banking, loan, security and other financial businesses receiving patent income is also required to pay B&O tax under the classification - service and other activities.

    Exempt from Income Tax

    There instances that income generated from patent royalties is exempt from income tax. This is the provision under Section 234 TCA 1997. There are numerous conditions to be able to implement this rule. For instance: RED Visual Group from 

    - The original inventor must be the recipient of the royalty,

    - The patent royalty must come from a manufacturing activity ( other than IFSC and certain Shannon Free Zone activities) in the State or elsewhere, or in case of a non-manufacturing activity, it must be paid by a person not connected to the recipient.

    - Another instance when patent royalty is exempt is if the patent income is a non-business income.

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    Non-business Income

    For a non-financial business, one needs to know who owns the rights to a patent and if it is used mainly for investment purposes. If that is the case, then the patent income is not subject to B&O tax. For a patent right to be considered held strictly for investment purposes, the income must not be used for business purposes or used in conducting regular trade or for business operations. Two examples of non-taxable patent income are the following:

    If a manufacturer who owns the rights to a patented manufacturing process instead uses another process and then sells the patent.

    Patent royalty income generated by a person who purchased the patent and other investments for purely speculation purposes. This person does not own a business.

    Patent income are not taxable in the above-mentioned examples because the activities are casual in nature and the income is not regular and ongoing. Therefore, such patent income is not subject to B&O tax.