Cooper v. Commissioner, No. 15-70863 (9th Cir. 2017)
Annotate this CaseIf the patent holder effectively controls the corporation such that he or she did not transfer all substantial rights to the patents, then the tax treatment allowed by 26 U.S.C. 1235 does not apply. The Ninth Circuit affirmed the Tax Court's decision on a petition for redetermination of federal income tax deficiencies in which taxpayers sought capital gains treatment of patent-generated royalties pursuant to 26 U.S.C. 1235(a). In this case, taxpayers did not transfer all substantial rights to the patents. The panel agreed with the Tax Court that taxpayers failed to meet their burden of showing that they actually relied in good faith on an adviser's judgment in order to avoid accuracy-related penalties.
Court Description: Tax. The panel affirmed the Tax Court’s decision, after a bench trial, on a petition for redetermination of federal income tax deficiencies in which taxpayers sought capital gains treatment of patent-generated royalties pursuant to 26 U.S.C. § 1235(a). Taxpayer James Cooper is an engineer and inventor whose patents generated significant royalties. He and his wife incorporated and transferred their rights to the patents to Technology Licensing Corporation (TLC), which was formed by taxpayers and two other individuals, Walters and Coulter. If a patent holder, through effective control of the corporation, retains the right to retrieve ownership of the patent at will, then there has not been a transfer of all substantial rights to the patent so as to warrant capital gains treatment of the royalties under § 1235(a). The panel held that the Tax Court permissibly concluded that Mr. Cooper did not transfer “all substantial rights” to the patents to TLC because Walters and Coulter acted at Mr. Cooper’s direction, did not exercise independent judgment, and returned patents to Mr. Cooper when requested for no consideration. Taxpayers claimed a deduction for a nonbusiness “bad debt” pursuant to 26 U.S.C. § 166(d)(1)(B), which allows short-term capital-loss treatment of a loss “where any nonbusiness debt becomes worthless within the taxable year.” COOPER V. CIR 3 The panel held that the Tax Court permissibly concluded that the debt had not become “totally worthless.” Finally, the panel upheld the Tax Court’s determination that taxpayers failed to meet their burden of showing that they actually relied in good faith on their advisers’ judgment so as to avoid accuracy-related penalties under 26 U.S.C. §§ 6662 and 6664. Judge Kleinfeld dissented as to Section A of the majority opinion regarding the royalty payments as capital gains, joined in Section B as to the bad debt deduction, and observed that the accuracy penalties discussed under Section C would need to be revisited if his view on the royalties were to be accepted. Judge Kleinfeld opined that the better approach to distinguishing “control” from “mere influence” over a corporation is the approach set forth in Charlson v. United States, 525 F.2d 1046 (Ct. Cl. 1975) (per curiam), and Lee v. United States, 302 F. Supp. 945 (E.D. Wis. 1969): that “control” means the ability to compel what the transferee corporation does.
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