Society is currently moving through a transition from a community whose wealth is based in tangible goods, such as the means of production, to a community whose true wealth lies in intangible forms of property. We are moving toward a period where knowledge and ideas are more valuable than physical objects. Intellectual property, such as patents, copyright, trademarks and even trade secrets are what drive many of this country’s booming sectors. With widespread internet access, the creation of intellectual property is no longer restricted to large corporations or wealthy people who can afford to develop such property. Any person can develop value through a copyright, a patentable invention or a trademark. As intellectual property continues to grow as a wealth creation tool, individuals will be faced with the challenge of determining the value of the property, and the effect that such property will have on estate taxes.
Estate taxes on intellectual property, especially those based on copyrights, can have a substantial effect. When determining a person’s estate for purposes of estate taxes, it is first necessary to determine one’s gross estate. A person’s gross estate includes probate property and other tangible and intangible assets, such as retirement accounts or joint property. The current exemption for estate taxes is $2 million and will remain at this level through 2008. The estate tax exemption amount will then increase to $3.5 million in 2009, and is currently scheduled to be repealed in 2010.
When valuing intellectual property for estate tax purposes, the taxable amount is generally accepted to be the fair market value of the intellectual property on the date of the creator’s death. For example, the fair market value of copyrights will generally be considered their income producing potential, discounted for net present value. A common method for determining a copyright’s fair market value is to determine the likely annual earnings for the intellectual property for a future period, often between 5 and 7 years. A multiple, often between 3 and 7 is then applied to that number for the current valuation. Much of the valuation analysis is largely subjective, so determining the accepted method with the lowest valuation is usually the best choice, at least in terms of estate tax purposes.
Often, the taxes on a valuable piece of intellectual property in a decedent’s estate will be more than the available liquid assets or cash on hand to pay the estate tax. This often results in the estate being forced to sell some of the property in the estate to pay for the estate tax. Alternatively, the Internal Revenue Code does allow for tax payment deferment. Internal Revenue Code § 6161 allows for the deferment of estate taxes for up to ten years with a reasonable cause showing. Reasonable cause has often been interpreted as being met with a showing that the estate is comprised of illiquid intellectual property. This deferment period can allow an estate to take its time in determining how to pay the estate taxes, without being forced to make a hasty decision to sell estate property. However, keep in mind that the estate does have to pay interest on the deferment amount, which is generally the short term federal rate, plus 3%. See, IRC § 6621(a)(2).
Much of society’s wealth lies in intangible intellectual property. When determining the amount of a decedent’s gross estate for tax purposes, it is necessary for the zealous advocate to choose the generally accepted valuation method that is most advantageous to the client. Valuation methods will vary by industry and type of intellectual property, be it copyright, trademark or patent. If you or your client’s estate is comprised largely of intellectual property, it may be necessary to contact an attorney experienced in intellectual property valuation and tax planning. Contacting the property advocate may save the estate a substantial amount in the form of taxes, allowing it to dispose of the rest of the property in accordance with the decedent’s wishes.