You have a great idea. Is patenting the best way to protect it? How much do patents cost? How do you find out if your idea is patentable?
Robert M. Hunter, Ph.D.
Registered Patent Agent
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When the great inventor Benjamin Franklin lamented that only death and taxes are certain, he spoke too soon. At both the State of Hawaii level and at the Federal level, some patent royalty income is taxed at a reduced rate or is not taxed at all. The following is an overview of taxation of royalty income from licensing of inventions with links to other information. It is legal or accounting advice and is not intended to replace the advice of your tax attorney, accountant or tax preparer.
Hawaii Exempts Patent Royalties from State Income Taxation
In 1999, the Hawaii State Legislature exempted royalties from patents and copyrights from State income taxation beginning in the year 2000. The patents or copyrights must be owned by an individual or a "qualified high-technology business" and developed and rising out of that business. The definition of "qualified high-technology business" excludes certain types of businesses, such as law, accounting, banking, etc., but includes almost all technology-based businesses that conduct technological research and development (R&D) or that develop software. The business need not be located within the State for royalty income produced by it to be exempt from State income taxation. Learn more about the exemption at the following State of Hawaii links (Adobe Acrobat is required):
The state laws reference the following sections of the Federal Internal Revenue Code:
IRS Publication No. 5350802 explains that "The costs of obtaining a patent, including attorneys' [or agent's] fees in making and perfecting a patent application, are research and experimental costs."
Here is a link to presentations about Hawaii's high-tech tax incentives by a highly respected Hawaii tax attorney, Ray K. Kamikawa:
To learn if the exemption applies in your situation, contact your tax attorney, accountant or tax return preparer or call the State Department of Taxation (800-222-3229). Within that department, Tom Smyth (808-586-2591) is reported to be especially knowledgeable.
Patent Royalties Received by Hawaii Inventors Exempt from State General Excise Tax
At present, the State's 4.166 percent general excise tax is not applied to royalties derived from inventions and copyrights that were the result of R&D conducted outside of the State, but does apply to those from inventions and copyrights that were developed inside the State under certain situations. If the license agreement calls for the exercise of patent or copyright rights outside of the State (e.g., the licensee's operations are outside the State), such royalties are exempt from the excise tax even if the licensee (e.g., the inventor) is located within the State.
Income from research or development activities conducted in Hawaii for the Federal Government is exempt from the excise tax (HRS 237-26). So, Hawaii is a great place from which to participate in Small Business Innovation Research (SBIR) programs. In fact, income from many types of services that are "exported" from the State is exempt from the excise tax, starting in the year 2000. See the details at the following links:
To learn if the exemption applies in your situation, contact your tax attorney, accountant or tax return preparer or call the State Department of Taxation (800-222-3229).
Royalties from Exclusively-Licensed Patents Taxed as Captial Gains by the IRS
Income from inventions and patents that have been exclusively transferred (all substantial rights have been licensed or assigned) is taxed at the lower (20 percent) capital gains rate at the Federal level in the U.S. Certain restriction apply, for example, the tax break can only be used by the inventor or by unrelated individuals who acquire an interest in the patent in exchange for consideration in money or money's worth paid to the inventor prior to actual reduction to practice (actual building and testing) of the invention covered by the patent. See the details at the following link:
To learn if this reduction in Federal tax rates applies in your situation, contact your tax attorney, accountant or tax return preparer.
How to Learn More about Patents
There is lots of information about patents on my website. Take a look at my site map to decide where to look next.
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