Technology transfers involving non-profit organizations: Special tax considerations

Many large non-profit research institutions have offices that are devoted to the transfer, development and commercialization of intellectual property, such as patents and copyrights. In today’s heavily regulatory environment however, the activities of non-profit organizations (in particular, colleges and universities) are being closely scrutinized by the Internal Revenue Service (IRS) and other state and federal government agencies. For example, in 2008, the IRS mailed compliance questionnaires to more than 400 colleges and universities to identify the types and amount of revenue generated by various activities, management and governance practices, and other areas that may be ripe for future compliance efforts. The survey of colleges and universities serves as one additional example of the growing emphasis on non-profit governance.

Against this backdrop, non-profit organizations that are engaged in technology transfer activities (and their commercial partners) should keep in mind some of the special tax considerations that may arise in connection with incoming and outgoing transfers of intellectual property.

Incoming Transfers
An incoming technology transfer is one in which the non-profit organization creates or receives intellectual property. First, the non-profit organization may create the intellectual property through the efforts of its employees, with whom it may have agreements governing the ownership of the resulting invention or other intellectual property or a formal written policy. Frequently the tax issue in these cases is the character of the resulting payments to the employee—not only whether the employee’s pre-invention compensation is reasonable (as required under the Internal Revenue Code), but also whether any post-invention payments should be characterized as (1) wages that are subject to the usual tax reporting and withholding requirements; (2) royalties that are subject to tax reporting but no withholding requirements; or (3) long-term capital gains that may not be subject to tax reporting or withholding. Furthermore, some organizations may “purchase” the property from the employee with the award of stock or an ownership interest in a licensee company, which may raise issues with respect to the timing and value of the payment for tax purposes.

Second, a non-profit organization may receive or accept a gift of intellectual property, in which case the donor may be looking to claim a charitable deduction for the value of the property and/or a charitable deduction for the income produced by the property in a subsequent year. In such cases, the organization should have in place a gift acceptance policy that expressly prohibits the organization from placing a value on or endorsing the donor’s claimed value of the gift (even where the donor provides the organization with a copy of a qualified appraisal). Rather, the organization should merely acknowledge receipt of the property (usually on a Form 8283), by describing the property contributed and any limitations on the organization’s use of the property. In addition, the organization may be required to report to the IRS any income produced by the property in subsequent years so that those figures can be matched with any additional deductions claimed by the donor (usually on a Form 8899).

Outgoing Transfers
An outgoing technology transfer is one in which the non-profit organization sells or licenses intellectual property to a third party. Such transfers may raise private inurement and unrelated business income tax issues. First, a non-profit organization’s sale or license of intellectual property to a disqualified person (e.g., significant contributors, directors, officers and their families or related businesses) at less than the property’s fair market value may run afoul of the Code’s prohibitions on private inurement and private benefit, and trigger significant penalties. The penalties can be severe—the organization’s tax exempt status could be revoked and/or excise taxes of up to 200 percent of the “excess benefit” could be imposed on a disqualified person and an excise tax of up to 10 percent of the excess benefit could be imposed on the organization’s managers. An “excess benefit” is generally the amount by which the value of the property or rights conferred exceeds the payment received. Second, non-profit organizations should ensure that any license agreements properly distinguish or allocate payments between non-taxable royalties and taxable unrelated business income. The need to make this distinction would typically arise when an organization provides some sort of ongoing maintenance or service to the licensee in connection with the license of the intellectual property. To the extent that the organization is providing such services, the organization should take care to track any expenses incurred in connection with the performance of those services so that those expenses can be allocated to the income realized.

Doug Pessefall is a tax attorney in the Milwaukee office of Whyte Hirschboeck Dudek where he heads the Tax Exempt Organizations practice group. For more information about the tax implications of technology transfers involving non-profit organizations, please contact Doug Pessefall at (414) 978-5534 or dpessefall@whdlaw.com.

The opinions expressed herein or statements made in the above column are solely those of the author, and do not necessarily reflect the views of Wisconsin Technology Network, LLC. WTN accepts no legal liability or responsibility for any claims made or opinions expressed herein.