Cooper v. Commissioner of Internal Revenue

Summary

After receiving legal advice, James and Lorelei Cooper co-formed a licensing company with others, and transferred their patent rights to the company in order to receive capital gains tax benefits. The Coopers owned less than 25 percent of the licensing company, and James' sister, as well as a friend of the Coopers, each owned larger percentages. James received royalties from the company for his patents, and claimed them as capital gains. In one instance, the company returned to James certain patent rights for no consideration. In 2008, the Coopers claimed a deduction for a nonbusiness "bad debt" arising from a working capital promissory note. A notice of deficiency was issued to the Coopers for three tax years. The Tax Court found James' royalties did not qualify as capital gains, and the promissory note debt did not qualify as a bad debt deduction.

Affirmed. If a patent holder transfers patent rights to a corporation, and effectively exercises control over the corporation such that all substantial rights have not been transferred, their resulting proceeds are not capital gains under 26 U.S.C. Section 1235(a). Here, the licensing company previously returned patent rights to James for no consideration. Because the right to retrieve ownership of a patent is a substantial right, James effectively controlled the licensing company pursuant to Charlson v. United States. The Tax Court permissibly held the Coopers' debt on the promissory note was not worthless. Further, the Coopers did not meet their burden of proof showing reasonable cause to avoid penalties assessed against them.

— David Mendenhall