Tax Treatment of Patent Expenses

Obtaining a patent is usually a long and expensive process. No one makes money during the patent process, and it's a gamble as to whether the new patent will ever pay off. But without new patents and subsequent new products, business and industry would grind to a halt. That’s why the IRS is generous in the latitude it grants for tax treatment of patent expenses. For tax year 2017, the IRS allows businesses or individuals to deduct expenses pertaining to research and development. Not every expenditure relating to research and development qualifies as a deduction, but patent expenses do. Understanding the patent fees deductible expectations can help you make a smart strategy for your annual tax return.

In most cases, you can only deduct these expenses in the tax year in which you incur them. If you didn’t deduct those expenses at that time, the only way you can deduct them in later years is with smart patent accounting and with the consent of the IRS Commissioner. But you have another option if you did not deduct your patent expenses in the year in which they occurred – you may opt to amortize these monies as a capital expense. The tax law passed in late 2017 by the U.S. Congress makes changes in patent expense deductions that affect the 2018 tax year.

When it comes to tax treatment of patent costs, many related expenses are deductible, including attorney’s fees. Such legal fees are considered part of research and experimental costs, as defined by the IRS. Other deductible expenses include the costs of applying for the patent and the research required for patent development. If you had to hire outside experts, like an engineering firm, to develop the patent, those expenses, including salaries, are deductible as well. The cost of the materials used in creating the patent are also deductible expenses.

The IRS does not permit deduction of certain expenses that may prove part of the patent process. These include:

• quality control testing
• research of similar or historical products
• promotion or advertising
• consumer or efficiency surveys
• management studies

If you decide to amortize your patent rather than deduct expenses in the first year they were incurred, the patent falls under the category of intangibles for IRS purposes. These expenses are usually amortized or written off over the period for which the asset is in use, generally for 15 years. Amortization is similar to depreciation and may end up saving you money instead of choosing to deduct all expenses in one year. Consult with an accountant experienced in patent law to decide whether amortization or deduction makes the most sense for you.

If you purchased a patent from another company or individual, you cannot deduct the amount you paid for the patent or any related expenses, such as legal fees. The same holds true if you purchase a product or a process because expenses would have already been deducted by the prior owner. If you sold a patent in 2017, it is treated for tax purposes like the sale of any other capital asset, with capital gains or losses taken into consideration. That provision will change for patents sold in 2018, with such sales treated and taxed as income for businesses and individuals rather than sales of assets.

If you are amortizing a patent, you will use IRS Form 4562. However, if you are deducting your expenses in a single year, you can use IRS Form 1040.