INTELLECTUAL PROPERTY: A PLANNING ISSUE FOR THE 21ST CENTURY

In the estate planning arena, property rights issues involving tangible assets are relatively “clear-cut.” This is true in the sense that there are generally concrete rules governing the taxation and distribution of such assets. However, individuals in various professions may accumulate certain types of intangible assets that may create rather nebulous estate planning issues. One area that may pose a particular challenge involves so-called, intellectual property rights.

Issues and Concerns

Intellectual property is unique in that it is an intangible asset that is generally acquired by an individual as a direct result of his or her work or trade. Examples of intellectual property include copyrights, trademarks, patents, trade secrets, and publicity rights. What makes the transfer of intellectual property rights such a potentially problematic estate planning issue is the general lack of authoritative commentary on the subject. Simply put, this area of estate planning is continually evolving, particularly as intellectual “capital” continues to become a greater factor throughout commerce in general.

Perhaps the best way to go about incorporating the transfer of intellectual property rights into an estate plan is to make an initial assessment of the various factors that may affect such a transfer. This can be a rather complex task, in and of itself, simply by virtue of the different types of intellectual property. For instance, it is important to determine if the intellectual property can be passed down to heirs. Certain types of intellectual property may have inherent renewal or termination rights (e.g., copyrights or patents). This can create additional questions as to when intellectual property rights become part of the public domain. Also, certain states may have more favorable laws than others with regard to protecting such rights. Generally speaking, it is important to become familiar with the type of intellectual property with which one is dealing.

Planning Perspectives

Several key estate planning issues need to be addressed when taking intellectual property into consideration. Certainly, the valuation of intellectual property poses an initial challenge. The Internal Revenue Service (IRS) offers guidelines for some, but not all, types of intellectual property. For instance, the valuation of literary work is based on the copyright’s future earnings potential reduced to its present value. Theoretically, this valuation methodology may apply to other types of intellectual property, as well. However, the biggest question is: How far into the future will the potential for earnings exist? In addition, it may be possible to reduce the valuation by restricting rights, in trust, to reduce marketability of property (e.g., placing a limitation on future reproduction or the owner’s use).

Another issue to be addressed is the treatment of current and future income from intellectual property. The question of income in respect of a decedent (IRD) may be one of the larger planning hurdles, especially if an individual’s assets are primarily comprised of intellectual property. Since IRD entitles the recipient of the intellectual property to a partial income tax deduction for estate taxes because of the inclusion of IRD in the estate, IRD may be desirable, in some cases.[i] 

The following points may merit further consideration: 1) IRD may be disposed by will; 2) transferring IRD to individuals in lower income tax brackets may make sense because IRD is taxed as ordinary income; 3) sale of property may be arranged to occur before or after death, thus creating the desired IRD result; 4) the sale of property at death may be a definitive way of establishing realistic property values; and 5) gifts to charity can give the estate a charitable deduction and eliminate any tax on IRD.[ii] With these factors in mind, it becomes necessary to calculate the tax implications of where best to position IRD.

In addition, some intellectual property may be treated as a terminable interest under marital deduction regulations.[iii] Generally, property with a terminable interest does not qualify for the marital deduction because someone other than the surviving spouse possesses all, or some, interest in such property. However, there are several exceptions in the Internal Revenue Code.[iv] One of these exceptions is qualified terminable interest property (QTIP). Such property is terminable interest property in which the surviving spouse has a qualifying income interest for life and the executor makes an irrevocable QTIP election on the decedent’s estate tax return. A properly drafted and structured will, revocable trust, and QTIP trust may help minimize the estate tax burden of the decedent’s and the surviving spouse’s respective estates, as well as provide a framework for the ultimate disposition of intellectual property.

The issue of estate taxation is one that affects anyone with substantial assets, regardless of the type of property that is included in his or her estate. However, intellectual property creates unique planning concerns. Just as an executor might be hard-pressed to sell a family vacation retreat solely for the purpose of raising cash for estate taxes, a best-selling author may be uncomfortable with the thought that after his or her death, the future publication rights to an unpublished work were to be sold for a similar purpose. This feeling can be further multiplied if a large portion of an individual’s assets is “intellectual” in nature.

Life insurance can play a pivotal role in keeping intellectual property in a decedent’s family. A life insurance policy purchased and owned by an irrevocable life insurance trust (ILIT) (created for the benefit of the decedent’s family) can provide cash at death to purchase property from the decedent’s estate. The estate can then use the proceeds from the asset sale to the ILIT to help satisfy any estate tax obligations. This use of life insurance can help solidify the estate plan and secure the future rights and ownership of intellectual property in accordance with the wishes of the decedent.

There are, however, several additional points to consider. For instance, the use of an ILIT may not be particularly important if intellectual property rights are close to expiration. Also, the actual amount of estate taxes attributable to intellectual property may ultimately dictate the amount of estate planning that will be necessary. Finally, the charitable giving of intellectual property is yet another option to mull over. The charitable income tax deduction for such gifts is generally insignificant, because such a deduction is based on cost basis rather than fair market value (FMV) at the time of the gift.[v] However, the charitable bequest of intellectual property through a will may yield a better result. In this case, the estate of the decedent would receive a charitable contribution deduction against estate taxes based on the fair market value of the gift at death, and would not be subject to limitations in the Internal Revenue Code.[vi]

One Step at a Time

Estate planning for intangible assets, such as intellectual property, involves an array of complicated considerations. The limited scope of current regulations pertaining to intellectual property rights will undoubtedly broaden in the years to come. In the interim, a basic understanding of the complex issues involved merely underscores the need for appropriate planning to help ensure the ultimate distribution of your assets is in accord with your desired wishes.