## Facts

- Howard S. Gable, an individual inventor, developed organo-iron compounds with magnetic properties and applied for a patent in 1965; no patent had issued during the relevant period.
- In 1969, Gable approached Chemetron Corporation to interest it in the invention and related know-how.
- On July 11, 1969, Gable and Chemetron executed a secrecy agreement under which Gable would disclose confidential information (including the patent application) so Chemetron could evaluate whether to obtain rights.
- The parties later entered an option arrangement giving Chemetron an option to acquire rights in the invention and providing that Chemetron would fund research and development to be performed by Gable.
- In 1969, Chemetron paid Gable $40,000 in two installments connected to Gable’s continuing research and development efforts under the arrangement.
- In 1970, Chemetron exercised its option and the parties executed a license agreement providing for royalties.
- Gable reported the $40,000 as proceeds from a disposition of a property right (seeking capital-gain treatment); the Commissioner treated the payment as compensation for services (ordinary income).
- After concessions, the only dispute was the federal income tax characterization of the $40,000 received in 1969.

## Issues

1. Whether the $40,000 paid to Gable in 1969 was compensation for research and development services (ordinary income) or consideration for patent-related rights or an option to acquire such rights (potential capital gain).

## Decision

- The Tax Court held the $40,000 was compensation for services rendered by Gable and was includible in gross income as ordinary income.
- The court sustained the Commissioner’s position on the remaining issue, with deficiencies adjusted as required by the parties’ concessions.

## Legal Principles

- When an agreement involves both patent (or patent-application) rights and services, the tax character of payments turns on the principal purpose of the arrangement and the transaction’s economic reality.
- Payments made primarily to finance or compensate continuing research, development, or technical efforts are ordinary income, even if the arrangement also contemplates a later transfer or licensing of intellectual property rights.
- Where a payer initially receives only an option and the inventor’s ongoing development work is a central feature of the arrangement, interim payments linked to that work are properly treated as service compensation rather than proceeds from a present sale or exchange of property.

## Conclusion

The court characterized Chemetron’s 1969 $40,000 payment as ordinary income because the arrangement’s dominant feature was Chemetron’s funding of Gable’s continuing research and development services while Chemetron evaluated commercial feasibility and held only an option for later rights.


Gable v. Comm'r, T.C. Memo. 1974-312 (1974)