## Facts

- The IRS National Office issued a Technical Advice Memorandum (TAM) addressing a request for guidance; the memorandum uses a hypothetical fact pattern.
- Professor X was employed by a state university and received a salary for teaching, research, and administrative tasks.
- More than half of Professor X’s work time was spent on research.
- Professor X developed an invention while working as a university employee.
- Under applicable state law, inventions created by an employee-professor belonged to the university.
- The university could choose to patent and license an invention and, consistent with state-law direction, would obtain an assignment of patent rights from the professor when it did so.
- The invention was patented, and Professor X assigned his interest in the patent to the university.
- After the assignment, Professor X and the university entered into an agreement under which Professor X would receive a stated percentage of the amounts the university received from licensing the patent.
- The university licensed the patent to a manufacturer, which developed and sold a product.
- The university treated the amounts it received from the manufacturer and the amounts it paid to Professor X under the agreement as “royalties,” rather than salary.

## Issues

1. For federal income tax purposes, are amounts paid by a state university to an employee-professor under a patent revenue-sharing arrangement taxable to the professor as compensation for services or as royalty income?
2. Does characterizing the payments as “royalties” in the university-professor agreement control their tax treatment when the university owns the patent and the professor has assigned any patent rights to the university?

## Decision

- The IRS concluded that the professor’s share of the licensing receipts is taxable as compensation arising from the employment relationship, not as royalty income from the use of a patent owned by the professor.
- The IRS treated the university as the patent owner and licensor; accordingly, the royalty income from the third-party license was the university’s income.
- The IRS viewed the professor’s right to receive a percentage of licensing receipts as a contractual payment right tied to services performed as an employee, rather than a retained property right in the patent.
- The TAM provided administrative guidance within the IRS based on the stated hypothetical facts and does not constitute a court decision.

## Legal Principles

- Federal tax treatment is determined by the substance of the rights and relationships created, not solely by the labels the parties use in their agreement.
- Royalty income treatment generally depends on the payee having a property interest in the intangible being exploited; payments based on exploitation proceeds can be ordinary income when paid to a person who does not own the underlying property.
- When an invention is created within an employment relationship and ownership rests with the employer under state law (and the employee assigns any rights to the employer), payments to the employee tied to the employer’s licensing revenue may be treated as compensation for services.

## Conclusion

In TAM 2002 49002, the IRS addressed a hypothetical involving a state university, an employee-professor inventor, and a patent-license arrangement, and concluded that the professor’s contractual share of the university’s patent-license receipts is taxable as employment-related compensation rather than royalty income, because the university owned the patent and the professor’s entitlement arose from the employment-based agreement rather than from a retained patent property interest.


Internal Revenue Service Technical Advice Memorandum, TAM 2002 49002, 2002 WL 31736299 (2002)