When Can I Start Deducting Invention Expenses?

Dear Rich: I've been working on a "green" invention for a few years but I haven't been deducting my invention expenses because I was told I had to wait until I start making the product. Is  that right? According to tax maven Steve Fishman, the general rule is that you can begin making these tax deductions once your inventing business begins using its assets to produce products for sale. However, it’s not necessary that the products be completed or sales be made. Thus, for example, courts have held that a writer’s business begins when he or she starts working on a writing project. The act of production itself is “carrying on” the trade or business of writing. Similarly, courts  have found that inventors who worked on inventions -- but never completed or patented them -- were carrying on a business. Under the logic of these court decisions, your inventing business begins for tax purposes on the day you actually begin developing an invention. Thinking or dreaming about an invention is not sufficient. You must do real work on it -- but it is not necessary for you to finish it, patent it or make money from it. A thorough and complete inventor’s notebook documenting your work is the best evidence you can have to prove when you started working on your invention.
Startup expenses. Startup expenses are a whole different topic. Unlike business operating expenses, start-up expenses cannot all be deducted in a single year. This is because the money you spend to start an inventing (or any other) business is a capital expense -- a cost that will benefit you for more than one year. Normally, you can’t deduct these types of capital expenses until you sell or otherwise dispose of the business. However, a special tax rule allows you to deduct up to $5,000 in start-up expenses the first year you are in business, and then deduct the remainder, if any, in equal amounts over the next 15 years. (IRC Sec. 195.)

Should I Reveal My Invention to Attorney?

Dear Rich: I have a series of inventions, but for right now my only focus is one and it is one of rather strong global consequence. Which is a big statement to make I know, but I also know what it means for global health. I am feeling trapped just by my ignorance of the best way to protect myself and even though I am going to an I.P. lawyer tomorrow the intimidation factor is quite strong. I know enough to inquire of the attorney's engineering background, patent experience and a full quote as well what payment arrangements would be expected and a reasonable expectation of a timeline. I do not really intend to reveal what it is I have as I am so afraid of losing the control of it, it's that attractive. The application is industrial in nature and affects every single exhaust source in the world. I realize you will read this most likely after my initial meeting but I intend to basically interview this lawyer, test the waters and listen closely. We're not sure what your question is, but we assume it has to do with whether you should (or when you should) make invention disclosures to an attorney. We know that many inventors see attorneys and manufacturers as wolves in corporate clothing and although we don't agree, we understand the paranoia. We're reminded of David Mamet's 1992 movie, The Water Engine, in which the creator of a machine that ran on water -- loosely based on the tale of these inventors -- was double crossed by crooked patent attorneys. The inventor had the last laugh (spoiler alert) when he prevented any commercialization of his invention and his patent drawings turned to dust in an attic.
Invention = disclosure. At some point every inventor who wants to commercialize an invention must make disclosures. These disclosures may be to the patent office, to business partners, to attorneys, or to manufacturers. Even if you seek to protect your invention under trade secrecy law, you will need to disclose it to others under the protection of a nondisclosure agreement.
Attorneys and disclosures. There is no reason you must disclose your invention at your preliminary meeting with your patent attorney. But if you retain this attorney, you will have to disclose your invention. Otherwise the attorney cannot properly assess its value and the protection it requires. Your communications with the attorney are privileged, meaning that unless you authorize publication, the attorney cannot disclose what you say. (BTW, USPTO rules establish confidentiality requirements for patent agents.) One situation in which you must make a public disclosure is if a patent application is filed. Unless you do not plan on filing foreign applications, your U.S. patent application will be published eighteen months after you file. Alternatively, if the patent is granted, it will also be published.
The trick with disclosures ... We believe that proper precautions should be taken when making invention disclosures. Maintain your information with secrecy and only disclose it under the protection of privilege, or nondisclosure agreements. But, perhaps more importantly, try to use personal radar to determine whether you can trust those to whom you have made disclosures. For example, prolific inventor Maurice Kanbar had a strong 35-year relationship with his patent attorney, Mike Ebert. In his book, Secrets from an Inventor’s Notebook,  Kanbar wrote:

“Most basically, you need to be able to communicate with your attorney. I can call Mike on the phone, describe my idea and detail its mechanics and Mike will ‘get it’ instantly and start writing it up. If an attorney has a different understanding of your invention, or if he or she doesn’t quickly get your drift, go elsewhere.”

Must Ex-Employee Disclose Post-Employment Inventions?

Dear Rich: Can an employer in California require an ex-employee to disclose all inventions created after the employment has ended. I've been asked to sign an agreement that requires me to disclose all inventions I create even for a year after I leave the company? The Dear Rich Staff is always fascinated by post-termination provisions. Yes, they are usually insidious, over-reaching, poorly drafted, and a desperate attempt to assert control by the legal-capitalist puppet-masters. But there's also an element of hopefulness to them. After all the employer sees some kind of future for you. So, when you get that call from the HR department and you start to see pink, remember that the employer who is about to end your career also has enough faith in you to pursue you for months after you've cleaned out your desk.
Right, you had a question. We can't say for sure whether your post-termination clause is enforceable but we can give you some background. California's Labor Code Secs. 2870-72 sets the rules for some invention disclosures. That law prohibits the employer from claiming rights to inventions you create on your own time with your own supplies and equipment. It also permits an employer to require employee disclosures of all inventions created during the course of employment. Unfortunately, it doesn't say anything about disclosures made after employment is terminated.
Two cases that shed a little light. In a 2006 case, STMicroelectronics v. Harari, a federal court indicated that California's disclosure requirements could be construed broadly for purposes of protecting an employer's trade secrets (although it didn't specifically address post-termination provisions.) In Yield Dynamics v. Tea Systems, a California Court of Appeal looked at a post-termination disclosure and ruled that an ex-employee had honored it. Again, the court didn't specifically address whether such clauses are always enforceable.
California policy. We think that a California court will consider it unenforceable if the provision is primarily being used as a means of preventing you from competing (that is, like a noncompetition clause). If a court considers it as a legitimate attempt by the employer to preserve company trade secrets, it is more likely to be enforced. The factors that are likely to tip the decision are the length of the provision (generally the longer, the less enforceable), the industry, or category of technology or invention involved (in some industries such as high-tech, trade secrets are short-lived), and the relative behavior of the parties (for example, it would be less enforceable if the employer customarily uses this provision to hassle ex-employees). We also think this is something you should make your new employer aware of as you want to avoid disclosing any newly acquired trade secrets. It's also the kind of thing you may want to consider hiring an attorney for an opinion.

Can an Inventor Ditch Her Investors?

Dear Rich: I entered into a corporate agreement with someone who had a patent pending idea. After a year of back and forth, we finally started a corporation in February 2010. In total we spent 1 year talking about creating a corporation together and 1.5 years involved in the corporation; she always kept meeting the next big investor at the club where she worked and would drop me until the investor lost interest. As per our agreement, she was to bring the patent into the corporation and I was to bring the business management and necessary prototyping funding. In the agreement, I was getting 38% of the company, she was getting the remainder. At the this point, the patent is close to being finalized, the trademark and slogan are now done, and the prototyping is virtually done. Unfortunately, she now wants to terminate the agreement and is going around me and telling the patent attorney and others not to speak with me. Her certified termination letter to me states nothing in regard to the amount of time, money, and work I have put into our company. We have a corporation formed with an operating agreement clearly indicating our roles and percentages. She now has amnesia and says she never agreed to give me part of the patent even though she has the original contract and corporate operating agreement. Ideally, I feel she has defaulted from the agreement and loses any rights whatsoever on the patent. This would have been the case had done something similar; I would lose my investment, work, time, and ownership if I defaulted and acted unethically behind her back. How should I best handle this situation? What would happen to one of the entrepreneurs on Shark Tank if they tried to do this to one of the Sharks? Please don't ask the Dear Rich Staff hypothetical questions about reality TV shows. We're not equipped to answer. It's not so much that we're old and out of touch (which is true), it's just that after the first season of Survivor -- the one where Susan and Richard got on each other's nerves ("Your inability to admit your failures without going into a whiney speech makes you a bit of a loser in life ...") -- we decided that the human race had created a fork in the road and we would take the path without reality TV.
Right, you had a question. The resolution of your problem depends on two things: your paperwork and the amount of money each party is willing to spend on a legal battle. Your lawyer needs to review the initial agreement, the corporate formation documents, and hopefully, if there is one, the assignment of patent rights. Even if there is no assignment to the corporation, your lawyer may still be able to force the transfer of rights (or at least a financial judgment tied to the value of the patent) if the remaining paperwork conclusively proves that the inventor was going to hand over the invention. In any case, based on the facts in your letter, it appears as if this matter is headed for some legal martial arts so we urge you to see an attorney ASAP.
Alternative courses of action. If you have an arbitration clause in your agreement, that may enable you to resolve the matter quicker, or you could always ask for arbitration if the inventor is willing to agree. More importantly, have you evaluated the patent's commercial potential? We know that you believe in the patent so much so that you're willing to fight about it, but the objectivity of a third-party evaluation my save you a lot of time and effort. As you may be aware, it's estimated that 50% of patent applications     never become patents and of those that do get issued, less than 2% are commercialized (offered for sale). (We're not sure how reliable these statistics are but they give you an idea.) In other words if the idea is uncommercial, its possible that your inventor friend is offering you a chance to walk away from your obligations without any more risk or investment. That may be a better choice than being trapped in a reality TV show with your so-called "partner."

The Lawyer Who Invented Copying

Wow are we annoyed! We missed celebrating Chester Carlson's 100th birthday last month. Oh well. Here's an article we recently wrote about  one of the coolest inventors ever.
Snazzy inventions aren’t just for science geeks and movies about time travel—they also changed the way that law offices did business in the twentieth century. The ballpoint pen made it easier to sign contracts, by eliminating attorney’s fountain pens and inkwells. Post-Its made it possible to flag legal errors and provide handy “sign here” notes. Liquid Paper enabled secretaries to make corrections (instead of retyping whole briefs), the Rolodex simplified keeping client information, and, of course, Scotch tape enabled lawyers to tape together legal bills after clients ripped them to shreds.
But one invention—the Xerox 914—turned out to be the most profitable device to drop into the law office. And surprise, surprise, it was invented by an attorney.
Like many people who worked with legal documents, Chester Carlson was frustrated by inefficiency. Back in the early 1930s before he became a lawyer, Carlson worked in the patent department of Bell Laboratories. He quickly tired of copying patents using carbon paper. The reproductions were time-consuming and prone to errors. (For those too young to remember, copies used to be made by jamming sheets of carbon paper between sheets of paper, stuffing them into a typewriter, and typing firmly enough so that the carbon made imprints—then swearing up a storm if there was a typo.)
At about the same time, Carlson’s hypercritical mother-in-law moved into his apartment. To avoid her unpleasant nightly tirades, Carlson enrolled in law school. While hand-copying passages from law books one night, Carlson again ran into the same frustration. Why wasn’t there a simple method of reproducing copies on paper? Carlson began to pursue an obscure idea—a process that would fuse fine black powder to paper using electrostatic charges. Carlson originally called his process “electron photography,” and then nicknamed it xerography (from the Greek words xeros (dry) and graphein (writing).
In 1937, by which time he was a patent attorney, Carlson perfected his theory and used his legal drafting skills to patent his revolutionary process. But he still had no actual proof that it worked. He offered his patent to IBM for a $10,000 advance and 5% royalty—in hindsight, one of the best offers of the twentieth century—but IBM passed. (Twenty years later, IBM still failed to see the potential when it reviewed the first Xerox copier and concluded that the device “has no future in the office copying market.” Ouch!)
It wasn’t until 1945 that Carlson partnered up with a nonprofit R&D firm in Ohio, which improved on the invention and licensed manufacturing rights to the Haloid Company, a tiny photographic paper manufacturer in Rochester, New York. Things dragged on until the mid-1950s when—just as Carlson’s initial patents were expiring—the Haloid Company (now renamed Xerox) perfected
Carlson’s process and tested it in nearby offices. Xerox knew it had a hit when the testing companies asked to keep their demo machines.
The debut of the Xerox 914 was one of those rare moments in inventing history when a device transforms the environment in which it is placed. Xerox believed that businesses would use the 914 primarily to make duplicates of outgoing correspondence. They never imagined that employees—no longer encumbered by messy and time-consuming copies—would use it for internal document reproduction, such as memos, reports, newsletters, and even personal documents or their faces and other body parts. The result was an explosion of office and personal copying. Within seven years of its introduction, Xerox was the 15th largest publicly owned company in the United States.
It’s said that the business of law is really about selling paper to clients; and the Xerox machine put that principle into overdrive. The law firms devised a clever system of markups. Initially, they leased copiers and paid per copy, allowing them to mark up and pass along those charges to clients. But even after law firms began to own their photocopiers, they retained the per-copy charges for clients. A few cents per copy may not seem like much at first, but hey, what if everyone is suddenly buried in paper?
And buried they are. Consider, for example, when one business sues another. As a normal part of the pretrial discovery process, in which each side asks to see evidence held by the other, attorneys review the other side’s relevant memos, phone records, financial records, and other documents. With piles more photocopied documents at each business, however, it creates an exponential increase in the size of discovery requests—literally boxes, and sometimes trucks of documents being sent back and forth. To deal with this paper explosion, law firms added more staff, thereby increasing the billing. In short, Xerox had created a cash machine for law firms.
The copier also triggered illegal activity (always a boon for lawyers). For example, there was office espionage, loss of trade secrets, and even fraud (for those who understood how to create fake photocopied documentation). The Xerox machine launched many copyright lawsuits: for example, a series of cases where authors and publishers protested the fact that people—students and teachers, in particular— were no longer buying their books and scholarly journals, but simply slapping a borrowed original onto a copy machine. Legislators took the device into consideration when creating the 1976 Copyright Act, by including provisions on academic photocopying. Although we now take the photocopier for granted, it was essentially the original VCR or Napster—a device that, for the first time, put infringement into the hands of ordinary Americans.
Carlson earned millions from Xerox, but never measured success by money. He had spent his childhood in poverty—during his last year in high school he lived in a converted chicken coop—and had a goal to rid himself of his wealth before he died. He spent his final years getting rid of his royalties via charitable contributions and pursuing spiritual goals. His process—which remains virtually unmodified from his 1937 patent—continues to supply copies to his legal brethren via photocopiers, laser printers, and fax machines.

Nonobvious Prior Art Claims

Dear Rich: Say there is a known prior art that currently has a patent pending and I file for a provisional stating claims with which I believe are nonobvious to the prior art. [Hi Readers. Before we lose you in a torrent of inventor-speak, allow us to provide a short translation.  This inventor has come up with something that he believes to be new and not obvious (nonobvious) to those in the field of invention. (These two standards --  new and nonobvious -- are the basis for getting a patent.) Another inventor has filed a patent application for a related invention (the "patent pending" reference).  In summary, the inventor doesn't believe his invention is substantially similar to the existing technology in that patent application (or "prior art"). What follows are his questions and our answers.
1. Can they accuse me of infringement and take me to court? The other inventors cannot sue you for patent infringement until their patent is granted. If 18 months have passed since the other inventors filed a patent application and the application has been published, they can notify you about the application and then sue you for any infringements that occurred after notification. (We've discussed that previously here). In either case, the actual lawsuit cannot be filed until the patent is granted. Whether the inventor succeeds obviously depends on whether you guessed right about the prior art.
2. Can I sell during my provisional status and if or when do I have to stop selling because there is a known prior art with a patent pending status? You can sell any time you want but if you sell your invention and it infringes, you'll be liable once the other patent is granted.
3. If this invention which I believe is nonobvious to the prior art shows that it has commercial value, but there's a known prior art, is it worth filing a non-provisional after 8-12 months? We're kind of going around in circles. If you have commercial potential and you're concerned about infringement (or issues of prior art) you should bring in a patent attorney to provide an opinion before you waste your money or time on the pursuit. Keep in mind that whether you're right or wrong about the prior art, the other inventor can come after you if there's enough of a case to get in court. And then you'll be spending money on a court battle when you could be devoting the time and money to some other great new idea.
4. If my invention is non-obvious to the prior art will a patent be issued and do I still have to license the basic idea of the prior art? If your invention is new, nonobvious and meets all the patent requirements, you're entitled to a patent. Keep in mind, these determinations are tied to the interpretation of the patent claims, explained here.) If the invention doesn't infringe, do you have to license rights from the other inventor? No.
5. I read in your book that changing something small may be considered as a novelty and may be considered patentable (if I am correct). If so, do you have to go to court to prove that, or can the examiner just approve it, and when a patent is issued to the nonobvious then you are protected? In some cases, small changes are enough to get a patent, in other cases, no. If an examiner feels the application is sufficient, you'll get your patent. Alas, that patent can always be challenged and then you may have to deal with two battles, a patent reexamination and a court case.