By Dennis Crouch
Sheridan v. US (3rd Cir. 2014)
Sheridan’s Patent No. 7,415,982 covers a pipe for smokeless tobacco that he alleges is being infringed to the tune of $20 billion over the past several years. Now, rather than filing suit against the infringers, Sheridan wrote-off the loss and then claimed that loss on his income tax returns. The IRS disagreed – finding that Sheridan had failed to establish any loss actually sustained and served him with a notice of deficiency for taxes owed of $40k.
Sheridan then filed a pro se complaint in federal court seeking an injunction against the IRS from any further audits or tax collection and an order directing a refund. District court sided with the IRS – finding that it lacked subject matter jurisdiction over the case. On appeal, the 3rd Circuit affirmed – citing the Anti-Injunction Act.
The Anti–Injunction Act, 26 U.S.C. § 7421(a), states that, with limited exceptions not applicable here, “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed.” Although the Act does not apply if it is clear that under no circumstances could the Government ultimately prevail in its claim of tax liability, Enochs v. Williams Packing & Navigation Co., 370 U.S. 1, 7 (1962), the exception does not apply to Sheridan’s case. The Act likewise would not apply if Sheridan had no alternative remedy, see South Carolina v. Regan, 465 U.S. 367, 378 (1984), but he could either petition the Tax Court pursuant to 26 U.S.C. § 6213 or, after paying the assessed taxes, file a refund suit under 26 U.S.C. § 7422(a). Thus, the Act applies in this case, and the District Court lacked subject matter jurisdiction to entertain Sheridan’s claims regarding the tax deficiency identified in his 2009, 2010, and 2011 returns.
The court also ridiculed Sheridan – calling his claim of “$20 billion in losses constitutes a tax for which he is owed a refund is nonsensical.”
I don’t know the facts here, but Sheridan’s claim of $20 billion in losses for the smokeless tobacco pipe may well be nonsensical. However, what’s not so nonsensical is the general notion that written-off patent infringement constitutes a business loss that could serve as the basis of a tax deduction. Would an opinion of counsel with supporting documents be sufficient to establish that the loss (past infringement) was real?
Professor Larrimore Ouellette suggested that we review 26 U.S.C 186 (link to law.cornell.edu). That statute provides that a taxpayer may deduct a written-off “compensable injury,” including “injuries sustained as a result of an infringement of a patent issued by the United States.”
Excellent pointer, but it shows why deductibility is not possible here (if my understanding is correct). It allows one to make a deduction for losses where one has registered compensation (by judgment, settlement) in one’s income.
I was just thinking about it guys and it seems likely that this guy believes his patent covers the “vaping” apparatuses common now. If that is so, his 20 billy isn’t probably all that outrageous.
A good point – have any contingency litigators pulled this guy’s contact info out of CM/ECF yet? Maybe a big payday out there for someone..
We really need to MM.
Sarah states “We really need to MM.”
LOL – that was so Sarah.
DC what’s not so nonsensical is the general notion that written-off patent infringement constitutes a business loss that could serve as the basis of a tax deduction
I don’t think you are allowed to “write off” patent royalties or damages that you wish you had tried to collect but never did. Why in the world would we allow people to do that?
Would an opinion of counsel with supporting documents be sufficient to establish that the loss (past infringement) was real?
Let’s hope not. “Hey, laywer guy, here’s $40,000. Write me an opinion saying that so many people are infringing my junk patents that I’m entitled to a $20 billion dollar tax write off.”
The court also ridiculed Sheridan – calling his claim of “$20 billion in losses constitutes a tax for which he is owed a refund is nonsensical.”
He should have been sanctioned for wasting the court’s time. Shall we dip into the file history of his pipe patent and see what other marvelous assertions this character might have made before the PTO?
MM: “Hey, laywer [sic] guy, here’s $40,000. Write me an opinion saying that so many people are infringing my junk patents that I’m entitled to a $20 billion dollar tax write off.”
That would be silly. Why pay someone $40K to a lawyer in order to avoid paying $40K to the IRS? If I understand taxes at all (I confess I’m no expert) writing off $20B in such “losses” would at best entitle the patent owner to a refund of taxes paid (or offset taxes owed) – it would not entitle the patent owner to a credit of $20B. Nevertheless, it stands to reason that losses would have to be proven.
That would be silly.
Depends on your tax liability. People pay tax attorneys every year to minimize their tax liability. $40,000 a year is nothing if it ends up saving you $100,000 in taxes.
Shall we dip into the file history of his pipe patent and see what other marvelous assertions this character might have made before the PTO?
One of his assertions is that he has been repeatedly and involuntarily committed due to a mental illness that renders him incapable of making rational and informed decisions regarding his personal affairs.
I wish I was making this up. But it does explain rather a lot.
I wish I was making this up.
No. Way.
If you read per curiam opinion, you’ll note that Professor Crouch used more words in his blog post than did the 3rd Circuit in rendering its judgment. There is more meat in the title of this blog than in either the opinion or the blog post, unless you are interested in the Anti-Injunction Act (i.e. the “Other AIA”).
Aside from the fact that this plaintiff appears to be a crackpot, I am not sure you could even establish his theory of recovery under federal tax law. Deductible expenses must be paid or incurred in order to offset income; lost anticipated profits are not the same as expenses paid or incurred. IRC 162. Likewise, a mere judgment of infringement is not income to the plaintiff, but rather the amount of recovery actually received, when collected. IRC 61.
If the plaintiff in this case is claiming a capital loss for his self-created patent (I haven’t pulled the complaint yet, and the district court opinion is as limited as the COA), he is limited to either amortization of his basis over the life of the patent or the alternative cost recovery under the income forecast method. In any event he cannot claim a loss in excess of basis.
Perhaps if the taxpayer acquired the patent in a IRC 197 context (i.e not self-created and acquired in connection with a trade or business) or otherwise had substantial unrecovered basis for self-created IP under IRC 167, and it subsequently became “worthless” due to widespread and unrestrained infringement, one could claim an ordinary loss for abandonment of worthless property under IRC 165. In any event the loss would be limited to the taxpayers adjusted basis. This may be where Sullivan was trying to go with his “theft” allegations.
I’d be interested to see what part of the code would justify Professor Crouch’s suggestion that a “written-off patent infringement constitutes a business loss that could serve as the basis of a tax deduction.” This is different from deducting legla fees actually incurred – this suggests that if a patent holder foregoes a claim of potential recover, an actual loss has been generated. I don’t even think an adjudication of infringement creates an actual loss to the taxpayer-patentee.
Lesson learned (if any): if you plan to follow the “Sullivan Strategy,” at the very least hire a lawyer. Then, at a minimum, you can deduct his bills.
How about this — What if I can prove lost-profits due to infringement?
What if I can prove lost-profits due to infringement?
Then you might care to sue your infringer instead of the IRS.
Why is it even a reasonable subject for debate that someone could write off revenue that he can “prove” he would have gotten had he tried? It’s doubly silly when making out that proof is the very means of realizing the revenue in court.
How about this — What if I can prove lost-profits due to infringement?
Dennis, you should walk down the hall and talk to the tax professor. You’re missing some basics here. For tax purposes, you can’t “lose” something you never had. Mr. Shaw’s detailed explanation looks exactly right to me – even the most aggressive approach is only going to let you “write off” the capitalized costs of acquiring the patent.
LB Said: For tax purposes, you can’t “lose” something you never had.
DC Responds: If we use the property model for patent rights, then the infringement is a degradation of those rights and an accountable loss. Its like if you had a trucking business and someone crashed into your truck who was unable to pay for the damage. In that case, you had something (a whole truck) and now you have a damaged truck. Here, you had the exclusive rights associated with patent ownership but the infringement injures those rights.
@Dennis / @LB: This is true, but the tax treatment of a recovery by way of settlement agreement or final judgment is often determined by the wording of the complaint and the text of the judgment or settlement agreement.
Where the recovery is based lost profits or reasonable royalty, the recovery is typically characterized as ordinary income.
Where the recovery is based on damage to or missapropriation of the patent itself (assumed to be a capital asset), the recovery may be characterized as a capital gain (as if the damage/misappropriation was deemed to be a disposition of the asset).
For a non-corporate litigant or a patentee with a high-basis patent, it can be smart to preserve the second theory of recovery in the alternative in the complaint as well as all the way through to final adjudication. Take a look at T.C. Memo. 2009-191, which has a good analysis of this potential distinction.
Going back to Sullivan’s case, he didn’t actually recovery anything or even prove an entitlement to such a recovery. Even under your theory of an “accountable loss” due to the degradation in the asset (somewhat of a “mark-to-market” theory), I don’t think you can say that damage to a truck that cost $40k (your basis) resulted in $1mm of loss.. at most, you write the value of the truck down to $0 and take a $40k loss (the basis limitation rule). Sure, you could sue the other driver for “consequential damages” i.e. your business losses stemming from the loss of use of the asset (the truck), but is merely a theory of recovery – it doesn’t equate to a realized tax loss.
Your analogy doesn’t work, Prof Crouch, either directly or conceptually.
Directly, in your truck case, you have lost the market value of the truck, which you can write off based either on its original value depreciated or its replacement value. But the closer analogy to what you’re talking about is losing your truck and claiming that that shut down your trucking business the following year, and you are entitled to not only claim for the actual losses, but some hypothetical profits , that you might have made.
Conceptually, I think you’re connecting tangible property issues, perhaps implicitly by way of trademark dilution principles, to patent rights. How is it possible to say that the value of the patent itself has been diminished by the infringement?
Miles asks “ How is it possible to say that the value of the patent itself has been diminished by the infringement?”
Miles to understand what the actual value of a patent is, is to show that such is not only possible – it is essential.
I suggest you read the Constitutional clause and think about the right to exclude. That, my friend IS the value. What you then turn around and do with that value – how you invest that initial value, should not be confused with the patent itself.
If we use the property model for patent rights, then the infringement is a degradation of those rights and an accountable loss.
No it’s not, for a bunch of reasons.
Firstly, infringement doesn’t affect your property rights in any way. The property right is the title to the patent, and the accompanying right to sue on it, which is completely unaffected by any acts of infringement.
Secondly, if anything, widespread infringement increases the value of a patent. People typically infringe patents for profit, and will probably stop on their own if they see no expectation of profit, so they should inherently be more able to pay for the damage than someone who crashes into your truck. “Widespread” infringement means the market for the invention is profitable enough to draw in competition. A patent that nobody wants to practice is worthless.
Thirdly, an established market for the patented product makes it more worthwhile to sue for an injunction, even if the infringer is penniless, if by so doing you can get exclusivity in that market.
Fourthly, if you can’t afford counsel, you can sell the patent, which is now much more valuable because of the ready and identifiable source of royalties.
Finally, if you were just sitting on your patent anyway, and weren’t going to sue anybody for infringement regardless of what they did, the infringement makes you no poorer.
Interesting. Thank you for these comments.
We do talk about the de facto reality that a patent merely confers a right to sue on the patent. But, I see that as a narrow and overly cynical view of patent rights.
Would it not be better to say that the right to sue comes from the inalienable right to seek government redress?
Sure standing rules must be met (for the plaintiff here as having the right to bring suit – not always present in some licencing deals) – but that is not the same (at all) as saying that the property right in a patent is only (or mainly, or even chiefly) the right to sue. So for IANAE to say that infringement does not affect your property right is an extreme and gross error. It is not only a narrow and overly cynical view – it is an incomplete and incorrect view.
His second point is likewise cockeyed. It is not the value of the patent that changes, but the level of possible recovery that changes with the level of infringement. Damages may relate to patent value but are separate and distinct.
His fourth point is actually the source of the “troll” phenomenom – and something that Malcolm blurts out incorrectly without proof of any kind such as studies or even polls – the typical troll is not one who files and prosecutes patents – but rather was one who bought them from those that filed and/or prosecuted them. This was shown previously with links to a study by Peter Zura of the late 271 blog. As such, it is unclear what IANAE is trying to say with his fourth point. Is he advocating that the creation of “Trolls” is a good thing? a necessary thing?
Finally his third and last points are nothing but truisms and I am also not certain what they add to the conversation.
I see IANAE beat me to the punch on the no harm.
“But, I see that as a narrow and overly cynical view of patent rights.”
I also see that D is a fan of the delusional view of patent rights. He probably even passes it on to some students knowingly or not.
6,
(sigh) you call anything outside of your belief system – no matter how grounded in fact and actual law “delusional”
You are the very ‘religious’ thing that you have previously posted that you despise.
Your belief system hinges (or more accurately is unhinged) on what you want the law and facts to be – not on what they actually are.
Too bad. So sad. For you.
anon: for IANAE to say that infringement does not affect your property right is an extreme and gross error. It is not only a narrow and overly cynical view – it is an incomplete and incorrect view.
It’s also a “view” ripped out of the context of the discussion (comparing the value lost when a relied-upon truck has been destroyed versus the value lost when an unasserted patent has been infringed) but I’ll let IANAE address that if he chooses.
Malcolm yammers “It’s also a “view” ripped out of the context”
No, I don’t see a poll that supports that, so that is just your opinion and it is only poo poo.
/sardonic mirror off
(and btw, if you want to have a conversation, well, you are wrong and I have the context perfectly handled, but thanks anyway)
“If we use the property model for patent rights, then the infringement is a degradation of those rights and an accountable loss. Its like if you had a trucking business and someone crashed into your truck who was unable to pay for the damage. In that case, you had something (a whole truck) and now you have a damaged truck. ”
Except here your patent property is still fully functional and in one piece. Ready for you to go sue someone with. If you try to act like infringement is “damaging” to your right to exclude I’d love to see them lol you right out of court just so that we get a sense of just how laughable that “theory” was from the beginning. Your right to exclude is still whole.
/double facepalm…
6 – try reading what you cut and pasted: infringement in the hypo is a given. If you have infringement, than you are not excluding someone who is violating that right to exclude, and your right to exclude CANNOT be whole.
You are not even bothering to read and understand the very words you are posting.
@Dennis – I agree that is one of the many critical questions this guy should have asked before filing his complaint. Just because “you can” doesn’t mean “you have” – if I prove to the IRS that I could earn an additional $20k a year mowing lawns in my neighborhood after I leave the office, should they tax me on that “income”? And if I refrain from firing up the old John Deere, can I then claim a loss?
If he _had_ proved out his lost profits (and he, not the IRS, bears the burden on that point), then any damages awarded and recovered would be income. An uncollectible judgment could be written off as a business bad debt (IRC 166) but this might also require the amount of the judgment to have previously been reported as income (presumably in the case of an accrual-basis taxpayer).
This is a great topic to bring up and often underrepresented in both IP and Litigation circles. In the tax world, generally you can deduct a capital loss, an ordinary loss, or an expense (where permitted). Just because the Patent Act provides for “lost profits” as a measure of patent infringement damages does not shoehorn the concept of a patentee’s “losses” into one of those three categories.
what’s not so nonsensical is the general notion that written-off patent infringement constitutes a business loss that could serve as the basis of a tax deduction.
But surely not just the dollar figure but also his means of computation is absurd. If he sunk costs into patent prosecution, I can see that being regarded as a capital investment that is lost (not to the tune of $20bn). If he stockpiled inventory that was unsold and needed to written off, I can see that as a loss– of the inventory not predicted profit upon it (in which case, the reason for non-sale and question of infringement is irrelevant). But in what context can a taxpayer deduct *anticipated profits* to say they had *actual losses*? That’s absurd and would have no business paying any tax.
I’m Not a Tax Lawyer, but I would expect that this sort of “loss” could only be written off if the business was an accrual-basis taxpayer, and had at some point booked relevant income. In my limited understanding from law-school “Income Tax,” a cash-basis taxpayer doesn’t get to take a loss for write-offs of bad-debts and the like, he just doesn’t book the income. Accrual-basis taxpayers need the ability to write such things off because they might be booked as income in one year and become worthless in a later year.
As to inventory or other expense items that he might have purchased in anticipation of sales, those would have already been booked as expenses, which would have reduced his income in whatever year he bought them. I can see this affecting the value of his patents if he’d capitalized those costs, but I don’t think you can take depreciation down to -$20bn.
How surprising is it that a pro se could be spectacularly wrong about the law?
Interesting idea. I don’t know enough about tax law to provide any insight, but if I were the IRS my initial inclination (before checking the tax rules myself) would be to say, “The IRS is not in a position to determine whether the patent is valid and infringed. If you think your patent is infringed, go to court, get it adjudicated as infringed, and have the court set the amount of damages. If you can’t collect, then you can call the uncollected amount a tax write-off. Until then, as far we’re concerned, it’s speculative and we won’t recognize it.”
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