The University of Michigan’s policy on the distribution of tech transfer licensing revenues provides that a percentage of net revenues are shared with U-M employees that are inventors or developers (“inventors”) of the licensed patent rights, materials, software, or other licensed inventions. Occasionally, a U-M inventor will desire to redirect (or “waive”) all or a portion of his or her share of revenues to a U-M entity.

Discussed below are the three separate scenarios under which redirections may be made (the redirection may be an up-front redirection of the entire royalty stream or a redirection on a periodic basis, and the inventor may make the redirection to an account that the inventor either controls or does not control). The tax consequences of any of these types of actions are the responsibility of the inventor and the inventor therefore needs to consult his or her own tax advisor. However the following describes how U-M will treat such redirections.

Redirection of the Inventor’s Entire Right in the Royalty Stream

(Irrevocable Redirection) – No IRS Form 1099 issued

An inventor may redirect his or her inventor’s share of agreement revenues without receiving a Form 1099 income statement for these revenues if both of the following are met:

  1. The revenues are not specifically designated to be transferred to an account under the control of that inventor or to support the activities of that inventor (even though the account is not directly under his or her control), and instead are designated to a U-M general fund or a U-M Unit; and
  2. The inventor’s entire share of the complete revenue stream (or a specified percentage of the inventor’s entire stream, say 25%) (whatever the stream might provide in the future) of current and future revenues is included in the redirection.

The redirection is irrevocable because the inventor is redirecting the entire royalty stream (or portion thereof) up front. Aside from the original designation, the inventor has no control over future use of the revenues, so the inventor may not change the redirection (e.g., to a different unit). There will be no further transactions, and the inventor will receive no further documentation from the University (unless the inventor has redirected a specified percentage of the royalty stream, which will be treated in accordance with the section below Periodic Redirection of Specific Amounts of Revenue).

The IRS might allow for a deduction for a charitable donation even though there will be no income attributed to the inventor. When such a redirection is made, U-M will consult with the inventor or the inventor’s tax advisor in order to determine whether such a deduction might be possible, and if so to determine whether U-M should issue a gift receipt to the inventor.

Periodic Redirection of Specific Amounts of Revenue

(Revocable Redirection) – IRS Form 1099 issued, Gift Receipt Issued

If the inventor’s share of licensing revenues is not specifically designated to be transferred to an account under the control of that inventor or to support the activities of that inventor (same requirement stated above), an inventor may redirect her right to the inventor’s share on a periodic or ad hoc basis (e.g., annually) or have a standing and revocable agreement to redirect revenues with the following consequences:

  • U-M will generate an annual IRS Form 1099 income statement exactly as though the inventor had received the revenue personally
  • U-M will provide a gift receipt in the same amount of the Form 1099 to the inventor to potentially allow the inventor to offset this 1099 income. Whether the gift receipt will fully offset this income is dependent upon the inventor’s tax situation (e.g., as limited by Schedule A), so inventors are strongly encouraged to seek tax advice before making this waiver to determine if a tax liability will occur.

Procedure

The inventor will have to instruct U-M annually (though standing instructions are acceptable) as to the redirection of cash (specific amounts of revenues) to U-M. Each redirected amount is a separate transaction, and the amount of each transaction may differ (and may range from $0 up to the total amount due to the inventor for the given period). This type of redirection is revocable in the sense that the inventor may decide annually to not redirect new inventor shares to U-M and may alter the amounts donated. These transactions will take place in each year until the revenue stream has ended.

U-M, with the help of Innovation Partnerships, will issue to the inventor each year:

  1. a single Form 1099 for the amounts redirected in that year and (assuming that the redirection legally qualifies as a donation)
  2. a corresponding gift receipt for the same amount.

U-M Innovation Partnerships will instruct the Office of University Development to issue a gift receipt for the applicable amount of the redirection.

Redirection of Revenues to Account over which Inventor has Control on Periodic Basis

(Revocable Redirection) – IRS Form 1099 issued, No Gift Receipt Issued

Regardless of whether the inventor redirects the entire royalty stream or any amount thereof, an inventor may redirect royalties to an account under the control of that inventor or designated specifically to support the activities of the person making the redirection, with the following consequences:

  • A yearly IRS Form 1099 statement will be generated exactly as though the inventor had received the revenue personally
  • U-M will NOT issue a gift receipt

Although inventors are strongly encouraged to seek tax advice before making this redirection, the IRS will likely require the inventor to declare all the Form 1099 income as personal income, without any offsetting charitable tax deduction. In such instances, U-M will be required to issue the inventor Form 1099 but U-M will not provide the inventor with a gift receipt.

Estimated Tax Payments by Individual Inventors

Although inventors receiving shares of U-M licensing revenues must seek their own professional tax advice, following is some general information that may provide a small framework that could be helpful when inventors seek that advice or are selecting the tax professional.

Taxes must be paid as one earns or receives income during the year, either through withholding or estimated tax payments. If an earner receives salaries and wages, the earner can avoid having to pay estimated tax on those salaries and wages by instructing the employer (e.g., U-M) to withhold tax from earnings. This is done through a Form W-4, and most employees are accustomed to completing these forms. If the amount of income tax withheld from one’s salary or other income is not enough, or if one receives income such as interest, dividends, alimony, self-employment income, capital gains, prizes and awards, one may have to make estimated tax payments. If one does not pay enough tax through withholding and estimated tax payments (or if the IRS considers those payments to be late), the IRS may charge a penalty.

Estimated taxes must often be paid with respect to recurring sharing of licensing revenues from U-M under applicable policy, because U-M does not withhold tax from those amounts. We understand for small amounts of tax liability (e.g., $1,000 or less), an inventor may not be required to make estimated tax payments at all. But if an inventor is required to make estimated tax payments, the inventor’s tax advisor will ask to see the inventor’s tax returns for the past several years, a listing of the dates the inventor has received royalty sharing from U-M, and the amounts of each payment.

We understand that the tax advisor will often assist in placing the inventor into a safe harbor position by calculating an amount of estimated taxes to pay each quarter of the upcoming year. If an individual properly pays estimated taxes in an amount of 110% of the prior year’s applicable taxes on this royalty income, then the safe harbor will apply and no additional estimated taxes need to be paid – and no penalties would need to be paid, even if the estimated taxes do not cover the actual taxes at tax time. (A different percentage may apply based upon the inventor’s adjusted gross income, further emphasizing the need to seek your own advice.)

Whether an inventor is computing taxes for a first year of an inventor royalty sharing or determining estimated taxes for second or subsequent years, the tax professional in all likelihood will advise the inventor that taxable income is attributable to an individual only once the individual has constructive receipt of the funds. We believe that the date of the inventor’s constructive receipt of the inventor’s share of royalties is not until the date U-M actually pays the inventor’s share to the inventor, and we are not aware of any other applicable date, absent unusual circumstances.

Once the total amount of estimated taxes has been calculated based upon the prior year’s actual taxes, the total is then divided into four. One of those equal payments must be made quarterly by the end of each calendar quarter, as required by the IRS.

Again, there can be special circumstances that are not recognzied by these suggestions (e.g., repeated, annual payments once per year), that a tax advisor will recognize and advise upon. Inventors should not consider this to be tax advice, but should seek consultation and advice from an individual tax advisor. Circumstances may vary, even as among inventors at U-M.

For More Information

For questions regarding the distribution of revenue, please contact Diane Rice.