In the ever-evolving landscape of tax regulation and compliance, a significant development has emerged regarding the deduction and capitalization of expenditures related to patent infringement litigation and other intangible assets. This update highlights key insights from recent court rulings and IRS positions that may affect businesses engaged in trade or business activities, particularly in the pharmaceutical industry.

The Internal Revenue Code (IRC) §162(a) permits deductions for all ordinary and necessary expenses incurred in carrying on a trade or business. Conversely, §263(a) mandates the capitalization of costs for permanent improvements or betterments to increase the value of property. Specifically, regulations under §1.263(a)-4 provide guidance on capitalizing amounts paid to acquire or create intangibles, including costs related to legal disputes over intangible property rights.

Central to determining the deductibility of litigation expenses is the "origin of the claim" test, established by United States v. Gilmore and further interpreted in subsequent cases. This objective test considers the nature and origin of the claim resulting in the expense, disregarding the taxpayer's motives or the formal titles of pleadings. Generally, legal fees related to business operations are deductible, whereas those tied to capital transactions must be capitalized.

A pivotal case, Mylan, Inc. v. Commissioner, has brought clarity to the treatment of legal fees incurred in patent infringement litigation. The Third Circuit affirmed that expenses from abbreviated new drug application (ANDA) filings are deductible as ordinary and necessary business expenses under §162(a). The court rejected the IRS's broader interpretation of "facilitate" in determining the need to capitalize costs associated with obtaining or creating intangibles.

This ruling is particularly relevant for pharmaceutical companies engaged in ANDA processes, distinguishing between costs that must be capitalized (e.g., preparing notice letters) and those deductible (e.g., defending against patent litigation). The decision underscores the specificity required in assessing whether expenses facilitate the acquisition of an intangible asset.

Taxpayers who have deducted legal fees related to patent litigation may find affirmation in their position, reducing uncertainty. Those who have capitalized such costs might reconsider and evaluate the potential for deducting these expenses moving forward, and consider filing an account method change to claim benefit under Sec. 481(a) for previously capitalized amounts.

A federal district court in Alabama, in the case of National Small Business United v. Yellen, ruled the Corporate Transparency Act (CTA), which mandates businesses to report beneficial ownership information as unconstitutional, siding with the National Small Business Association and other plaintiffs. The court found the act exceeded Congress's authority, arguing it lacked constitutional backing for its broad requirement on businesses to disclose detailed ownership information. Despite recognizing the act's aim to deter financial crimes, the court highlighted its failure to align with constitutional precedents, emphasizing the legislative overreach beyond enumerated powers.

The CTA sought to combat money laundering by requiring over 32 million entities to provide comprehensive details about their owners and, for new entities, their applicants, with strict penalties for noncompliance. However, the court criticized the act for not fitting within Congress's commerce or taxing powers and suggested the possibility of constitutionally acceptable legislation, referencing past laws as examples.

The ruling dismissed the government's defense based on various constitutional powers, focusing on the act's broad scope and its intrusion into areas traditionally governed by state laws.  As of this point, it is unclear whether the Treasury Department's Financial Crimes Enforcement Network (FinCEN) will appeal the decision.  Therefore, until FinCEN issues an official press release or statement, all businesses should continually comply with the BOI filing requirements.  We will provide updates regarding any further developments as they arise.