Petition for Writ of Certiorari — Baker v. Illinois Department of Revenue

Supreme Court, U.S.

\ FIL & D

) 94121 7 VAN 9 1995

OFFICE OF THE CLERK

No.

IN THE

Supreme Court of the United States

OcTOBER TERM, 1994

GEORGE H. BAKER, SR. and BESSIE J. BAKER,

Petitioners,

THE DEPARTMENT OF REVENUE OF

THE STATE OF ILLINOIS, ROGER D. SWEET,

Director, and DEPARTMENT OF REVENUE,

STATE OF ILLINOIS INCOME DIVISION,

JAMES P. PIECZONKA, Administrative Law Judge,

Respondents.

On Petition for Writ of Certiorari to the

Appellate Court of Illinois for the Third District

PETITION FOR WRIT OF CERTIORARI

GEORGE H. BAKER, SR.

BESSIE J. BAKER

Petitioners in propria persona

4211 Simpson Drive, Meadowood

Dunlap, Illinois 61525

(309) 243-5212

4 |

i

FEDERAL QUESTIONS PRESENTED

4,

May the Illinois Department of Revenue attach the sub-

ject matter jurisdiction and tax the payment received by

the inventor in sale of his patent. . . Where all substan-

tial right and interest, including title of ownership, have

been assigned to other persons under constitutional federal

law and the U.S. Code, Title 35—Patents.

2.

Whether the court of appeals decision has violated due

process under federal law. Moreover, has the lower court

decided a federal question contrary and in direct conflict

with long established U.S. Supreme Court precedents.

ii

TABLE OF CONTENTS

FEDERAL QUESTIONS PRESENTED ...... i

TABLE OF AUTHORITIES ................. ili

SC GUY 8 sav viwedsdéaceeebetecns: 1

Bs ree rs es 2

STATEMENT OF THE CASE ............... 2

REASONS FOR GRANTING THE PETITION .. 3

1

Reason For Granting This Writ For Review

Arise From Gross Judicial Error Relating To

The Federal Question Presented.—The Ques-

tion Was Actually Decided.—And Finally, The

Judgment Of The Lower Court Could Not

Have Been Rendered But For Clear Judicial

BAUR oc cvcicsuscsasgenwanescueuetenneses 3

2

The Illinois State Court Of Appeals Has

Decided A Federal Question That Is Express-

ly Clear And In Direct Conflict With Applica-

ble Decisions Of This Court ..............

SUDRCSAL, FOPSGRME 6 aoa tecnnnseatpivsnseses

The Final, But Not Least Reason For

Granting This Petition Is That The Court Of

Appeals Fails To Find Any Non-Federal And

Independent And Adequate Illinois State Law

In Support Of Its Decision ............... 8

CORFUAINE oc cc cccsvesvavesussunesoseeuns 9

PERE I it eiass bate infra

eS Oe eS Or ae

SO Sat

iii

TABLE OF AUTHORITIES

CASES: PAGE

Army & Air Force Exchange Service v. Sheehan,

te EE cis cenebenaneceecesers 8

California v. Krivda, 409 U.S. 33 (1972)....... 9

E.I. du Pont de Nemours and Co. v. United

States, 296 F.Supp. 823 (D. Del. 1969), modi-

fied, 482 F.2d 1052 (8rd Cir. 1971)......... 6

Fox Film Corp. v. Doyal, 286 U.S. 123 (1932)... 7,8

Long v. Lockwood, S.C. Reporter’s ed. 142-148, 151

PT VAceiAbGdeeheses eb deueesbkieceeces >< 7,8

FEO ED A 9

Powerlift, Inc. v. Weatherford Nipple-Up Systems,

871 F.2d 1082 (Fed. Cir. 1989)............. 5

Raley v. Ohio, 360 U.S. 423 (1959)............ 3

Southwestern Bell Tel. Co. v. Oklahoma, 303 U.S.

AES es a ee 3

Waterman v. McKenzie, 138 U.S. 252, 34 L.Ed.

ee Ee MS ON COPED a ccc ccccccsccccce 5, 6, 7, 8

STATUTES:

vik bcuveseesseccavescecses

Be ons Vw bsdubeesscoaeen

a ee

RULES:

Nice wewaeneecneens 5

In THE

Supreme Court of the United States

OcTOBER TERM, 1994

GEORGE H. BAKER, SR. and BESSIE J. BAKER,

Petitioners,

THE DEPARTMENT OF REVENUE OF

THE STATE OF ILLINOIS, ROGER D. SWEET,

Director, and DEPARTMENT OF REVENUE,

STATE OF ILLINOIS INCOME DIVISION,

JAMES P. PIECZONKA, Administrative Law Judge,

Respondents.

On Petition for Writ of Certiorari to the

Appellate Court of Illinois for the Third District

PETITION FOR WRIT OF CERTIORARI

George H. Baker, Sr., discoverer of invention and

patentee, respectfully petitions for issuance of a writ of

certiorari to the Appellate Court of Illinois for the Third

District in this case.

OPINIONS BELOW

In the Illinois Supreme Court the motion to file peti-

tion instanter (App., infra, A-1) was denied on October

Petitioners are Natural persons and United States citizens under

Rule 291).

=~

13, 1994. The decision of the Appellate Court of Illinois

for the Third District (App., B-1 thru B-12) is unreported.

The order of the Circuit Court of the Tenth Judicial Cir-

cuit of Illinois to affirm the decision of the Department

of Revenue (App., C-1 and C-2) is unreported. The Admin-

istrative Hearing Officer Decision is not reported (App.,

D-1 thru D-9).

STATEMENT OF JURISDICTION

The Appellate Court of Illinois entered its judgment on

June 30, 1994. Then following, a petition was filed in the

“state court of last resort” in the Illinois Supreme Court

but denied on October 13, 1994. The jurisdiction consid-

erations of this Court is of the character of substantial

reasons under Rule 10.1(c) and further invoked under 28

U.S.C. sec. 2104.

STATEMENT OF THE CASE

1. In this case, George H. Baker, Sr., made a Special

Appearance at the Administrative Hearing to challenge the

Illinois Department of Revenue jurisdiction over the sub-

ject matter. App., D-5, para. (9). The objection points to

lack of state jurisdiction to tax any compensation received

by the patentee, where by Assignment made transfer to

others all substantial right, title and ownership of his

patent issued to him under constitutional federal laws.

2. The Administrative Hearing Officer failed to discern

the substantial difference between the sale and transfer,

including title ownership, of patent under federal law,

from just a mere license under contract law, where pa-

tent ownership is not transferred to the licensee, but in-

stead, is retained by the licensor.

St DE I OR ETIIT

==

3. Thus, motion to dismiss for lack of jurisdiction over

the subject matter was denied. App., D-5, para. (10).

4. This same jurisdictional point came before the trial

court on administrative review. The local court Order

found that “The decision of the Department of Revenue

is not contrary to the law.” Such a finding made without

a written opinion may be taken as just a handy discre-

tionary procedure used unreasonably to avoid a decision

relative to a constitutional federal question of National

importance raised by the plaintiff.

5. The constitutional federal question was preserved for

appellate review in the Illinois State Appellate Court that

accepted such a question, not before, but should be heard.

See its decision with opinion. App., B-1 thru B-12.

REASONS FOR GRANTING THE PETITION

1.

Reason For Granting This Writ For Review Arise

From Gross Judicial Error Relating To The Federal

Question Presented.—The Question Was Actually De-

cided.—And Finally, The Judgment Of The Lower Court

Could Not Have Been Rendered But For Clear Judicial

Error.

Southwestern Bell Tel. Co. v. Oklahoma, 303 U.S. 206

(1938); Raley v. Ohio, 360 U.S. 423, 434-437 (1959).

Petitioner (Baker) made special appearance at the Ad-

ministrative Hearing to challenge Department of Revenue

to attach jurisdiction to tax the payment received in sale

of his patent. . . Where all substantial right to make, use

and to vend, including the Title of ownership to his pa-

tent have been assigned and transferred to other persons.

App., B-4.

es

The challenge to state jurisdiction to tax property gov-

erned by superior federal statutory law under U.S. Code,

Title 35-Patents was preserved and thus presented in the

Illinois Court of Appeals for review where the objection

to jurisdiction over subject matter was overruled:

“The Baker’s first contention is whether the income

derived from sale of a patent is subject to State tax-

ation. We determine that the State has the power

to tax such income and that this matter was prop-

erly before the Department.” App., B-5.

2.

The Illinois State Court Of Appeals Has Decided A

Federal Question That Is Expressly Clear And In Direct

Conflict With Applicable Decisions Of This Court.

The constitutional federal question that is in conflict

with applicable decisions of this U.S. Supreme Court

points to the principal difference between a sale of patent

by assignment under federal law from that distinct differ-

ence of a mere license transaction under state contract

law. The court below said, relating to a license versus

sale of patent:

“We can discern no principled distinction. . . Regard-

less of the nature of the agreement by which the pa-

tent was used or by whom it was used, the Bakers

nevertheless realized income derived from the pa-

tent’s sale.” App., B-6.

The lower court committed gross judicial error for cause

of ignoring the well settled principal difference between

the absolute sale of patent including Title of ownership

to another person from that distinct license contract with-

out transfer of ownership, i.e.,

wien

Patents, like other property rights, provide the owner

thereof with a federally mandated monopoly right to ex-

clude. This right to exclude specifically relates to the right

to exclude others from making, using, or selling the

patented invention. 35 U.S.C. sec. 271. Patent rights can

be assigned or licensed by their owners, with certain dis-

tinctions between these two types of transfers.

As to ownership of a patent, “{tJhe inventor is presumed

i to be the owner of a patent application, and any patent

that may issue therefrom, unless there is an assignment.”

37 CFR sec. 3.73. And, pursuant to 35 U.S.C. sec. 261,

it is stated, “subject to the provisions of this title, patents

shall have the attributes of personal property. Applica-

tions for patent, patents or any interest therein, shall be

assignable in law by an instrument in writing... .”

In an assignment, an assignor transfers ownership rights

in a patent, usually by sale, to the assignee. To deter-

mine whether an assignment has occurred, the rights trans-

ferred and retained by the assignor must be examined.

A patent licensor retains the ownership rights, and there-

fore the title, of patent. Generally, in a patent license,

the licensee obtains the right to infringe, i.e., to not be

sued for making, using, or selling that which is covered

by the patent. Since a license is a contract, “it is governed

by ordinary principles of state contract law.” Powerlift,

Inc. v. Weatherford Nipple-Up Systems, 871 F.2d 1082,

1085 (Fed. Cir. 1989) (citation omitted).

At times there can arise questions as to whether a cer-

tain transaction is an assignment or a license. In Water-

man v. McKenzie, 138 U.S. 252, 34 L.Ed. 923, 11 S.Ct.

334 (1891), the Court found that a patent license is any

transfer of intellectual property rights which does not

amount to an assignment:

| |

a

The patentee or his assigns may, by an instrument

in writing, assign, grant and convey, either (1st) the

whole patent, comprising the exclusive right to make,

use and vend the intention throughout the United

States; or (2nd) an undivided part or share of that

exclusive right; or (8rd) the exclusive right under the

patent within and throughout a specified part of the

United States. Rev. Stat. sec. 4898.

A transfer of either of these three kinds of interest

is an assignment, properly speaking, investing the

assignee a title and so much of the patent itself, with

a right to sue infringers; in the second case, jointly

with the assignor; in the first and third cases, in the

name of the assignee alone. Any assignment or trans-

fer, short of one of these, is a mere license, giving

the licensee no title in the patent, and no right to

sue at law in his own name for an infringement. Rev.

Stat. sec. 4919; Gaylor v. Wilder, 51 U.S. 10 How.

477, 494, 495 [13:504,511]; Moore v. Marsh, 74 U.S.

7 Wall. 515 [19:37].

Waterman, 34 L.Ed. at 925.

The court in E.J. du Pont de Nemours and Co. v.

United States, 296 F. Supp. 823 (D. Del. 1969), modified,

432 F.2d 1052 (8rd Cir. 1971), followed the ‘“‘all substan-

tial rights” test. That is, when all of the substantial rights

flowing from the grant of a patent have been transferred

in an agreement, then the agreement is an assignment

with the corollary being that a transfer of anything less

than all of the substantial rights of a patent is deemed

to be a license.

= =

JUDICIAL NOTICE

Judicial notice should be taken of the Assignment

recorded in the U.S. DEPARTMENT OF COMMERCE,

United States Patent and Trademark Office, and re-

corded under Federal statutory law, 35 U.S.C. Sec.

152, on August 17, 1971. Such Document shows prima

facie weight of the evidence that the assignment

transferred “all of the right, title and interest’ in

United States Letters Patent, including transfer of

ownership. App., E-1 thru E-3.

Judicial Notice should further be taken that the trans-

fer of the “all substantial rights” test follows the 100

year well settled rule of the Waterman case, the con-

trolling precedent decided by this Court.

The lower court commits gross error in its application

of Fox Film Corp. v. Doval, 286 U.S. 123 (1932), to this

instant case, where the Supreme Court held, in clear lan-

guage, that the case before the court was relative to in-

come derived from a license and which case the lower court

relies upon, where opinion states:

“income derived from licensing of copyrights to other

persons is subject to taxation by States.” App., B-5,

see opinion p. (4).

It is clear that Fox Film, at 286, is “engaged in the

business of licensing copyrighted motion pictures, and that

Fox Film brought the suit to refrain the collection of the

state tax upon the gross receipts of royalties received

under such licenses.” And further, a property right is tax-

able by the state when it is held in private ownership.

Fox Film, at 129.

The lower court further has reliance on Fox Film in-

sofar as it overruled Long v. Lockwood, S.C. Reporter’s

ed. 142-151 (1928). App., B-5, see opinion p. (5).

~

The overruled case relates to state taxation on the net

income of the patentee, computed on the manufacture and

use of the patented product. Long, at 143.

Both Fox Film and Long, cited by the lower court and

necessary to decide the constitutional federal question pre-

sented are to be deemed pure metaphor, for reason:

Long retained ownership right to patent, so likewise,

Fox Film also retained ownership of the copyrighted

movie film. Neither property right was transferred. Both

Long and Fox Film transactions fail to meet the “all sub-

stantial rights” test of the Waterman case which governs

such transfers of intellectual property. The metaphor deci-

sion of the lower court in application of Long and Fox

Film to this distinguishable instant case is in clear and

direct conflict with long-standing high Court precedents.

Certiorari should be granted in this case and the mat-

ter clarified where the decision below “appeared to be

in conflict with our precedents.” Army & Air Force Ex-

change Service v. Sheehan, 456 U.S. 728, 733 (1982).

3.

The Final, But Not Least Reason For Granting This

Petition Is That The Court Of Appeals Fails To Find

Any Non-Federal And Independent And Adequate IIli-

nois State Law In Support Of Its Decision.

It is clear and explicit that the lower court has decided

a constitutional federal question that is in direct conflict

with the applicable decisions of this U.S. Supreme Court,

contrary to law, and should be reversed.

Further, it is most difficult to see a tenable finding of

an independent and adequate state law in support of the

~

lower court decision. Therefore “where there is uncertain-

ty about what the state court did, the usual practice is

to remand for clarification.” Minnesota v. National Tea

Co., 309 U.S. 551 (1940); California v. Krivda, 409 U.S.

33 (1972).

CONCLUSION

For the “certworthy” reasons stated above, the Peti-

tion for Writ of Certiorari should be granted.

Respectfully submitted,

GEORGE H. BAKER, SR.

BESSIE J. BAKER

Petitioners in propria persona

4211 Simpson Drive, Meadowood

Dunlap, Illinois 61525

(309) 243-5212

APPENDICES

A-1

APPENDIX A

No. 77972

IN THE

SUPREME COURT OF ILLINOIS

GEORGE BAKER, SR., ET AL., ie

Petitioners,

vs.

ILLINOIS DEPARTMENT OF REVENUE, ET AL.,

Respondents.

Motion to File Petition

for Leave to Appeal Instanter

ORDER

This cause coming to be heard on the motion of the Peti-

tioners, due notice having been given, and the Court fully

advised in the premises:

It is hereby ordered that the Petitioners’ motion to file

their petition for leave to appeal instanter is denied.

/s/ James D. Heiple

Justice James D. Heiple

October 13, 1994

B-1

APPENDIX B

STATE OF ILLINOIS

APPELLATE COURT

THIRD DISTRICT

OTTAWA

3-93-0823

Baker v. Dept. of Revenue

At a term of the Appellate Court, begun and held at

Ottawa, on the 1st Day of January in the year of our

Lord One Thousand Nine Hundred and Ninety Four,

within and for the Third District of Illinois:

Present—

HONORABLE KENT SLATER, Presiding Justice

HONORABLE ALLAN L. STOUDER, Justice

HONORABLE PEG BRESLIN, Justice

HONORABLE TOM M. LYTTON, Justice x

HONORABLE TOBIAS BARRY, Justice

HONORABLE MICHAEL P. MC CUSKEY, Justice x

GIST FLESHMAN, Clerk

BE IT REMEMBERED, that afterwards on June 30,

1994 the Order of the Court was filed in the Clerk’s Office

of said Court, in the words and figures following viz:

B-2

“Not To Be Published”

No. 3-93-0823

IN THE

APPELLATE COURT OF ILLINOIS

THIRD DISTRICT

A.D. 1994

GEORGE H. BAKER, SR., and BESSIE JANE BAKER,

Plaintiffs-Appellants,

Vv.

THE DEPARTMENT OF REVENUE OF THE STATE

OF ILLINOIS, RODGER D. SWEET, Director, and

DEPARTMENT OF REVENUE, STATE OF ILLINOIS

INCOME DIVISION, JAMES P. PIECZONKA,

Administrative Law Judge,

ministrative Law Judge Defendants-Appellees.

Appeal from the Circuit Court of the 10th

Judicial Circuit, Peoria County, Illinois

No. 90 MR 165

Honorable John A. Barra, Judge Presiding

ORDER

The defendant, Illinois Department of Revenue (the De-

partment) assessed additional income tax liability against

the plaintiffs, George H. Baker and Bessie Jane Baker

(the Bakers). The Department reached this decision after

determining that the Bakers failed to report capital gains

from the sale of a patent. A hearing officer reached the

same conclusion after an administrative hearing. The cir-

cuit court of Peoria County affirmed the hearing officer’s

B-3

decision as consistent with the manifest weight of the evi-

dence and the law. The Bakers appeal. We affirm the

judgment of the trial court.

FACTS

On January 10, 1967, the United States issued a patent

to George Baker. This patent was due to expire on Jan-

uary 10, 1984. On June 23, 1970, the Internal Revenue

Service issued a ruling (revenue ruling) in response to

Baker’s inquiry concerning the tax consequences of the

patent’s sale. According to the revenue ruling, selling the

patent would constitute the sale of a capital asset, which

would then entitle the Bakers to treat the sale as a long-

term capital gain if held for more than six months.

In 1971, Baker sold the patent to Baker Drapery Cor-

poration (the corporation). At the time of the sale, the

Bakers owned 76% of the corporation’s stock. In exchange

for the patent’s transfer, the corporation agreed to make

annual payments to Baker for the duration of the patent.

The precise amounts of these payments are not contained

in the record.

On their 1984 joint federal income tax return, the

Bakers reported that the patent sale resulted in a long-

term capital gain of $337,569. The Bakers reported net

long-term capital gains of $322,713 for 1984. Pursuant to

federal tax law, the Bakers properly reduced their net

capital gain by 60%, or $193,627, and listed the adjusted

figure of $129,085 as part of their gross income on the

tax return.

A Department audit revealed the Bakers did not report

the 60% capital gain deduction as base income on their

1984 Illinois tax return. In a letter dated October 2, 1987,

the Department informed the Bakers of their failure to

B-4

report the deduction as income. The Department assessed

the Bakers’ additional Illinois income tax liability of

$5,325; accrued interest of $1,879.96; and additional in-

terest to accrue at the rate of $1.31 per day. In a letter

dated December 22, 1988, the Bakers filed a formal pro-

test and demanded a hearing. The Department scheduled

an administrative hearing for March 16, 1990.

At the hearing, the Bakers challenged the State’s power

to tax income derived from the sale of a patent, arguing

that the Department lacked subject matter jurisdiction

over the dispute. The hearing officer overruled this ob-

jection. The Department offered into evidence the Bakers’

federal and Illinois income tax returns for 1984. The De-

partment indicated that federal law allows capital gain

deductions from gross income for federal tax purposes.

However, Illinois law requires that any such deductions

must be included in determining taxable income for State

tax purposes. In response, the Bakers offered into evi-

dence copies of the original patent and the assignment

of the patent to the corporation. The Bakers offered no

other evidence or argument at the hearing.

On April 27, 1990, the hearing officer agreed with the

Department’s decision to impose additional tax liability

upon the Bakers. In his written notice of decision, the

hearing officer found that the Department and the State

could properly exercise subject matter jurisdiction over

the dispute. With regard to the merits, the hearing of-

ficer said the Bakers’ capital gain deduction of $193,627

in 1984 was apparently proper. However, Illinois law obli-

gated the Bakers to report the capital gain deduction as

income on their Illinois income tax return for the same

year. The hearing officer found the Department properly

determined that the Bakers were liable for an additional

$5,325 in income tax plus interest.

B-5

On May 23, 1990, the Bakers filed a request for a re-

hearing. The Department denied this request on June 1,

1990. On July 3, 1990, the Bakers filed a complaint in the

circuit court of Peoria County seeking administrative re-

view of the Department’s decision. After hearing and

argument on August 13, 1993, the trial court affirmed the

hearing officer’s findings of fact as consistent with the

manifest weight of the evidence. The court also found that

the hearing officer committed no error in stating and

applying the law to the facts. The trial court entered a

final order of judgment for the Department on September

22, 1993. The Bakers filed a timely notice of appeal on

October 22, 19938.

ANALYSIS

The Bakers’ first contention is whether the income de-

rived from the sale of a patent is subject to State taxa-

tion. We determine that the State has the power to tax

such income and that this matter was properly before the

Department.

The Constitution gives Congress the power to grant

patents. (U.S. Const., art. I, §8.) The Supreme Court has

held that income derived from the licensing of copyrights

to other persons is subject to taxation by States. (Fox

Film Corp. v. Doyal (1932), 286 U.S. 123, 131, 76 L. Ed.

1010, 1016, 52 S. Ct. 546.) In so holding, the Court stated

that a patent is private property. Therefore, State taxa-

tion of that property right does not impermissibly burden

the United States. (Fox Film, 286 U.S. at 128-29, 76 L.

Ed. at 1014-15, 52 S. Ct. 546.) Finally, the Court said it

could not draw any distinctions between the taxation of

copyright royalties and the taxation of patent royalties.

Consequently, the Court expressly overruled Long v. Rock-

wood (1928), 277 U.S. 142, 72 L. Ed. 824, 48 S. Ct. 463,

B-6

in which the Court had previously held that patent royal-

ties were exempt from State income taxation. Fox Film,

286 U.S. at 131, 76 L. Ed. at 1016, 52 S. Ct. 546.

The Bakers argue that Long and Fox Film are distin-

guishable because those cases addressed the taxation of

income derived from selling the right to use intellectual

property. However, the instant case involves the taxation

of income derived from the sale of the patent itself. We

can discern no principled distinction in the case at hand.

Regardless of the nature of the agreement by which the

patent was used or by whom it was used, the Bakers

nevertheless realized income as a result of the patent’s

sale. Moreover, imposing a tax on income derived from

the patent’s sale would not impose any burden upon the

United States. Baker owned the patent and could dispose

of it as he wished. Furthermore, Illinois imposes a tax

on individual income. (85 ILCS 5/201(a) (West 1992).) As

a result, the profit derived from the sale of the patent

is subject to income taxation in Illinois. Therefore, the

question of the Bakers’ additional tax liability was prop-

erly before the Department.

The next issue is whether the Department applied the

correct legal analysis in determining the tax consequences

of the patent sale. We find no error in the Department’s

analysis.

A “capital asset” is defined as property held by a tax-

payer, unless that property falls within any of the follow-

ing categories: (1) inventory held for sale or stock in trade;

(2) depreciable assets used in the taxpayer’s business; (3)

intellectual property held by the taxpayer; (4) accounts

receivable; and (5) publications of the United States. (26

U.S.C.A. §1221 (West 1988).) Any item which does not

fall within one of the five exceptions listed above is a

capital asset. (Arkansas Best Corp. v. Commissioner of

B-7

Internal Revenue (1988), 485 U.S. 212, 217-18, 99 L. Ed.

2d 183, 189, 108 S. Ct. 971.) A “long-term capital gain’”’

is defined as a gain realized from the sale or exchange of

a capital asset held for more than six months. (26 U.S.C.A.

§1222(3) (West 1988).) “Net long-term capital gain’’ is

defined as the excess of long-term capital gains for a tax-

able year over the long-term capital losses for that year.

(26 U.S.C.A. §1222(7) (West 1988).) In 1984, a taxpayer

was entitled to deduct 60% of net long-term capital gains

from his adjusted gross income. 26 U.S.C.A. §1202 (West

1984).

However, Illinois does not allow the deduction of capital

gains from base income. Under section 203 of the Illinois

Income Tax Act, capital gains reported as deductions on

a federal income tax return must be added to the tax-

payer’s base income for Illinois income tax purposes. 35

ILCS 5/203(aX2XD) (West 1992).

We hold that the profits received from the patent sale

were a capital asset. Baker’s right to receive payments

in exchange for the patent did not fall within any one of

the five categories excepted in section 1221. The right to

receive payments is not a depreciable asset used in the

Bakers’ trade or business. The Bakers admit this fact in

the briefs they filed before the hearing officer and this

court. A patent is considered to be intellectual property.

However, section 1221(3) requires a patent to be held by

the taxpayer to avoid treatment as a capital asset. Here,

George Baker held only the right to receive benefits from

the patent’s transfer. He held no ownership rights in the

patent itself after its sale. Furthermore, the Bakers re-

ported the patent sale on their federal income tax return

under the heading entitled “Long-term Capital Gains and

Losses—Assets Held More Than One Year (6 months if

acquired after 6/22/84).’”’ Consequently, Baker’s right to

B-8

receive payments is a capital asset under section 1221 of

the Internal Revenue Code.

On their 1984 federal income tax return, the Bakers re-

ported a net long-term capital gain of $322,713. They re-

duced that figure by 60%, or $193,627. They reported the

balance of the gain ($129,085) as part of their adjusted

gross income. Nothing in the record indicates that the

Bakers reported their income improperly on their federal

return. The revenue ruling indicates that any gain from

the patent sale could properly be considered as a capital

gain. However, the Department’s audit demonstrates the

Bakers failed to report the 60% deduction as an addition

to base income on their Illinois income tax return as re-

quired by section 203(aX2XD). As a result, the Department

imposed additional tax liability upon the Bakers. Based

upon our review of the applicable law, we conclude that ©

the Department applied the correct law in analyzing the

tax consequences of the patent sale.

The Bakers next argue that the Department used in-

correct legal principles in determining their tax liability.

In support of their contentions, they advance four essen-

tial arguments. We shall address each in turn.

First, the Bakers correctly point out that under federal

law, patents are considered personal property. (35 U.S.C.A.

§261 (West 1984).) They also note that the Illinois Consti-

tution abolishes personal property taxes. (Ill. Const. 1970,

art. IX, §5(c).) Based on these provisions, the Bakers con-

clude that the State may not levy any tax on a patent.

However, the tax at issue in this case is not imposed upon

the patent as personal property. Rather, the tax is im-

posed upon the income received as a result of the patent’s

sale. Thus, we find no merit to this contention.

Second, the Bakers argue that as the owner of the pa-

tent, only the corporation incurs tax liability for the use

B-9

and benefits of the patent. The Bakers contend they owe

no taxes on the patent sale because they hold no owner-

ship interests in the patent. We find no merit to this argu-

ment. As part of the contract for sale, George Baker re-

tained a right to receive income from the corporation dur-

ing the life of the patent, though he sold the patent itself

to the corporation. Based upon this intangible personal

property right, the Bakers realized a gain which they re-

ported on their federal income tax return in 1984. Since

the Bakers took a long-term capital gain deduction for that

year, they were required to add the deduction amount

to their base income for Illinois income tax purposes.

Third, the Bakers claim the gain from the patent sale

should have been considered “ordinary income’”’ for Illinois

income tax purposes. Section 1239 of the Internal Revenue

Code sets forth the prerequisites for treatment as ordi-

nary income. The property sold or exchanged must be a

depreciable asset and the sale must be between related

persons. (26 U.S.C.A. §1239(a) (West 1988).) The statutory

provision in effect in 1984 defined “related persons” as

an individual and a corporation in which the individual

owns at least 80% of the outstanding stock. 26 U.S.C.

§1239(bX2) (1984).

The Bakers’ contention is misguided for two reasons.

Initially, the corporation did not qualify as a “related per-

son” under section 123%a). Here, the Bakers owned only

76% of the corporation’s stock. Furthermore, if the gain

qualified for ordinary income under section 123%a), the

Bakers would not have been entitled to the capital gain

deduction on their federal income tax return. The Depart-

ment does not contend that the Bakers improperly treated

the income as a deductible capital gain of their federal

return. The revenue ruling establishes that any gain

realized from the sale of the patent qualified for long-term

B-10

capital gain treatment. In addition, the Bakers character-

ized the income received from the patent sale as a long-

term capital gain on their federal income tax return. Ac-

cordingly, we conclude that the Bakers’ argument on this

issue is without merit.

Fourth, the Bakers argue that the sale price of the pa-

tent constituted a valuation limitation amount for the pur-

pose of computing their Illinois income tax liability. All

valuation limitation amounts, like net capital gains, must

be added to a taxpayer’s base income for Illinois income

tax purposes. (85 ILCS 5/203(aX2XG) (West 1992).) This

argument lends no support to the Bakers’ ultimate con-

tention that the patent sale does not result in tax liabil-

ity. Even if the sale price was a valuation limitation, sec-

tion 203(aX2XG) would still have required the Bakers to

add the amount to their base income. This method of tax

treatment would have resulted in the identical computa-

tion of tax liability now imposed upon the Bakers.

The Bakers assert the value of the patent is the cash

value, i.e. the price upon which a willing buyer and seller

agree. (Consolidation Coal Co. v. Property Tax Appeal

Board (1975), 29 Ill. App. 3d 465, 468, 331 N.E.2d 122,

126.) While the Bakers have stated the principle correct-

ly, Consolidation Coal in no way supports exemption from

income taxation for the sale of a patent. The Consolida-

tion Coal case addresses the proper methods of assess-

ing the value of certain items of personal property. That

case does not address the tax consequences of these assess-

ments under the Internal Revenue Code or the Illinois

Income Tax Act. As a result, we conclude that the De-

partment and the trial court applied the correct legal prin-

ciples in finding the Bakers liable for additional income

taxes in 1984.

B-11

Additionally, the Bakers contend that the Department’s

decision is against the manifest weight of the evidence.

We disagree with this argument.

A court’s function in reviewing an administrative agen-

cy’s decision is to ascertain whether the agency’s factual

findings and decision are against the manifest weight of

the evidence. (Abrahamson v. Illinois Department of Pro-

fessional Regulation (1992), 153 Ill. 2d 76, 88, 606 N.E.2d

1111, 1117.) Part of the court’s function is to determine

whether the record contains enough evidence to support

the agency’s findings. (Clark v. Board of Fire & Police

Commissioners (1993), 245 Ill. App. 3d 385, 392, 613 N.E.

2d 826, 830.) An agency’s factual findings are considered

to be prima facie true and correct. (735 ILCS 5/3-110

(West 1992); Dillavou v. County Officers Electoral Board

(1994), __ Ill. App. 3d : , 682 N.E.2d 1127,

1132.) An agency’s decision is contrary to the manifest

weight of the evidence only if no rational trier of fact

could have agreed with the agency’s decision. Farmers

State Bank v. Department of Employment Security (1991),

216 Ill. App. 3d 633, 640, 576 N.E.2d 532, 537.

Following our thorough review of the record, we agree

with the trial court that the decision to assess additional

tax liability upon the Bakers was consistent with the

manifest weight of the evidence. In his written decision,

the hearing officer made findings of fact based upon the

evidence which the Department presented. First, the offi-

cer found that the dispute was properly before the De-

partment. Second, the Bakers reported the profits from

the patent sale as a long-term capital gain and made the

appropriate deduction on their federal income tax return.

Third, the Bakers did not report the amount of the deduc-

tion as income on their Illinois income tax return. The

Bakers presented no evidence to refute these findings of

B-12

fact. Accordingly, we conclude that a rational trier of fact

could have arrived at similar findings. The evidence pre-

sented was sufficient to support the agency’s findings.

Finally, the Bakers argue that they owned only 16%

of the corporation’s stock. The Department hearing offi-

cer found that they owned more than 25% of the stock.

The Bakers contend that the facts do not support the

hearing officer’s conclusion. To support their contention,

the Bakers refer to an argument contained in a brief filed

with the Department during the early stages of this dis-

pute. They have not directed us to, nor can we find, any

evidence or proof in the record which indicates that the

Bakers owned only 16% of the corporation’s stock. On the

other hand, the revenue ruling indicates that in 1970, the

Bakers owned 76% of the stock. Based upon the revenue

ruling, the officer was justified in finding that the Bakers

owned more than 25% of the stock.

CONCLUSION

In summary, we conclude that this dispute was properly

before the Department. Based upon our review of the rec-

ord, we find the trial court was correct in holding that

the Department’s decision was not contrary to the law

or the manifest weight of the evidence. For the reasons

indicated, the judgment of the circuit court of Peoria

County is affirmed.

Affirmed.

McCUSKEY, J., with BARRY and LYTTON, JJ., con-

curring.

[Certificate of Clerk omitted in printing.]

C-1

APPENDIX C

[Filed September 22, 1993]

IN THE CIRCUIT COURT OF THE

TENTH JUDICIAL CIRCUIT OF ILLINOIS

PEORIA COUNTY

Case No. 90-MR-165

GEORGE H. BAKER, SR., and BESSIE JANE BAKER,

Plaintiffs,

vs.

THE DEPARTMENT OF REVENUE OF THE STATE

OF ILLINOIS, RODGER D. SWEET, Director, and

THE DEPARTMENT OF REVENUE OF THE STATE

OF ILLINOIS, Income Tax Legal Division, JAMES

P. PIECZONKA, Administrative Law Judge,

Defendants.

ORDER

This matter comes before the Court on administrative

review, and the Court, having reviewed the record and

the briefs of parties, FINDS:

1. The decision of the Department of Revenue is not

against the manifest weight of the evidence; and

2. The decision of the Department of Revenue is not

contrary to the law.

The decision of the Department of Revenue is affirmed.

C-2

Judgment is entered in the amount of $9,467.00 against

the Bakers.

The Clerk is ordered to mail a copy of this order to

the persons listed below.

ENTERED: 9/22/93 /s/ John A. Barra

Circuit Court Judge

CC: John Simpson, AGA

George H. Baker

Bessie Jane Baker

D-1

APPENDIX D

[Dated April 27, 1990]

ILLINOIS DEPARTMENT OF REVENUE

ADMINISTRATIVE HEARINGS DIVISION

STATE OF ILLINOIS CENTER

100 W. RANDOLPH STREET, LEVEL 7

CHICAGO, ILLINOIS 60601

DEPARTMENT OF REVENUE

OF THE STATE OF ILLINOIS

V.

George H. and Bessie J. Baker

Taxpayer

Docket #

SSN/FEIN # 347-14-8795

For Tax Years Ended:

12/31/84

Deficiency Amount: $5,325.00

NOTICE OF DECISION

TO: George H. and Bessie J. Baker

4211 Simpson Dr.

Meadowood Subdivision

Dunlap, Illinois 61525

YOU ARE HEREBY NOTIFIED that the attached recom-

mended decision of the Administrative Hearings Division

in the above entitled cause has been accepted by the

Director of Revenue as dispositive of the issues therein.

{

D-2

Unless you otherwise request a rehearing pursuant to the

provisions of Section 908(c) of the Income Tax Act, this

determination shall become a final administrative decision

30 days from the date of issuance. Following expiration

of the 30 days, or after issuance of a denial of rehearing,

should one be requested, you may pursue your rights to

administrative review by filing a complaint in the circuit

court under the requirements of Ill. Rev. Stat. ch. 110,

Sec. 3-101 et seq.

April 27, 1990

Date of Issuance

/s) Roger D. Sweet, Director

Illinois Department of Revenue

JPP:mh

|

II.

Il.

D-3

JURISDICTION:

Notice Protest Protest

Tax Year of Deficiency Due Filed

12/31/84 10/2/87 11/16/87 10/15/87*

12/22/88

ISSUES:

Whether Taxpayers are liable for additional income

taxes due to an increase in their adjusted gross in-

come pursuant to a Federal Tape Match and failure

to report an addition modification in the amount of

$193,627 as reported on their U.S. 1040 Schedule

“D’”’, Line 22 (60% capital gain deduction).

Whether Taxpayers’ filing dated October 15, 1987

was a timely protest.

FINDINGS OF FACT:

Taxpayers, George H. and Bessie J. Baker reported

installment payments on Schedule “D”, Line 9 of

their 1984 U.S. 1040, an installment from the sale

of a patent in the amount of $337,569.00. Additional-

ly, Taxpayer reported a 60% capital gain deduction

in the amount of $193,628 on Line 22 of Part III of

their U.S. 1040 return for 1984 (DOR Ex. No. 5).

Taxpayers failed to report on their 1984 IL-1040 the

capital gain deduction reported federally in 1984 in

the amount of $193,627.00 (DOR Ex. No. 5).

On October 2, 1987, the Department timely issued

a Notice of Deficiency to Taxpayers pursuant to a

Federal Tape match and stating that Taxpayers failed

to report as an addition modification the 60% federal

capital gain deduction in the amount of $193,627.00.

D-4

The resultant tax was proposed at $5,325.00 (DOR

Ex. No. 3).

On October 15, 1987, the Department received an

“Answer to Notice” from Taxpayers. Said answer

stated that the patent transferred to Taxpayer by

the U.S. government in 1971 by assignment was an

I.R.C. Section 1221 capital asset and governed by

Section 453. Consequently, the proposed assessment

is exempt from Illinois tax under Chapter 120, Sec-

tion 203(aX2XN). Additionally, said answer did not

request a hearing (DOR Ex. No. 4).

On June 24, 1988, in a letter to Tax Analyst, Stephen

J. Giannangelo; Taxpayer, George Baker, admitted

that his patent was intangible personal property,

however, it was not property used in Taxpayer’s

trade or business under Section 1231 nor of a char-

acter subject to depreciation under Section 167, real

property under Section 1221(2) or property included

in the inventory of Taxpayer under Section 453(b)

(1XB) (DOR Ex. No. 5).

The IRS Revenue Ruling dated June 23, 1983 ad-

dressed to Taxpayer concluded that any gain from

the sale of the patent realized by Taxpayer consti-

tutes a sale of a capital asset as provided in Sec-

tion 1221 and is treated as long term capital gains

within Section 1222(3) (DOR Ex. No. 5).

On December 22, 1988, Taxpayer filed a request for

hearing to the subject Notice of Deficiency stating

that he had no items of tax modification add back

on his IL-1040 return for 1984 (DOR Ex. No. 4).

On March 16, 1990, a hearing was held before Ad-

ministrative Law Judge, James P. Pieczonka, at the

Department’s offices in Peoria, Illineis- Staff-Attor-

10.

11.

12.

13.

14.

15.

D-5

ney, John Doherty introduced DOR Exhibits 1-7 as

the Department’s prima facie case (DOR Ex. Nos. 1-

7). Taxpayers, George and Bessie Baker appeared

with their son George Baker, Jr. and without coun-

sel (Tr. p. 1-8; DOR Ex. No. 1).

Taxpayer contested the jurisdiction of the State by

a special and limited appearance, not generally, based

upon lack of jurisdiction over the subject matter,

the U.S. Patent (Tr. p. 4-9).

The Administrative Law Judge denied Taxpayer’s

motion to dismiss for lack of subject matter juris-

diction (Tr. p. 10-12).

Taxpayer denied that his letter dated October 15,

1987 was his protest (Tr. p. 15), however, the let-

ter dated December 22, 1988 was his protest which

requested a hearing (Tr. p. 17-21). Subsequent to

Taxpayers December 22, 1988 protest, the Depart-

ment transferred Taxpayer’s case to the hearing

division (Tr. p. 21; DOR Ex. No. 5).

Taxpayers objection to admission of DOR Exhibits

1-7 based upon lack of subject matter jurisdiction

was denied (Tr. p. 23).

Taxpayer, George Baker Sr. was called as an ad-

verse witness, however, he refused to testify (Tr.

p. 23-26).

Taxpayer submitted a copy of the subject patent

No. 3296651 as Taxpayer Exhibit No. 1 (Taxpayer

Ex. No. 1).

The Administrative Law Judge finds that the sub-

stance of the document filed by Taxpayer on Oc-

tober 15, 1987 was a sufficient and timely protest.

16.

17.

IV.

D-6

The Administrative Law Judge finds that the State

of Illinois has jurisdiction of the Taxpayers and sub-

ject matter, the addition modification of Taxpayers

U.S. capital gain deduction from the sale of the sub-

ject patent pursuant to Chapter 120, Ill. Rev. Stat.

Section 203(aX2XB).

Finally, Administrative Law Judge finds that Tax-

payer failed to report as an addition modification on

their IL-1040 return for 1984, the 60% capital gain

deduction in the amount of $193,627.00 as reported

on their 1984 U.S. 1040 return.

DISCUSSION OF LAW AND FACTS:

Section 203(aX2Xb) of the Illinois Income Tax Act

provides:

That an addition modification must be made to

an individuals federal adjusted gross income for

“an amount equal to the amount of deduction

allowable under Section 1202 of the Internal

Revenue Code (Code) to the extent deduction

from gross income in the computation of AGI.”

Ch. 120, Ill. Rev. Stat. Section 203(aX2XB).

The instant case involves the 1984 income tax treat-

ment of an installment sale by the creator or inven-

tor (the Taxpayer in this case) of a United States

Letters Patent and a Canadian Patent. Taxpayers

did not add back to Illinois a 60% capital gain deduc-

tion reported on their federal 1040 return for 1984.

Section 203(aX2XB) of the Illinois Income Tax Act

(Act) in effect during this taxable year requires the

following addition modification to be made to an indi-

vidual’s federal adjusted gross income (AGI): ‘“‘an

amount equal to the amount of deduction allowable

cae

D-7

an

under Section 1202 of the Internal Revenue Code

(Code) to the extent deducted from gross income in

the computation of AGI.” Section 1202 of the Code

as in effect in 1984 stated: “if for any taxable year

a Taxpayer other than a corporation has a net capital

gain, 60% of the amount of the net capital gain shall

be a deduction from gross income.” This capital gain

deduction was allowed in Part III, line 22 of Sched-

ule D of Taxpayer’s federal individual income tax

return for 1984.

Since Taxpayers deducted an amount on the above

line for 1984 federally, it must be added back to

AGI on his Form IL-1040. In general, under Sec-

tion 1235 of the Code, a patent holder is specifical-

ly allowed capital gain treatment on the sale or ex-

change of a patent or of an undivided interest in

patent rights. Thus, the sale or exchange of patents

are generally considered to be that of the sale or

exchange of a capital asset. Because the sale was

apparently made to a related taxpayer in Mr. Baker’s

situation (Baker Drapery Corporation—a corporation

in which taxpayer owned more than 25% of the

voting stock within the meaning of 1235(d)), this spe-

cific rule for the treatment of sales and exchanges

of patents probably would not apply in this case.

the BL ee Am ah a6

A AB ERY RTE RES ALLEL AMEL ALANS

i OD ail BR SE te

eS es

However, in Mr. Baker’s case, for federal tax pur-

poses, he did realize and did recognize a long term

capital gain (as that term is defined in Section 1222(3)

of the Code) on the sale of his patent. This long

term capital gain was apparently determined under

the treatment provided for in Section 1231(a) of the

Code, not Section 1235. Regardless of whether Sec-

tion 1235 is applicable to this case, the Department

properly added backed the capital gain deduction as

D-8

a modification to Mr. Baker’s base income on his

1984 IL-1040. He had correctly reported the gain

on Schedule D of his federal return and then took

the deduction (for which has was entitled) of 60%

of the recognized capital gain.

In his prior correspondence with the Department,

Mr. Baker’s citing of Section 1221 of the Code in

support of his position is incorrect. As clarified in

the 1988 U.S. Supreme Court opinion in Arkansas

Best v. Commissioner, 108 C.Ct. 971, Section 1221

of the Code defines capital assets by listing specific

categories which are not capital assets. All assets

that do not fall within those categories are capital

assets. Taxpayer’s patent does not fall under any

of the five narrow exceptions in Section 1221. As

a result, the intangible personal property at issue

here would fall under the general definition of a

capital asset contained in Section 1221 as “property

held by the taxpayer.”

The Sections of the Act cited by Mr. Baker in prior

correspondence do not support his position either.

The sale of the patent is not exempt from Illinois

income taxation under Section 203(aX2XN) of the

Act, since Taxpayers are domiciled in Illinois neither

Section 303(bX3) or 303(dX2XA) of the Act would not

allow the sale to be allocable to any state other than

Illinois.

In conclusion, the 60% capital gain deduction reported

on Taxpayers’ Federal 1040 return for 1984 must

be added back into Taxpayers’ AGI on their IL-1040

return as corrected by the Department, therefore,

the deficiency must stand in its entirety.

D-9

V. DECISION:

It is the decision of the Director of Revenue that

the Notice of Deficiency shall stand and Taxpayers

are liable for the following taxes:

COMPUTATION:

Tax Year Ended

12/31/84

1. Adjusted Gross Income $ 35,766.00

2b. Capital Gain Deduction 193,627.00

4a. Illinois Property Tax Paid 2,553.00

4g. Other Subtractions 87.00

6. Exemptions 2,000.00

Tax @ 2%% 6,181.00

Total IL-1040 Withheld 464.00

Total Payments & Credits 464.00

15. Balance Due 5,717.00

16. Tax Paid With Original

Return 392.00

20. Balance Due $ 5,325.00

/s/ James P. Pieczonka

Administrative Law Judge

JPP:mh/1260

ee a Sy rs ae

eget ee ae a ee

E-1

APPENDIX E

U.S. DEPARTMENT OF COMMERCE

United States Patent and Trademark Office

April 9, 1987

(Date)

THIS IS TO CERTIFY that the annexed is a true copy

from the records of this office of a Document recorded

August 17, 1971.

By authority of the

COMMISSIONER OF PATENTS

AND TRADEMARKS

/s/ Diane G. Russell

Certifying Officer.

E-2

ASSIGNMENT

WHEREAS, on May 26, 1971, GEORGE H. BAKER, SR.,

Dunlap, Illinois, and BAKER DRAPERY CORPORATION,

a Delaware corporation having a place of business at 1116

Pioneer Parkway, Peoria, Illinois 61614, entered into a

Patent Assignment Agreement; and

WHEREAS, said Patent Assignment Agreement was ex-

ecuted in three and only three duplicate originals, with

no copies, and the plates and film with which the orig-

inals were printed have been destroyed; and

WHEREAS, one each of the originals is in the posses-

sion of GEORGE H. BAKER, SR., BAKER DRAPERY COR-

PORATION and RICHARD S. PHILLIPS of Hofgren,

Wegner, Allen, Stellman & McCord, 20 North Wacker

Drive, Chicago, Illinois 60606.

NOW, in furtherance of and subject to the rights and

obligations of said Assignment Agreement, GEORGE H.

BAKER, SR. assigns to BAKER DRAPERY CORPORA-

TION all of the right, title and interest in United States

Letters Patent 3,296,651 and Canadian patent 770,972.

/s/ George H. Baker, Sr.

E-3

STATE OF ILLINOIS

COUNTY OF PEORIA-—ss.

Before me, a Notary Public in and for the County and

State aforesaid, appeared GEORGE H. BAKER, SR., to me

personally known to be the same person whose name is

subscribed to the fcregoing instrument, and acknowledged

that he executed said instrument as his free and volun-

tary act and for the uses and purposes therein expressed

this 10th day of August, 1971.

/s/ Griffin

Notary Public

RECORDED

U.S. PATENT OFFICE

AUG 17 1971