The following letter was sent by Tom Robinson, CPA, of Delucchi, Hawn, & Co., LLP, San Jose, CA, in response to my (Nagle's ) request for an opinion on taxability of a contribution to our organization.
February 18, 2003
John Nagle
999 Woodland Avenue
Menlo Park, CA 94025
RE: DARPA "Grand Challenge"
Dear John:
Received your email regarding your involvement in the DARPA Grand Challenge. Below are some ideas for you to think about.
To begin with, let’s discuss the $300,000 inflow of cash. The recipient of these funds (be it an individual, corporation, partnership, or limited liability company) could probably be construed as revenue by the IRS. The question that would be asked is why was this money received and what will be given in return for it. If something is given in return (patent rights, advertising, etc.) then it would be revenue. If nothing was given or done in return then it would most likely be classified as an advance (subject to repayment) or an outright gift. If it could be classified as a gift then it would have no tax impact on the recipient.
Since this person resides in Switzerland I am assuming he is not a US citizen and does not have to abide by any of our tax laws. While gifts are not taxable to the recipient they are taxable to the giver if they exceed $11,000. Again, this point is probably moot because of his residency and citizenship.
So, what this means is you could deposit these funds using your Social Security number and need not worry about being taxed on these funds. However, if it cannot be shown that these monies are a gift, the IRS will take the position that they are income to you.
There are ways to alleviate this problem should these funds be considered revenue. The easiest way is to spend these funds in total on the manufacture of the vehicle. The logic here is that you would have $300,000 of income received and $300,000 of cost to build with the net being zero. I believe that all these expenses would be deductible since they would be classified as research and development costs.
R & D costs are defined as "research and development costs in the experimental or laboratory sense. This includes all costs incident to the development or improvement of a product, including a pilot model, process, formula, invention, technique,, patent, or similar property." I believe that you are "inventing" new technology and creating a "pilot model" that falls within these guidelines. If you believe differently please let me know.
As to the type of entity to work under I would look at what liability you could be facing. If insurance will not cover the potential exposure of this endeavor (or it is cost prohibitive) then you will need to form an entity that will protect your personal assets. These are either a corporation or a limited liability company. Both of these entities will protect your personal assets. A corporation requires recordkeeping (yearly meetings, and corporate minutes updates) that an LLC does not. Formation of both are similar (you will need a lawyer for either) and the bookkeeping is the same. I would go with an LLC as it is easier to manage and you can now have single member LLC’s in California.
If you were to win this contest (and the $1,000,000) the funds could be disbursed from the LLC to your co-inventors via a 1099 MISC as non employee compensation and your winnings would be taxable to you through the LLC or all of you could be members in the LLC and be taxed through it.
Creating a non profit organization would also alleviate the taxability of the $300,000. This will take some time to put together as applications have to be made to the IRS for its’ creation. If you went this route the original $300,000 would be a donation to the non profit. The organization by laws could include wording as to the disbursement of the winnings (should that happen) and then the non profit could either be dissolved or kept alive for other such endeavors down the road. I am not sure about the liability protection with this type of arrangement and would ask you to discuss this with an attorney. Either of these two entities will satisfy your needs concerning the initial funding of this project. However, I think an LLC will be less difficult to put together and maintain.
Hope this is helpful information and please call me with any questions.
Sincerely
Thomas S. Robinson CPA
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