McClain v. Commissioner of Internal Revenue

Thomas McClain (plaintiff) was hired by Lockheed Aircraft Corp. (Lockheed) in 1936 as a file clerk and went on to work there for many years, gaining promotions in various engineering positions. Lockheed was a major company in the aerospace industry that required all employees to assign any inventions developed by an employee to Lockheed as a condition of employment. McClain executed the inventions agreement. In 1940, McClain invented a novel aircraft windshield, comprising two separate patentable ideas. In 1941 and 1942, McClain assigned the inventions to Lockheed, which became patented. Lockheed licensed and obtained substantial royalties on the patented inventions, prompting the company to roll out a patent program that encouraged employees to develop patentable inventions. The “patent plans” entitled employees to share in any royalties received from sales of patented products. Pursuant to the plans, McClain shared in royalty payments received by Lockheed, including in the tax years 1957 and 1958. McClain also received a salary for performing his job duties. Lockheed separately tracked salary payments and royalty payments made to employees but reported and deducted both types of payments as employee salary expense. McClain asserted that the royalty payments should be treated as capital gains, but the Internal Revenue Service (IRS) (defendant) determined that they were ordinary income. McClain sued the IRS to recover allegedly overpaid income taxes.