Tax Bulletin

May 2007

Can You Patent a Tax Strategy?

By Brandt Mori

Triggered by the 1998 Federal Circuit Court’s holding in State Street Bank & Trust Company v. Signature Financial Group, Inc. that “business methods” can be patentable subject matter, tax practitioners have increasingly pursued patents for various tax-reducing strategies. The United States Patent and Trademark Office (“USPTO”) has already issued scores of tax-related patents; however, this area of patent law has come under heavy criticism. Given the wide-reaching implications that the patenting of tax-related strategies could have on both tax practitioners and taxpayers, the patenting of tax-related strategies is certain to remain controversial.

Patent Law in General

Patent law encourages invention by granting an inventor an exclusive right to exclude others from making, using, offering to sell, or selling within the United States, or importing into the United States, the patented item for a limited time period. Patents may be obtained on “processes, machines, manufactures, and compositions of matter” (“patentable subject matter”) that are (a) novel (e.g. new) (b) nonobvious (e.g. differences from the prior art would not be obvious to one “of ordinary skill in the art”), and (c) useful. As referenced above, in 1998 the Federal Circuit Court held in State Street Bank that a “business method” was patentable subject matter as long as it involved a “process” or “machine” within the meaning of patent law.

Problems with Patenting
Tax-Reducing Strategies

Tax practitioners have argued that patents for tax-reducing strategies should not be granted and have indicated that action must be taken to curtail this developing area of patent law.¹

First, many argue that it is against public policy for a private person to patent a technique used to reduce the taxpayer’s tax liability. As tax practitioners have pointed out, a patent for a tax-reducing strategy is unlike other business method patents because with other business method patents an individual who wishes to implement the patented business method has the choice to either (a) pay for the right to use the method, (b) engage in the business activity in a different way, or (c) not to engage in the business activity at all. However, since taxpayers are required to comply with tax laws, they are not afforded the same choices.

Moreover, granting patents for tax-reducing strategies is similar to granting the patentholder an ownership right over the relevant provisions of the tax law. Congress certainly did not intend to limit the beneficial provisions of the tax code to only those persons who were the first ones to conceive of a certain taxreducing strategy. Thus, granting tax-reducing strategy patents prevents taxpayers from exercising their rights to lawfully minimize their taxes.

Additionally, patenting tax-reducing strategies unfairly imposes additional costs and risks on taxpayers and tax practitioners. When a taxpayer is considering whether to use a patented tax-reducing strategy, he or she must decide whether to (a) file a lawsuit to invalidate the patent, (b) ignore the patent and hope that the patent-holder does not find out about his or her infringement, or (c) pay a licensing fee to the patent holder to use the strategy. Each of these options carries with it additional risks and/or costs to the taxpayer. Tax-related patents have already become the subject of patent infringement suits. For instance, the USPTO issued a patent on the tax strategy of funding a grantor retained annuity trust with non-qualified stock options. The former Chief Executive Officer of Aetna disclosed such a transfer in an SEC filing and is currently being sued for infringing the patent.²

Additionally, since attorneys owe a duty to their clients to explain all issues that are likely to result in adverse legal consequences to the client, attorneys will have to satisfy an additional due diligence obligation in order to assure that any tax strategies they propose do not infringe others’ patents. The taxpayer will ultimately bear the burden of this additional due diligence in the form of increased legal fees.

Further, there is a concern that these patents deter compliance with federal tax laws because patents on aggressive tax planning techniques add credibility to an otherwise objectionable tax planning strategy. The grant of a patent does not constitute government approval of the purported tax treatment asserted by the patent holder; however, many taxpayers mistakenly believe that the grant of a patent does constitute such approval. Thus, dishonest tax promoters could take advantage of taxpayers’ misunderstanding by falsely holding out a patent as evidence that an aggressive tax strategy has been approved by a United States government agency.

Finally, numerous practical issues regarding the application and administration of patents relating to tax-reducing strategies have been raised. For example, when a tax advisor assists a taxpayer in implementing a patented tax strategy, are both the advisor and the taxpayer liable for infringement? Similarly, when does the infringement occur? Given the confidential nature of tax returns, how will patent-holders know when another taxpayer has infringed his or her patent? Is the USPTO equipped to determine whether a particular tax strategy is novel, non-obvious, useful, or even lawful?

Conclusion

Given the widespread implications that the patenting of tax-reducing strategies has on both tax practitioners and taxpayers, the patenting of tax-related advice is an area of patent law that will likely receive continued attention from both tax practitioners and Congress. Taxpayers and tax practitioners must be aware of the developments in this area of patent law. Additionally, if a taxpayer, based on the advice of his or her tax advisor, implements a patented tax strategy, both parties may later be subject to costly patent infringement litigation.

¹ See Statement of Dennis I. Belcher, Testimony Before the Subcommittee on Select Revenue Measure of the House Committee on Ways and Means (July 13, 2006).

² See Wealth Transfer Group v. Rowe, No. 06CV00024 (D. Conn. filed Jan. 6, 2006).

The Tax Reporter is published by the Law Firm of Ervin, Cohen & Jessup LLP. The publication is intended to present an overview of current legal trends; no article should be construed as representing advice on specific, individual legal matters, but rather as general commentary on the subject discussed. Your questions and comments are always welcome. Articles may be reprinted with permission. Copyright © 2007. All rights reserved. ECJ is a registered service mark of Ervin, Cohen & Jessup LLP. For information concerning this or other publications of the Firm, or to advise us of an address change, please contact the Director of Marketing at mchumo@ecjlaw.com, or the firm’s website at www.ecjlaw.com.

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