Tax Strategy Patents – Traps for the Unwary?  Let's Hope Not

By Patrick J. Lavoie, CPA

Imagine your tax accountant or attorney pitches you a great tax saving idea that also helps you meet one or several of your long-term life goals.  It's all very legitimate, may even be encouraged by the IRS, but there is one catch.  A few weeks after engaging in the transaction that had you so impressed with the low initial cost, you receive a legal complaint from an attorney in Washington claiming your accountant or attorney and you have infringed on his company's patented tax strategy.  Think it can't happen?  Think again. 

Background

There is no measure to the amount of astuteness when creative minds in a capitalistic society see and seize an opening such as the one created by the Federal Circuit's 1998 decision in State Street Bank & Trust Co. v. Signature Financial, Inc.  In that case, the Federal Circuit (which has exclusive jurisdiction over patent appeals taken from the district courts and the U.S. Patent and Trademark Office) decided a "business method" could be patented.

For those, like me, who might only envision patents traditionally issued for new innovative products one could see and touch (tangible) or for the more complex products produced by the software and pharmaceutical worlds, patents issued on business methods might seem a tad absurd.  Who is going to spend the time to do all the things necessary (including paying lawyers and filing fees) to complete a patent application on a "way" to do business?  The answer is, of course, plenty of people will and have done everything necessary to be granted this exclusive license on their innovative business method that comes from the U.S. Patent and Trademark Office ("PTO").  In addition, once granted, these patent holders have filed lawsuits against perceived infringers of their unique business method.

One of the most famous of these cases was when Amazon.com, the online retailer, sued Barnes & Noble for use of its patented "1 Click" technology that allowed online shoppers to click once and purchase the product displayed on the screen by having credit card and shipping information already in the company's records.  Barnes & Noble also had a method of express checkout which Amazon.com claimed was too similar to its patented technology.  This case eventually settled, but one can imagine the havoc that could be raised against many internet retailers that use or want to use similar technology.  One can also imagine the large legal bills which accrued in defense of this lawsuit.

Tax Strategy Patents

It was not a complete surprise when tax attorneys and tax accountants realized this opportunity for obtaining business method patents and started applying to protect their innovative tax strategies.  Currently, to date, there have been more than 60 patents issued with an estimated 80 or more pending at the U.S. Patent and Trademark Office, all having to do with tax strategy.

The person that received the first tax strategy patent actually transferred it to an entity (The Wealth Transfer Group, LLC) which then used the patent to sue an executive at Aetna, John Rowe, who had put some of his Aetna stock options into a grantor retained annuity trust (GRAT).  The Wealth Transfer Group alleged Rowe had infringed their tax strategy patent of putting options into a GRAT.  This case settled, details undisclosed, but certainly enlightened people to the extent that these patents could be used against taxpayers who were employing tried-and-true tax strategy in their private lives to try to minimize the amount of tax paid to the Federal government.

Only time will tell whether or not this type of litigation will start a trend or not, but one thing is for sure – absent legislation by Congress limiting the issuance of patents on tax strategy – more applications will be filed with the PTO.  Tax professionals as well as their clients need to be aware that the risk of litigation exists when employing even the most mundane tax strategies (such as putting your own stock options into a GRAT).  Quantifying this risk to the client is now undoubtedly an added cost of engaging in tax planning and the tax professional may now have an ethical obligation to perform a due diligence search for issued and published patents on the specific strategy involved.

Help on the Way?

As controversial as the patenting of business methods has been, this particular subset of that category – the patenting of tax strategies – has caused a firestorm on Capitol Hill.  Calls for legislation to outright prohibit the issuance of these types of patents or at the very least to provide protections against patent infringement liability to taxpayers and tax practitioners have been raining down on the House Ways and Means Committee and the Senate Finance Committee.

In February of 2007, for example, the American Institute of Certified Public Accountants (AICPA) sent letters to the Congressional tax-writing committees urging Congress to pass legislation to restrict patents on tax strategies.  In their view, the AICPA argued that patents for tax strategies:

• Limit taxpayers' abilities to fully utilize tax law interpretations intended by Congress;

• May cause taxpayers to pay more tax than Congress intended or others pay;

• Complicate the process of providing tax advice;

• Hinder taxpayer compliance;

• Mislead taxpayers into thinking a patented strategy is valid under the tax law; and

• Prevent professionals from challenging the validity of tax strategy patents

Possibly as a result of these letters from the AICPA, more recently, the House Judiciary Committee has approved an amendment to a bill that would prohibit patents of "tax planning methods" defined as "a plan, strategy, technique or scheme that is designed to reduce, minimize or defer" tax liability.  We will have to wait and see if this bill eventually becomes law and saves all taxpayers and tax professionals at least one headache.  Stay tuned.

If you would like to discuss this subject further, please contact Patrick Lavoie (plavoie@pmn.com) or any member of our tax service team at 617-426-9440.

Note: This article represents a general overview of Federal and/or Massachusetts tax issues or developments and should not be relied upon without an independent, professional analysis of how any of these provisions may apply to a specific situation.

IRS CIRCULAR 230 NOTICE:  In compliance with U.S. Treasury Circular 230 Regulations and any applicable state laws, we hereby notify you that any tax advice contained in the body of this document, or attachments thereto, was not intended or written to be used, and cannot be used, by the recipient or any other party for the purpose of  (1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein.