Strategy Patents: Truth and Consequences
Can Patents Encourage Invention Without Complicating
Tax Preparation and Compliance?
2008 - The recent settlement of a lawsuit against a former CEO of
a major insurance company has only further fanned the flames over
patented tax strategies—the right to prevent others from making,
using, selling, and offering for sale or importing one’s own
tax strategy. Due diligence for tax advisors must now include checking
for patent infringement and advising clients about the legal ramifications
of adopting a patented tax strategy. To date, more than 60 patents
are held on tax strategies, and only Congress can halt the patentability
of these strategies or limit infringement damages. A review of the
issues surrounding patented tax strategies requires familiarity
with the background behind patenting tax strategies, an understanding
of the implications of patenting, and knowing the current status
of proposed changes to the law.
What Are Tax Strategy Patents?
Act of 1952, the basis for the modern patent process, provides
that any person who “invents or discovers any new and useful
process, machine, manufacture or composition of matter, or any
new and useful improvement thereof, may obtain a patent therefore,
subject to the conditions and requirements of [Title 35].”
The four core requirements for the issuance of a patent are as
- the invention
or discovery is of a proper subject matter;
- the invention
or discovery is useful;
- the invention
or discovery is novel; and
- the invention
or discovery is non-obvious at the time it was made to a person
of ordinary skill in the relevant art.
gives the patentee a 20-year right over the invention or discovery,
and violators can be assessed monetary damages. Patents cannot
be obtained upon a mere idea or suggestion.
It was unclear
whether business processes could be patented until the 1998 decision
in State Street Bank & Trust Co. v. Signature Financial
Group, Inc. [149 F. 3d 1368 (Fed Cir. 1988), cert. denied,
525 U.S. 1093 (1999)]. In that case, the judge ruled that mathematical
algorithms used to calculate the share prices of mutual fund holdings
in a way that satisfied tax regulations to be “a useful,
concrete and tangible result” and, therefore, they could
be patented. After this ruling, business method patents became
one of the fastest-growing segments of patent applications, with
8,678 and 8,959 filed in 2005 and 2006, respectively.
to the United States Patent and Trade Office (USPTO), 60 patents
and 86 published applications in the special subcategory for tax
strategies and data processing have been processed since June
2007 (www.uspto.gov). The special category, current U.S. classification
705/36T, includes patents for a wide variety of tax planning techniques.
Some patents focus on the use of a computer as a crucial element
of the business method. Others rely mainly on the tax structure
of patents granted and pending applications are included in Exhibit
9, 2007, an important lawsuit regarding tax strategy patents was
settled. In the case, Wealth Transfer Group LLC v. John W.
Rowe [Docket No. 3:06-cv-0024-AWT (D. Conn.)], Robert Slane,
president of the Florida-based Wealth Transfer Group, alleged
that John Rowe, former CEO of Aetna, Inc., used his patented tax
strategy on his personal tax return. The patent, number 6,567,790,
was designed to minimize estate and gift tax liability through
the use of a grantor retained annuity trust (GRAT) funded with
nonqualified stock options. Slane’s accusations were based
on an Aetna SEC filing. The case, also known as the SOGRATS patent,
was settled out of court with parties agreeing to a confidential
patent licensing agreement. Court records stipulated that the
patent was presumed to be valid.
to testimony given by Dennis Belcher, an officer of the American
College of Trust and Estate Counsel, to the subcommittee on Select
Revenue Measures of the House Committee on Ways and Means on July
13, 2006, many estate-planning professionals were shocked to learn
that the common gift tax strategy described in the SOGRATS patent,
which had been authorized under the Treasury Regulations and approved
by the IRS, was able to be patented.
patent and the subsequent lawsuit highlighted the fears of many
tax professionals. First, there is a possibility that a well-known
tax strategy could be patented, albeit in error. Second, one person
or corporation can restrict the use of a tax strategy and seek
damages for infringement. Third, taxpayers can be sued while complying
with tax law and relying on their advisor’s tax advice.
Other Patent Concepts
of “prior art” refers to the earlier existence of
a claim made in the patent application. To determine whether a
claim is novel, the patent examiner must search for the existence
of prior art. If at any stage of the patenting process, including
after the patent has been granted, prior art is found, the patent
will be invalidated. Consequently, tax strategies documented in
seminars, textbooks, and newsletters may be considered prior art
and thus are important in the patenting process.
may be unable to provide evidence of prior art for some patents
because some applications are never published. Patent applications
are generally published within 18 months after the filing date;
applicants not filing for protection outside of the United States
can request that the application be unpublished until granted.
According to Wynn Coggins, director of business methods technology
center at the USTPO, only about 10% of business method applications
are not published (see Dustin Stamper, “Tax Strategy Patents:
A Problem Without Solutions,” Tax Notes, April
23, 2007). Exhibit
2 lists some resources to search for patents.
After a patent
is granted, any unauthorized use of the method described constitutes
an infringement. Under 35 USC section 271(a): “Whoever without
authority makes, uses, offers to sell, or sells any patented invention,
within the United States or imports into the United States any
patented invention during the term of the patent therefor, infringes
the patent.” In the case of a tax strategy patent, the infringers
are likely to be the tax advisor and the taxpayer, with the taxpayer
being the direct infringer. An infringer is liable for damages
even if he was not aware of the patent. Trebled damage can be
assessed if the infringer was aware of the patent. In addition
to monetary damages, the law provides for injunctive relief. In
other words, the patentee may have the right to stop the infringer
from using the patented tax strategy.
The law provides
a limited “prior user” defense from an infringement
lawsuit. After State Street Bank was decided, there was
concern that other persons using business methods that were previously
thought not to be patentable could be sued by someone who held
a patent. The American Inventor’s Protection Act of 1999
included the First Inventors Act, which provides an infringement
defense to a defendant who can show she used the business method
in the United States at least one year before the effective date
of the patent and had commercially used it before the filing date.
provided by patents depends on the ability of the patentees to
enforce it. Filing lawsuits and retaining legal counsel can be
expensive. An individual with means is better able to enjoy the
benefits of a patent than others. In addition, a patentee must
be able to detect infringement to achieve the advantages of a
patent. In the case of a tax-related strategy patent, patentee
detection can be difficult due to the confidential nature of tax
Implications for Stakeholders
of tax strategy patents, including Ellen P. Aprill, tax lawyer
and Associate Dean at Loyola Law School (Los Angeles), fear that
the practice of giving tax advice may become more expensive and
difficult. Due diligence and ethical considerations may require
practitioners to determine whether a tax strategy is patented
and whether to disclose that information to the taxpayer. The
additional billable hours increase the cost to the taxpayers.
Due to potential licensing costs and fear of lawsuits, some tax
advisors may decide not to recommend patented tax strategies to
their clients, negating the intent of tax policy and limiting
the taxpayer’s ability to legally reduce taxes. In theory,
proponents argue, good tax policy should disclose to taxpayers
how to comply with the law, and only non-obvious, unforeseeable
tax strategies would be eligible for a patent. Consequently, the
intended effects of tax policy would not be hampered.
that tax strategy patents promote unequal treatment of “similarly
situated taxpayers” and violate a fundamental tenet of the
U.S. law. The Supreme Court stated, in Thor Power Tool Co.
v. Com’r [439 U.S. 522 (1979)], that the tax system
is designed to “ensure as far as possible that similarly
situated taxpayers pay the same tax,” also known as the
principle of “horizontal equity.” If one taxpayer
has access to a patented strategy and the other does not, they
will pay unequal taxes. Furthermore, a basic tenet of the U.S.
legal system is to allow equal applicability to all. Critics contend
that patentees of tax strategy patents can legally restrict a
taxpayer’s ability to comply with the tax laws.
on the free transfer of information within the tax profession
is another disquieting issue. Tax preparers may become reluctant
to share new ideas and strategies because doing so will make their
ideas less novel and non-obvious, jeopardizing the ability to
obtain a patent. As a result, the dissemination of tax knowledge
might be significantly reduced.
that the government will encourage tax avoidance is another concern.
As suggested by Ellen P. Aprill in her testimony before the Subcommittee
on Select Revenue Measures, since tax strategy patents will likely
be promoted through marketing, a corresponding reduction in tax
revenues may ensue, placing a heavier burden on other taxpayers.
Consequently, opponents have questioned the usefulness—a
core requirement of patentability—of these types of patents,
because the loss of tax revenues may result in a loss to society
as a whole. On the other hand, it could be argued that legitimate
patented tax strategies are beneficial to society, because they
enable taxpayers to pay only the amount required by law.
a patent on a tax strategy, taxpayers may construe that the strategy
is sanctioned by the government—after all, one branch of
government, USPTO, has legitimized it. In his hearing before the
House Ways and Means Subcommittee on Select Revenue Measures in
July 2006, former IRS Commissioner Mark Everson stated that this
mixed message is a major concern of the IRS.
concern is that a tax shelter promoter can use the patenting process
to avoid the reportable transaction regulations under Treasury
Regulations section 1.6011-4. These regulations require that taxpayers
participating in a reportable transaction must disclose the nature
of the transaction in an attachment to their tax return. This
notification allows the IRS to scrutinize the transaction. Confidential
transactions, where a tax advisor requires the taxpayer to keep
the details of the tax strategy confidential and is paid a minimum
fee, are considered reportable transactions and must be disclosed.
The patenting process allows a tax advisor to lift its confidentiality
requirement, receive the assurance that no one can benefit from
the tax maneuver, and bypass the disclosure requirement.
2007, the IRS issued proposed regulations adding a new “patented
transaction” category of reportable transactions requiring
users of tax strategy patents to document their transactions.
The transaction threshold amounts in Treasury Regulations section
301.6111-3(b)(3)(i)(A) are reduced from $50,000 to $250 and from
$250,000 to $500 [see proposed Treasury Regulations section 1.6011-4,
REG-129916-07, 72 FR 54615 (9/26/2007)].
of tax strategy patents proclaim that gathering complete prior
art to determine novelty and non-obviousness is nearly impossible.
Tax returns—the major source of evidence of prior art—are
unavailable because of confidentiality. If a taxpayer is sued
for infringement, she will find it difficult to invalidate a patent
on the grounds that it is obvious and lacking novelty because
tax-return evidence showing prior use cannot be obtained. Because
the USTPO also lacks access to tax-return data, it cannot improve
the quality of tax strategy patents. It should also be noted that
the USTPO typically hires staff with engineering backgrounds,
who may not have the general business and tax expertise to search
other existing literature and other forms of prior art.
of tax strategy patents say that innovation is spurred by incentivizing
inventors. With a patent, a tax strategy developer can be rewarded
for developing a unique and valuable way to reduce taxes by charging
others for using their ideas. In addition, because, in theory,
these strategies are unknown prior to the issuance of the patent,
the patenting process can help publicize knowledge and make these
tax-saving techniques available to others. Opponents argue that
tax innovation is encouraged by the tax savings themselves and
fees advisors receive for tax services, making patents unnecessary.
of the arguments for tax strategy patents, many in the accounting
and legal professions, as well as regulatory agencies, have serious
concerns and are currently seeking solutions. Because patents
are established by laws, only an act by Congress can change the
patentability of tax strategies. The AICPA, the American Association
of Attorney-CPAs (AAA-CPA), the American Bar Association Section
of Taxation, and some state accounting and legal associations
have expressed their concerns in letters to the House and Senate
judiciary and tax committees.
2007, the AICPA proposed that Congress eliminate the consequences
of tax strategy patents by either restricting the issuance of
patents for tax strategies or providing tax preparers and taxpayers
protection from patent infringement liability. In May 2007, Senators
Carl Levin (D-Mich.), Norm Coleman (R-Minn.), and Barack Obama
(D-Ill.) introduced section 303 of the Stop Tax Haven Abuse Act
(S. 681). Representative Lloyd Doggett (D-Texas) introduced H.R.
2136 (the House version of the act). Section 303 of both versions
would stop tax strategy patents by prohibiting the USPTO from
issuing patents for inventions “designed to minimize, avoid,
defer, or otherwise affect liability for Federal, State, local,
or foreign tax.” Commentators have observed that the language
in the proposed statute is broad, and could extend to business
method patents that have a primary purpose other than tax avoidance,
such as tax preparation software.
In May 2007,
Representative Rick Boucher (D-Va.) introduced H.R. 2365, a bill
intended to limit monetary damages and other remedies, including
injunctions, with respect to patents for tax-planning methods.
If the bill were to be passed, infringement under subsection (a)
or (b) of section 271, and the provisions of sections 281, 283,
284, and 285 would not apply against the taxpayer, the tax preparer,
or any related professional organization.
remedies is a solution borrowed from the medical profession, which
suffered from a bout of lawsuits in the mid-1990s, when patent
law threatened doctors performing patented medical procedures.
The medical profession was successful in obtaining the Physicians
Immunity Statute, which removed all remedies, both monetary and
injunctive, against licensed medical practitioners in the performance
of a medical activity that infringed on a patent. It is interesting
to note that the statute did not make medical processes, surgical
devices, and related methods ineligible subject matter for patents—the
Stop Tax Haven Abuse Act would make tax strategies ineligible
In July 2007,
the House Judiciary Committee approved a patent reform bill (H.R.
1908) which included a provision that would make tax planning
techniques unpatentable. The wording of the provision is more
specific than the Stop Tax Haven Abuse Act. Rep. Boucher proposed
the amendment, which provides that a patent may not be obtained
for “a tax planning method”—a plan, strategy,
technique, or scheme designed to reduce, minimize, or defer a
taxpayer’s tax liability, or that, when implemented, has
that effect. An unpatentable tax-planning method does not, however,
include the use of tax preparation software or other tools used
solely to perform or model mathematical calculations or prepare
tax or information returns. The provision would cover tax planning
with regard to any federal, state, county, city, municipality,
or other governmental levy, assessment, or imposition (whether
measured by income, value, or otherwise) from the enactment date.
On September 7, 2007, H.R. 1908 was passed by the House. At the
time of this writing, the Senate version of the bill, S. 1145,
does not include this provision, and it has not been brought to
On the other
hand, S.2639, introduced on November 15, 2007, will amend Title
35 to specifically state that “tax planning inventions are
not patentable.” In this bill, the term “tax planning
invention” is defined as “a plan, strategy, technique,
scheme, process, or system that is designed to reduce, minimize,
avoid, or defer, or has, when implemented, the effect of reducing,
minimizing, avoiding, or deferring, a taxpayer’s tax liability
or is designed to facilitate compliance with tax laws, but does
not include tax preparation software and other tools or systems
used solely to prepare tax or information returns.”
section proposed reforming the patenting process to increase patent
quality and disclosure to the IRS. These reforms include publishing
all patent applications (so others can dispute its claims to novelty
and non-obviousness and the IRS can judge its validity), extending
the time a patent claim can be disputed, and expanding USPTO review
of prior art.
To give the
IRS more data to evaluate the potential concerns of tax strategy
patents, the ABA Section of Taxation has proposed requiring taxpayers
to report their use of patented tax strategies and their use of
tax advisors, including the name of the patentee, to the IRS.
This would be done by expanding the existing disclosure requirements.
The IRS has
instituted procedures to assist the USPTO in developing the resources
to determine “prior art” in the area of tax strategies.
According to former IRS Commissioner Everson, the IRS has formed
a task force with members from both agencies and conducted a workshop
designed to update the USPTO on the latest sources of information.
To avoid sanctioning a particular tax strategy, however, the IRS
is opposed to directly taking on responsibility for reviewing
prior art from the USPTO. In response, the USPTO plans to hire
more professionals with broad tax, finance, and business knowledge.
The IRS has also asked tax professionals to supply the USPTO with
useful information on business methods and tax strategies for
consideration as prior art.
the right policy for dealing with tax strategy patents is complicated
by the conflicting goals of enforcing tax compliance and encouraging
tax strategy innovation. The implementation of general tax policy,
on one hand, requires that all taxpayers have equal access to
tax reduction strategies. On the other hand, innovation requires
that developers of knowledge be rewarded with the power to restrict
access and collect licensing fees or damage awards.
tax strategy innovation is an exciting notion; however, having
to pay a user fee for each use, complicating an already complex
tax system, living with the possibility of infringement for simple
compliance, having taxpayers unable to reduce their taxes because
they are unable to pay fees, and having taxpayers subjected to
increased IRS scrutiny for using it, represent a very high price
for tax innovation.
recent proliferation of bills that would eliminate or weaken the
effects of tax strategy patents and a President who is sympathetic
to a ban, it would appear likely that Congress will eventually
eradicate tax strategy patents. Right up until that day occurs,
however, the applications and patents will likely continue at
increasing rates, further complicating the tax system and taxpayers’
ability to comply with both tax and patent laws.
over the patentability of tax strategies may be far from a resolution,
and more dialogue from affected members of society is needed.
Unless and until a change in the law eliminates the patentability
of tax strategies or exculpates taxpayers and preparers from patent
infringement, tax advisors should consider learning how to search
for tax strategy applications and patents; rendering prior art
for tax strategy applications; documenting and retaining evidence
of their business practices and tax strategies; and retaining
patent law attorneys when needed. Engaging in the debate by contacting
government representatives is another way to get the profession’s
A. McDowell, PhD, CPA, is an assistant professor of accounting
at Rider University, Lawrenceville, N.J.