Allowing firms to patent tax strategies may mean you and your clients have to foot the bill.

    Financial advisors certainly face no shortage of headaches in trying to minimize their clients' tax liabilities. But worrying about royalties typically hasn't been one of them-until now.
    During the last few years, the U.S. Patent and Trademark Office (USPTO) has been allowing private companies to patent specific tax strategies. This is a new development. Until 1998, there was a general consensus in the intellectual property (IP) community that "business methods" could not be patented. But that year, in its State Street Bank decision, the U.S. Court of Appeals for the Federal Circuit, the court charged with general oversight over patent issues, transformed American IP law by upholding a patent on Signature Financial Group's "hub and spoke" mutual fund asset pooling system. A business process is patentable, the court concluded, so long as it "produces a useful, concrete, and tangible result." Unsurprisingly, State Street opened the floodgates to patents on all sorts of strategies that could be labeled "business methods" with any plausibility, including tax strategies. Over the past eight years, the USPTO has issued 41 tax strategy patents, while more than 60 are under review.
    Consequently, financial advisors, accountants and tax lawyers are faced with two disagreeable alternatives-either pay hefty licensing fees to give advice that is the part and parcel of their jobs, or risk being sued for patent infringement.
    Some businesses reasonably might conclude they would rather take the risk; after all, no patent holder can sue for an infringement of which it is unaware, and while it is fairly easy to discover if someone is unlawfully selling a generic version of your patented drug or computer software, this isn't the case regarding confidential personal tax strategies. Even so, patent holders do have their ways of finding out.
    In 2003, the USPTO awarded a Florida company called Wealth Transfer Group a patent for a complex tax strategy called a "SOGRAT." Shortly thereafter, John Rowe, executive chairman of Aetna, at the suggestion of his lawyers and a financial advisor, used a similar strategy in an attempt to minimize estate and gift taxes without paying Wealth Transfer a licensing fee. He then reported the transfer of the options to regulators, as he was required to do as a corporate officer. Wealth Transfer appears to have discovered his alleged infringement from the report and filed suit in January 2006.
The plaintiff enjoys one major advantage: Their patent, like all others issued by the Patent Office, enjoys a "presumption of validity." Nevertheless, Rowe's lawyers have several possible defenses in their arsenal whose effectiveness could have major implications for all future tax strategy cases.
First of all, they can argue that Wealth Transfer's patent does not meet all three criteria necessary for validity-utility, novelty and nonobviousness. While the SOGRAT is evidently useful, it may very well not be novel (very similar strategies having been used before) and it may in fact be rather obvious to the well-informed financial advisor. However, here the statutory and case law is somewhat unfavorable. Essentially, the defense can only disprove a patent's novelty if the patented product or method was publicly known-if it was a trade secret, or even if it just wasn't described in detail in a published source, the courts will still consider it "novel."
    But specific tax advice is confidential, and even when specific tax advice is disseminated, this is not generally done in publications accessible to the general public but rather through closed seminars and similar gatherings. For these same reasons, it is difficult to concretely establish what is or is not "obvious" to what the law calls "a skilled artisan knowledgeable in the field."
    Rowe's attorneys can also claim a special statutory defense under the First Inventor Defense Act, which Congress passed partly in response to State Street Bank. Under the Act, a defendant in a business method lawsuit is protected from litigation if it can prove that it had, in good faith, used the method in practice at least a year before the plaintiff's patent was filed. This is a considerably lower standard than is required to successfully claim a patent is not novel; however, confidentiality issues can still potentially prove problematic: A financial advisor may well have numerous letters to clients suggesting they adopt certain tax methods dated over a year before those methods were patented, but that doesn't mean those clients will authorize those private records to be disclosed to the courts.
    If Wealth Transfer ultimately does prevail, many tax advisors are predicting damaging consequences across the financial planning, accounting and legal professions. "For many strategies you consider that haven't been in the public domain for very long, you'll have to perform due diligence to make sure someone hasn't patented them. It would be a major burden," says Thomas D. Sykes, a tax attorney in the Chicago office of McDermott, Will & Emery LLP. "And whoever does get that license is going to have a substantial advantage over the competition. Is that a good thing from a public policy perspective?"
    Clearly, Skyes thinks not, a view he seems to share with the vast majority of financial advisors, estate planners and tax attorneys. Given such substantial opposition, some question why the USPTO ever approved many of the tax method patent applications in the first place. The simple answer is that the Patent Office is simply following the law as written by Congress, which instructs it, generally speaking, to issue the patent if the preponderance of the evidence suggests that the applicant has met the three-part standard and several other requirements.
    That argument is fair enough, as far as it goes. It is not clear, however, whether the Patent Office is nearly as well equipped to evaluate whether tax strategies are useful, novel and nonobvious as it is to judge software, mechanical devices or pharmaceuticals. First of all, the Patent Office lacks what patent specialists call "prior art"-the collection of books, magazines, seminar reports and previous patents-for taxation that it possesses for more traditional patentable inventions. But perhaps more importantly the USPTO, while amply staffed by engineers and molecular biologists, lacks a cadre of tax specialists. It is not necessarily a simple matter to know whether something is "nonobvious" or "novel" even when one is a "skilled artisan," because of the requirement that the IRS keep all of its information secret, even from other government agencies. For the layman, it is all the more difficult.
    Considering these factors, many commentators believe that the Patent Office is simply out of its depth when considering tax patents. This has led some (perhaps not wholly disinterested) experts to offer to lend the government a hand. And yet the only really plausible solution would entail hiring a bunch of tax experts at the USPTO. Some find that notion a bit farfetched. "To employ tax experts at the Patent Office seems very inefficient," comments Dennis I. Belcher, an estate planner with McGuire Woods LLP in Richmond, Va.
    Belcher thinks there is a much simpler solution to the problems engendered by tax strategies: Congressional prohibition of the patenting of tax strategies, a view he articulated at a July 13 hearing before a House subcommittee. He and other tax professionals bring up numerous practical issues in order to bolster their case. For instance, they point to the risk that clients will (not unreasonably) assume that, because their advisor is using a tax strategy under a patent granted by one part of the federal government (the Patent Office), that another arm of the same government (the IRS) will necessarily accept it. This simply isn't the case-the IRS has nothing to do with the patenting process.
Critics of the existing policy also argue against it on grounds of principle. Tax issues, they argue, are fundamentally different than ordinary business issues because taxes are mandatory. No business or individual needs to use a certain technology or business process in quite the same way that they need to pay taxes. According to this view, the government should not be in the business of forcing taxpayers either to pay at higher rates or to pay licensing fees to some private entity. Every group of similarly situated taxpayers should be treated equally. Some even say that the current situation is tantamount to the Patent Office granting ownership rights over areas of the tax code to private individuals.  
    How this controversy will ultimately be resolved is, of course, anyone's guess. Tom Sykes, the tax attorney, believes that the legislature will eventually act to change the law, but cautions that action may be delayed because changes in patent law sometimes involve sophisticated treaty issues that need to be worked out with foreign governments. Dennis Belcher also thinks change will eventually come, citing positive reactions to his testimony on the Hill. "I think it will happen once someone patents something mainstream that affects many people. Congress will be forced to act." He may not need to wait long: A private business recently filed an application to patent the conversion of regular to Roth IRAs.

Michael D. Brier is a freelance writer in Boston.