Just because the idea of violating a patented tax strategy sounds ridiculous on its face doesn’t mean you won’t get sued for using it.Currently, some 65 tax patents have been issued, and 109 more are pending, according to Eileen Sherr, technical manager at the American Institute of CPAs’ Tax Division. “Many of these are common twists on everyday transactions,” observed Sherr, who attended a recent Internal Revenue Service hearing on the issue.

“There are several patents dealing with the use of charitable remainder trusts, and there’s one on deferred real estate exchanges under Code Sec. 1031,” she said. “These are fairly common little twists on transactions that people have been doing for years.”

Other tax strategy patents on the books include a patent for tax savings on converting from a regular IRA to a Roth IRA; a method and system for converting a designated portion of future Social Security and other retirement payments to current benefits; and a system and method of controlling the cash value growth of an insurance policy.

The tax patent door was initially opened in 1998, when a federal appeals court ruled that business methods can be patented. Since then, the issue of tax patents has crept up on the profession.

At least one patent infringement suit has been brought over the SOGRAT patent — an acronym for stock-option grantor-retained annuity trust — involving a grantor-retained annuity trust, funded with nonqualified stock options. Since GRATs are permitted by the Tax Code, some questioned the granting of a patent for a variation of such a common technique.

“The concept seems so absurd,” said Tom Ochsenschlager, AICPA vice president for taxation. “Moreover, patents are issued in a black box. You don’t know about it until it’s issued, or you’re in a lawsuit for violating it.”

The AICPA has come out in opposition to these patents because they potentially:

* Limit the ability of taxpayers to utilize fully interpretations of tax law intended by Congress;

* May cause some taxpayers to pay more tax than Congress intended and may cause other taxpayers to pay more tax than others who are similarly situated;

* Complicate the provision of tax advice by professionals;

* Hinder compliance by taxpayers;

* Mislead taxpayers into believing that a patented strategy is valid under the law; and,

* Preclude tax professionals from challenging the validity of tax strategy patents.


The IRS recently issued proposed regulations that would add a new category of reportable transactions for patented transactions. In comments, the Tax Section of the American Bar Association commended the proposed regulations.

“In our view, the principal benefit of tax patent reporting is that it will permit the IRS and the Treasury Department to identify the areas of the tax law for which patents are being claimed — and thus areas of the tax law that private parties are asserting the right to control,” the ABA stated.

“Even though there are a relatively small number of tax strategy patents compared to all the business method patents, it just does not seem like good public policy, perhaps because people are mandated to pay taxes, and everyone should have the same opportunity and not have to pay a separate fee,” said Dennis Drapkin, a tax attorney at the Dallas office of Jones Day. Drapkin is the former chair of the ABA Tax Section and currently serves as co-chair of the task force on tax patents.

Drapkin, who spoke at the recent hearing, noted that there is movement afoot in the judicial area that could affect tax strategy patents. “The Court of Appeals for the Federal Circuit has indicated the entire court would hear In re Bilski, which has to do with what kinds of business method patents are valid,” he said. Bilski involves a patent for a method for managing risk in commodities trading.

In contrast to the ABA Tax Section, the Tax Division of the AICPA discouraged the adoption of the reportable transaction solution.

At the IRS hearing, the institute stated, “We are concerned (as a general proposition) that the proposed regulation’s reporting regime might be unnecessarily burdensome to taxpayers and tax advisors for whom the patenting of tax strategies is already burdensome.”

Moreover, the proposed regulations place the burden of reporting patented tax strategies on the taxpayers and advisors using the strategies, rather than the patent holder, according to Sherr, who spoke at the hearing.

Sherr said that there are several bills pending that would solve the problem. “We support the Patent Reform Act of 2007 [S. 1145], as well as S. 2369, a free-standing bill introduced by Senators [Max] Baucus and [Chuck] Grassley, which would prohibit tax strategy patents,” she said.

“We’d like to see the problem solved as soon as possible, since the number of patents is only going to grow,” said Mark Peterson, the AICPA’s vice president for congressional and political affairs.

A legislative possibility is to remove the remedy for violation of a tax strategy patent, he said. “Sixteen years ago surgical techniques could be patented. Imagine someone on the operating table, with their surgeon worried that he might be violating someone’s patent,” said Peterson. Congress has since passed a law granting limited immunity to medical practitioners in such situations.

However effective the proposed regulations are in alerting the IRS and practitioners to the tax strategies being patented, they won’t keep them from being issued in the first place, according to observers.

“That’s why Congress needs to pass legislation,” Peterson explained. “Although there are a number of pending cases that address the larger business-method patent issue, and the concern that is raised is a positive thing, from our perspective it will take legislation to fix tax strategy patents.”

In lieu of legislation, the AICPA recommended that the IRS establish procedures to coordinate the review and analysis of tax strategy applications before the patents are issued, or to require that applicants provide the IRS with a copy of their application when they file it with the U.S. Patent and Trademark Office.

Either of these suggestions would result in the IRS receiving actionable information well in advance of what is envisioned under the proposed regulations’ reportable transaction disclosure regime.

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