Think you've come up with a perfect tax strategy for your high-end clients? Before you go ahead with it, you might want to check if it's been patented. You're liable to be sued for patent infringement if someone else thought of it first.It all started in 1998, when a federal appeals court ruled that business methods could be patented. Since then, more than 60 tax-strategy patents have been granted, and 86 more are pending. And the first infringement suit has been filed over the SOGRAT patent.

The SOGRAT patent, granted by the U.S. Patent Office to Robert C. Slane of Wealth Transfer Group, involved a grantor retained annuity trust, or GRAT, funded with nonqualified stock options. Since GRATs are permitted by the Tax Code, it came as a surprise to many professionals that a patent was granted for a variation of such a common technique.

Both the American Institute of CPAs and the American Association of Attorney-CPAs have come out strongly against the practice.

"Tax-strategy patents may make it impossible for the U.S. Tax Code to be applied equally to all taxpayers," said AICPA president and chief executive Barry Melancon. The problem is growing, he noted, since the patents "do not pertain to just esoteric portions of the Tax Code affecting a handful of taxpayers; the patents cover a broad range of areas, including estate and gift tax, pension plans, tax-deferred exchanges and deferred compensation, that affect millions of taxpayers."

"We're against it," said E. Martin Davidoff, CPA and tax liaison chair of the AAA-CPA. "The U.S. Patent and Trademark Office should not be in the business of acknowledging and rewarding the first user of a tax scheme that effectively reduces government revenue."

The patenting of financial strategies essentially places two federal agencies at odds with each other, according to Davidoff. The Internal Revenue Service strives to discourage the use of tax shelters, yet the Patent Office - and, in effect, the Department of Commerce - encourages their use by issuing patents on them.

"We believe that it should be against public policy for an agency of the government to encourage proprietary tax-reduction strategies," he said.

"The issuance of patents on tax-reduction strategies may convey to the public the erroneous impression that such strategies are approved by a federal agency," noted Sydney S. Traum, CPA and a past president of AAA-CPA and member of its Executive and Tax Liaison Committees. "This falls far short of the USPTO's goal of safeguarding consumers against confusion and deception in the marketplace." Moreover, there is no guarantee that any patented strategy or scheme will be accepted by the IRS, or have any effect at all in reducing a tax liability, he noted.


H.R. 2365, introduced by Rep. Rick Boucher, D-Va., with co-sponsors Reps. Bob Goodlatte, R-Va., and Steve Chabot, R-Ohio, would limit damages and other legal remedies available to holders of patents for tax-planning methods. The bill has been referred to the House Judiciary Committee, which has jurisdiction over patent issues.

Under the bill, tax prep software would be exempt from the limits on damages and remedies for tax-planning methods.

"That's important, because the IRS in principle is against patenting tax strategy, but they are in favor of patents for software because that will enhance their e-filing goals," said Tom Ochsenschlager, the AICPA's vice president of taxation. "They are concerned that no legislation be passed that would affect innovation in the software area."

However, Ochsenschlager noted, the question arises as to what exactly constitutes software. "There's a patent for evaluating the financial consequences of converting a standard-form IRA to the Roth IRA," he said. "It sure looks like nothing more than an Excel spreadsheet. I suspect that many professionals will want to make that computation in the next few years."

Under 2006 legislation, the $100,000 adjusted gross income limitation on a conversion of a traditional IRA to a Roth IRA is eliminated. For conversions in 2010, the conversion amount is recognized ratably over two years, unless the taxpayer elects to recognize it all in 2010.

Other tax strategies issued a U.S. patent include: a system and method for creating a defined-benefit pension plan funded with a variable life insurance policy and/or a variable annuity policy; 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 for controlling the cash-value growth of an insurance policy.

The tax-strategy patent issue has been below the radar for most tax professionals for several reasons, according to Ochsenschlager. "It seems such an absurd concept, it never occurred to us to look for it," he said. "In addition, they don't have to make it public. Patents are issued in a 'black box,' so you don't know about it until it's been issued - or you get sued for violating it."

The AICPA said that it opposes tax-strategy patents because they:

* Violate the core principle of equity that undergirds the entire tax system - namely, that people in similar situations ought to pay a similar amount of taxes;

* May cause some taxpayers to pay more tax than Congress intended;

* Complicate the provision of tax advice by professionals;

* Make compliance by taxpayers more difficult; and;

* Mislead taxpayers into believing that a patented strategy is valid under the tax law.

"It's one thing if there's a patent on a pharmaceutical pill," said Ochsenschlager. "With only a dozen manufacturers, if someone sees a different manufacturer's version on a store shelf, they can go and sue. It's different when you have a patent used by thousands of practitioners."

"It's not likely that anyone got patents thinking they will get a ton of money by licensing the strategy," he added. "It seems more of a marketing option."

He noted that a number of AICPA members received a letter regarding a patented estate-planning technique. "If someone wants to use it, they could talk to the patent holder about a fee," he said. "The alternative is for the patent holder to do that part of the planning for the transaction."

"The natural progression is that they'll ultimately try to enforce it when there's a violation," he said.

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