When Does It Make Sense To Patent Tax Strategies?

NJBIZ, Jul 30, 2007 by Daks, Martin C

Critics say it threatens to create two classes of taxpayers

GROWING CONCERN OVER a federal agency's four-year-old decision to grant patents on tax strategies has some CPAs in New Jersey and elsewhere worried about counseling clients on tax planning.

But "if drugs can be patented, why not tax strategies?" asks E. Martin Davidoff, a Dayton CPA and tax attorney, referring to a decision by the U.S. Patent and Trademark Office to extend patent protection to tax strategies.

"In theory, if a person comes up with an innovative procedure to save taxes, why shouldn't they be able to patent it and charge royalties to other people who want to use the same procedure," asks Davidoff, who chairs the tax liaison committee for a trade group called the American Association of Attorney-CPAs.

Supporters call patenting tax strategies no different from the intellectual protection that's helped build powerhouse drug companies like New Brunswick's Johnson & Johnson or software companies like Microsoft Corp.

But Congress may use a legislative end run to get around the decision. Last month a House subcommittee took up HR 2365, a bill that would limit the ability of tax-strategy patent holders to collect damages from people who use their methods without approval. The measure would let tax-preparation companies keep their patents on software.

"If Congress doesn't do something, then tax patents will have a chilling effect on tax planning," says Dan Meehan, a tax partner with the Roseland CPA firm J.H. Cohn LLP. "Every CPA likes to think his or her ideas are unique, but the fact is that thousands of CPAs are examining the Internal Revenue Code, and what happens when one person patents the idea?"

However, he adds, "tax patents probably won't affect an average person's strategy. But even if only a small percentage of taxpayers are affected, the impact may because dramatic, because you're dealing with highend taxpayers."

The American Bar Association (ABA) says the U.S. Patent Trade Office issued the first tax-strategy patent in 2003 to Robert Slane, a financial adviser in Altamonte Springs, Fla., for exclusive rights to a "grantor retained annuity trust"-a sophisticated form of estate planning.

Although the patent meant that anyone who used Slane's technique would have to remit a royalty to him, few eyebrows were raised at first.

But the esoteric issue caused a big splash last year when Slane's estate-planning company, Wealth Transfer Group, filed a tax-strategy patent infringement suit in Connecticut's Federal District Court against John Rowe, the former chair and CEO of insurance giant Aetna Inc.

In March the parties agreed to a confidential settlement that did not require an admission or denial of liability.

The American Institute of Certified Public Accountants has been critical of patenting strategies. "Tax-strategy patents may make it impossible for the U.S. Tax Code to be applied equally to all taxpayers," says Barry Melancon, who heads the national organization. "It violates the core principle of equity that under girds the entire tax system-namely, that people in similar situations ought to pay a similar amount of taxes."

Such critics say patents could create two classes of taxpayers: those whose advisers are licensed to use the patented strategies, and those who are not.

Other experts question whether patent examiners have the training to decide which strategies merit patents. "It is the duty of patent examiners to make the determination that a patent is novel and not obvious," says Ellen Aprill, a tax law professor at Loyola Law School in Los Angeles.

But she says examiners "are trained as engineers, with few having some additional financial education, such as an MBA. They are not tax lawyers or accountants."

Dennis Drapkin, who chairs the ABA's tax-patent strategy tax force, says the organization takes no position on the merits of tax-strategy patents. "We've invited speakers to explain the issues so our members can consider it," says Drapkin, a partner in the Dallas office of Jones Day who focuses on tax matters and other issues.

Local CPAs and attorneys say they're not aware of any tax patents developed by New Jersey residents.

But a review of the U.S. Patent and Trade Office's Web site indicates that some Merrill Lynch employees in New Jersey and elsewhere were behind a patent the company won in May for a strategy called "Convertible Financial Instruments With Contingent Payments." That technique may bring companies tax breaks when they issue debt to raise capital.

E-mail to mdaks@njbiz.com