Surviving and Thriving in the Tax Patent Era

Just as things seemed to be quieting down after the Pension Protection Act of 2006, along came the latest challenge to the peace of the estate-planning world: tax patents.

In early 2006, an infringement suit was filed over the first “business method” patent for a method to reduce taxes by transferring stock options into grantor retained annuity trusts (GRATs). The parties ultimately settled, but not before the tax-planning community was in an uproar over the realization of the patent’s and the suit’s implications.

The shock sparked a hearing by the House Ways and Means Committee in the summer of 2006. Testimony was heard from those who opposed the issuing of tax patents, those who supported it, and those—including the Internal Revenue Service—who were decidedly neutral. Indeed, IRS Commissioner Mark Everson testified: “[W]e have found little evidence to suggest that tax shelters or aggressive tax avoidance transactions are being patented.”
The anti-tax-patent forces were able to get bills introduced in the House and Senate that would limit at least some categories of tax patents. While Congress traditionally restrains itself from tinkering very much with the patent laws, particularly when an industry or profession seeks a change, it may impose restrictions on the types of tax patents that are permitted.

Success for the anti-tax patent movement would buck the trend. All businesses and professions naturally want to be exempt from the patent laws. For years, opponents of patents for computer-related inventions unsuccessfully pushed for an exception. And that’s just one example. So far, it appears that only a single profession has succeeded in getting an exemption, albeit in a limited manner. In 1996, Congress amended the patent laws in response to concerns raised about physicians’ use of patented methods of medical treatment. On the theory that imposing patent restrictions on doctors could impact patients’ health and in many cases mean the difference between life and death, the laws were amended to deprive patentees of monetary and injunctive remedies against medical practitioners engaging in patent-infringing “medical activity.” When the “medical activity” exception was adopted, only a handful of medical treatment patents had been issued and the effect of the provision was therefore minimal, further supporting the break from tradition the exception constituted.

Certainly the stakes are lower with tax patents; it seems unlikely that any estate-planning client would actually expire because of a tax patent.

Proposed Bills

Patent protection in the United States has an impressive pedigree. Ben Franklin spearheaded the inclusion of the U.S. Constitution’s patent clause “to encourage and protect fellow inventors.” The U.S. Patent and Trademark Office (USPTO) essentially is the IRS of patent law. The courts respect its determinations. In 1998, a federal court confirmed the USPTO’s determination that a “business method” is patentable. The USPTO has since determined that tax-planning methods constitute patentable business methods. Hence, tax patents are legal.

How might the two legislative proposals change this? The first iteration of the House bill would have amended the remedies provisions of the patent laws to deny infringement remedies as to “a tax planning method,” defined as “a plan, strategy, technique, or structure that is designed to reduce, minimize, or defer, or has, when implemented, the effect of reducing, minimizing or deferring, a taxpayer’s tax liability.” Excluded from the definition of a tax-planning method would be “the use of tax preparation software or other tools used solely to perform or model mathematical calculations or prepare tax or information returns.” This bill was incorporated into the House’s patent reform bill. Although that patent reform bill had earlier been pronounced D.O.A., the text was redrafted and a revised version of the tax patent provision was added. That proposal went the whole nine yards—it simply made tax-planning methods unpatentable. A later version even substituted the word “scheme” for the word “structure,” reflecting the emotion the tax patent controversy has elicited.

In the Senate, a provision dealing with tax patents was introduced as a relatively brief portion of the lengthy and multi-faceted “Stop Tax Haven Abuse” bill. Section 303 of that bill would amend the patent provisions by excluding from patentability an invention that “is designed to minimize, avoid, defer, or otherwise affect the liability for Federal, State, local or foreign tax.” Arguably, the phrase “otherwise affect the liability for” is overly broad.

Even if one or both of these bills are adopted and future tax patents are curtailed, estate planners still will need to be concerned about those tax patents that get grandfathered in and, presumably, tax patent applications that were pending when the new legislation is enacted. (See “Grandfathered In,” p. 59). Advisors must learn how to ensure that they do not expose their clients—or themselves—to patent infringement actions.

Patent Law

Mercifully, the statutory provisions relating to patents, set forth in U.S. Code Title 35, are relatively pithy; key elements can be summarized briefly. The USPTO is responsible for granting and issuing patents in a manner consistent with “the public interest in continuing to safeguard broad access to the United States patent system.” The patent holder and the original patent holder’s successor in title each are referred to as the “patentee.” Patents are available to “[w]hoever invents or discovers any new and useful process,” or “any new and useful improvement thereof.” The term “process” includes “a process, art or method, and includes a new use of a known process.”

A person is “entitled to a patent” unless, inter alia, “the invention was known or used by others in this country . . . before the invention thereof by the applicant for patent,” or “the invention was patented or described in a printed publication in this or a foreign country or in public use or on sale in this country, more than one year prior to the date of the application for patent in the United States,” or the person “has abandoned the invention.”

A patent “may not be obtained” if “the differences between the subject matter sought to be patented and the prior art are such that the subject matter as a whole would have been obvious at the time the invention was made to a person having ordinary skill in the art to which said subject matter pertains.”

The reach of the patent statutes is virtually all-encompassing as to matters within their scope, including even, rather imaginatively, “inventions in outer space,” which enjoy their own dedicated provisions.

To protect the patent applicant in accordance with the policy purposes of the patent statutes, applications for patents are “kept in confidence” by the USPTO, and applications are published on the USPTO website only after 18 months from the earliest filing date. At the request of the applicant, an application may be withheld from publication and kept confidential even after that 18-month period, so long as it is not and will not be the subject of an application filed in another country. Patents granted for unpublished applications are sometimes referred to, informally and colorfully, as “submarine patents.”

A patent is generally valid for 20 years from the date of the application. And the law warns: “[W]hoever without authority makes, uses, offers to sell, or sells any patented invention . . . during the term of the patent therefor, infringes the patent.” Similarly, “[w]hoever actively induces infringement of a patent” is liable as an infringer. The patentee has “remedy by civil action” and injunctive relief for infringement of the patent. The patent is “presumed valid” and in the case of multiple claims, each claim is “presumed valid independently of the validity of other claims.” The patentee’s recoverable damages in a successful infringement suit are to be “adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court.” The court has the discretion to “increase the damages up to three times the amount found or assessed.” The patentee is entitled to royalties for the period prior to the issuance of the patent if the infringer had “actual notice” of the published patent application, as to claims that are “substantially identical” in the published application and the issued patent. In “exceptional cases,” the court may award “reasonable attorney fees to the prevailing party.” A six-year statute of limitation applies to infringement actions.

If these key elements of the patent provisions are fairly easy to comprehend, the same is not always true for the core of a patent or application: the claims asserted for the invention, and the strange, often opaque language in which these claims are expressed. To someone unfamiliar with this arcane area of legal drafting, the claims language can be reminiscent of the Dark Ages riddle-poetry you find in English literature anthologies, sandwiched between Beowulf and The Canterbury Tales excerpts. Here’s an example of some good claims language, excerpted at random from the USPTO website: “A method according to claim 1 wherein said hinge portions are deformed to position each of said fins such that an imaginary line tangent to an innermost surface of said hinge portion and to an outermost edge at a distal end of said fin is at an angle in the range of about to about relative to a radial of said rotational axis.”

Of course, patent attorneys probably would find the Treasury Regulations heavy reading. Perhaps the claims language for a tax patent may be less daunting for estate planners, who at least are familiar with the invention’s basic elements.

First, Search

Estate planners are well-advised to craft and adopt a protocol for identifying and dealing with potential tax patent issues as promptly as possible. Such a protocol also will be useful in light of another emerging trend: the issuing of patents for non-tax legal and accounting innovations.

How is the estate planner to know whether an idea he wishes to recommend to a client is already patented or patent-pending? First, consider the age of the idea. If the idea was presented at a seminar or published in an estate-planning journal before, say, 1998—the year of the State Street Bank decision recognizing business method patents —and has been in general use since, it’s unlikely the idea is the subject of a patent or patent application. Of course, novel variations or applications of the idea may well have become the subject of a patent or application in the interim.

So better to be safe than sorry: always check the USPTO website.

Because patent searches are new for most estate planners, the assistance of a skilled patent attorney would be helpful, even essential, if the estate planner’s initial patent search turns up a potential conflict with an existing patent or application.

Happily, negotiating the USPTO website is not difficult. From the home page, an initial patent search begins with a click on the “Patents” tab to the left of the screen, which offers a “jump to” scroll leading to a “5 Search Patents” link. Clicking on that link brings up links to “Issued Patents” and “Published Applications,” each of which will be important to consult. Each has a “Quick Search” link, which brings up a search page.

From this search page, there are a variety of ways to access the patent archive. One method is to click the “All Fields” scroll menu, select “Current US Classification,” and insert “36T/706” in the “Term” window. My click on the “Search” button on Aug. 7, 2007, brought up the 60 patents assigned to this classification.

A similar search process can be used in the “Published Applications” database. On the same day, it brought up 89 applications.

The list of “titles” located by this means can serve as a starting point for identifying a patent or application that may be related to the idea the estate planner is searching. Selecting promising-looking titles brings up the full patent or application. These begin with an “Abstract,” which as its name implies is a brief summary of the invention. Abstracts can help give a quick sense of whether there might be overlap with the estate planner’s proposed strategy.

If there is a possible overlap, a searcher can examine the much more detailed “Claims” and “Description” sections of the patent or application. One caveat: not all abstracts afford ideal guidance as to what in fact is claimed and described in the claims and description sections. Certainly, whenever an estate planner identifies a potential overlap, he should consider consulting a patent attorney to determine whether his strategy infringes. Expect to educate the patent attorney about the estate-planning concepts involved, as tax patent searches, by necessity, draw upon both, very different, and disciplines.

An alternative method of exploring the USPTO database is to search for specific words or phrases. This kind of search can be helpful when an unusual word or term is involved, the acronym “ILIT,” for example. Using a variety of search methods helps guard against a patent or application that the USPTO might not have assigned to the 36T/706 classification.

Patent attorneys are skilled in performing patent searches in a variety of ways, in addition to those I’ve noted. There is no dearth of web-based patent search services, including one carrying the Google logo; presumably, these can be useful adjuncts for the patent-searching estate planner as well.

When There’s a Match

If the patent search and analysis fails to identify any potential problems, estate planners probably should feel free to use the idea or recommend it to a client. If the results of the patent search indicate the idea would or potentially could infringe, the estate planner has a number of options. Probably the safest, least complicated course would be to refrain from using or recommending the idea. But such restraint might deprive a client of a useful solution for his planning need. The next alternative would be to contact the patentee or applicant to determine whether a license can be secured to permit the use of the idea, free of liability concerns.

The terms of such a license agreement will vary widely, but in general the patentee or applicant will likely be anxious to negotiate a fair and reasonable license arrangement; that is, after all, often the very reason the patentee or applicant persevered through the expensive, time-consuming application process. If the client chooses not to incur the additional cost involved, the patentee/applicant loses an opportunity. It is very much in the patentee’s interest to request reasonable terms in the license arrangement. The involvement of a patent attorney with experience in negotiating or reviewing license agreements would be useful.

There are more aggressive alternatives, including simply infringing the patent or application and hoping the patentee never finds out. The risk to the estate planner and to his client: Treble damages might be imposed in an infringement action. If an estate planner feels strongly that an idea is not patentable, he conceivably could counsel a client to use the idea without securing a license, then offer to defend the client in a later infringement suit. But few clients are likely to want to take this risk, and in some scenarios, it could expose an estate planner to a malpractice action as well as an infringement suit. There also would be ethical concerns under the rules governing professional conduct.

Crafting a “workaround” that achieves the same goal as the patented idea but in a different manner than is described in the claims and descriptions, might be another alternative. But, as most patent attorneys are well aware that would-be infringers sometimes are tempted to take this course, the lawyers craft their claims and description language in such a way as to reduce or eliminate the workaround phenomenon.

New World

Clearly, tax patents raise the prospect of a new type of legal malpractice claim. Clients could sue, alleging that an estate planner should have familiarized himself with the ideas expressed in patents and applications, at least those published on the USPTO website. Damages claimed could be the loss of the benefit accorded by the patented method or idea.

This concern warrants at least a basic familiarity with the USPTO website and the patent and application database. A good tax patent protocol might include periodic reviews of the site for new developments. Presumably, estate planners already are accustomed to checking on “listed transactions” for Circular 230 purposes. Checking the USPTO website from time to time is more of the same.

Whether we like it or not, tax patents are with us and not going away even if the proposed legislation is enacted. Prudent estate planners will be creating appropriate protocols now, not later. Those who do so will find that they can survive and thrive in the tax patent era.

1. US Patent No. 6,567,790, issued May 20, 2003. Wealth Transfer Group LLC v. Rowe, No. 3:06-cv-00024-AWT (D.Conn.), filed Jan. 6, 2006.
2. Consent to final judgment regarding settlement agreement, Wealth Transfer Group, LLC v. John W. Rowe, Case No. 3:06CV00024 (AWT) (D. Conn. 2007).
3. See, for example, the statement of Ellen P. Aprill, associate dean of academic programs, professor of saw, and John E. Anderson, chair in tax law, Loyola Law School, Los Angeles, Testimony Before the Subcommittee on Select Revenue Measures of the House Committee on Ways and Means, 109th Cong., July 13, 2006. (“The proliferation of tax strategy patents would change and burden tax practice.”)
4. See, for example, the statement of Richard S. Gruner, professor of law, Whittier Law School, Costa Mesa, Calif., Testimony Before the Subcommittee on Select Revenue Measures of the House Committee on Ways and Means, 109th Cong., July 13, 2006. (“[P]atents on tax planning methods, while highly foreign and seemingly dysfunctional to tax planners at present, may ultimately be beneficial to this field.”)
5. H.R. 2365 (introduced May 17, 2007).
6. S. 681 (introduced Feb. 17, 2007).
7. See, for example, Crystal Tandon, “Increased Awareness of Tax Patent Risks Needed, Say Practitioners,” 115 Tax Notes 304 (April 23, 2007). (“[L]awmakers and regulators have historically been resistant to bending the patent rules to accommodate specific industries.”)
8. See, for example, the statement of Ellen P. Aprill, supra, note 3 (suggesting a number of alternatives, including providing the U.S. Patent and Trademark Office (USPTO) with “the necessary resources and training.”) These comments are expanded upon in Ellen P. Aprill, “Responding to Tax Strategy Patents,” Loyola Law School Legal Studies Paper No. 2007-26 (April 2007).
9. See the discussion in Roger E. Schechter and John R. Thomas, Intellectual Property—The Law of Copyrights, Patents and Trademarks, Section 14.5 (Thompson/West 2003) (describing this failed attempt as a “long saga.”)
10. 35 U.S.C. Section 287(c) (P.L. 104-208, Section 616 (1996)).
11. Significantly, patent applications filed before the effective date of the exception were grandfathered, based on the earliest application date, which usually would be the date of the initial provisional application. Grandfathering was not based on whether a patent had actually issued as of the date of enactment, in light of fundamental fairness and due process considerations as to applicants who already had begun the patent process. 35 U.S.C. Section 287(c)(4). (“This subsection shall not apply to any patent issued based on an application the earliest effective filing date of which is prior to September 30, 1996.”)
12. See, for example, Warren D. Woessner, and Michael A. Dryja, “US Doctors Find Swift Relief in Patent Law Amendment,” IP Worldwide (March/April 1997).
13. Article 1, Section 8.
14. State Street Bank & Trust Co. v. Signature Financial Group, Inc., 149 F.3d 1368 (Fed. Cir. 1998), cert. denied, 525 U.S. 1093 (1999).
15. H.R. 2365, supra note 5.
16. Ibid. In its original version, the legislation would have applied to “any action for patent infringement that is filed after” the date of enactment.
17. H.R. 1908 (Patent Reform Act of 2007).
18. See Harold Wegner, Harold, “Berman H.R. 1908, Patent Reform Bill, Pronounced D.O.A.,” IPFrontline (April 29, 2007).
19. S. 681. See also H.R. 2136.
20. 35 U.S.C. Section 2(a)(1).
21. 35 U.S.C. Section 2(b)(2)(E).
22. 35 U.S.C. Section 100(d).
23. 35 U.S.C. Section 101.
24. 35 U.S.C. Section 100(b).
25. 35 U.S.C. Section 102(a), (b), (c).
26. 35 U.S.C. Section 103(a).
27. 35 U.S.C. Section 105.
28. 35 U.S.C. Section 122(a), (b). Expedited review of an application is available under 37 CFR 1.102.
29. 35 U.S.C. Section 122(b)(2)(B)(i).
30. 35 U.S.C. Section 154(a)(2).
31. 35 U.S.C. Section 271(a).
32. 35 U.S.C. Section 271(b).
33. 35 U.S.C. Sections 281 and 283.
34. 35 U.S.C. Section 282.
35. 35 U.S.C. Section 284.
36. 35 U.S.C. Section 284.
37. 35 U.S.C. Section 154(d). (These retroactive rights are termed “provisional rights” in the statute). Treble damages relief does not apply to such “provisional rights.” 35 U.S.C. Section 284.
38. 35 U.S.C. Section 285.
39. 35 U.S.C. Section 286.
40. Excerpted from U.S. Patent 6,814,021 (Nov. 9, 2004).
41. State Street Bank & Trust v. Signature Fin. Group, Inc.,149 F.3d 1368 (Fed. Cir. 1998), cert. denied, 525 U.S. 1093 (1999).
43. Subclass 36T in Class 705 has recently been established and dedicated to tax strategies. See statement of James Toupin, general counsel, USPTO, Testimony Before the Subcommittee on Select Revenue Measures of the House Committee on Ways and Means, 109th Cong., July 13, 2006.
44. As of August 7, 2007.
45. As of August 7, 2007.