Taxes: Patent that loophole
You may save on your tax bill but also owe licensing fees. Can all this be legit?
By Jeremy Kahn, Fortune

NEW YORK (Fortune Magazine) -- The Internal Revenue Service has a surprising new enemy in the battle against abusive tax shelters: The United States Patent and Trademark Office.

In recent years, the Patent Office has begun granting patents to people who claim to have invented novel ways of avoiding taxes. The trend is part of a larger explosion in the number of patents granted to financial firms for so-called "business method" innovations.

So far, 48 patents for tax reduction strategies have been granted and at least another 61 applications are pending.

To tax shelter touts, the patents are a potentially deceptive new marketing tool. After all, if something is patented, it sounds as if it is government-approved. But just because something is patented doesn't mean it's legal.

"A patent carries with it no assurance whatsoever that the patented process, transaction or structure will pass IRS muster," IRS Commissioner Mark Everson told a Congressional hearing in July. "We are concerned, however, that taxpayers may be confused about this."

Even if a tax savings strategy is legit, giving it patent protection alarms many tax experts. That's because most tax advice hinges on interpretations of the law and, tax lawyers argue, the law should be available to everyone equally, without the need to pay a licensing fee. "It is not right that Congress can give a tax payer a benefit and someone can prohibit you from using that benefit to reduce your taxes," says Dennis Belcher, a tax lawyer with the firm McGuire Woods in Richmond, Virginia.

Earlier this year, a Florida company called Wealth Transfer Group filed suit against John Rowe, the executive chairman of Aetna, alleging he infringed on the patent it holds for a tax savings technique involving the transfer of stock options to a certain type of trust because he used a similar technique without paying Wealth Transfer a licensing fee.

The case, which has yet to go to trial, is being closely watched by both tax and intellectual property lawyers.

Some are warning of dire consequences if the court sides with Wealth Transfer. "If you can patent an interpretation of the tax law, why not patent anyone's legal advice?" asks Carol Harrington, a lawyer with the firm McDermott Will & Emery in Chicago. "Then you could say people being prosecuted for murder can't use a certain defense without paying a licensing fee. Something is seriously wrong with that in my view."

But a number of intellectual property lawyers accuse their tax law brethren of histrionics. "If you can get patents on medicines for HIV treatments that are desperately needed by poor people in the developing world, I have a hard time having any sympathy for tax attorneys and their wealthy clients," says Stephen Schreiner, an intellectual property lawyer with Hunton & Williams in Washington, DC. "To me, that is totally unpersuasive."

A more practical concern is whether the Patent Office has the ability to review patent applications for tax shelters. After all, the Patent Office has few examiners with knowledge of the arcane world of tax law. "It is unrealistic to think that the Patent Office can be up to date on tax reduction techniques," Belcher says.

And some intellectual property lawyers agree. Stephen Wallach, an attorney at Ladas & Perry in New York, helped write the first business method patent in 1993. But he thinks the Patent Office's quality control process for business method patents is seriously flawed. Too many bad patents are being issued, Wallach argues, only to be later invalidated by the courts.

Polk Wagner, an intellectual property law expert at The University of Pennsylvania, says there is always a concern about patent quality when the Patent Office begins reviewing applications in a new field. "But that is a temporary argument that goes away," says Wagner, who thinks that, over time, the Patent Office will develop the correct expertise -- perhaps with the help of once secretive financial firms eager to cash in on patents for tax shelters.

One thing is clear: If patenting tax strategies becomes the norm perhaps we'll have to amend that old adage: nothing in life is certain, except death, taxes -- and licensing fees.

Tax man eyes the eBay crowd IRS considers changes that could mean new rules for those that sell goods online.

The joy of tax-free retirement income New rules will soon allow many more retirement savers to have a Roth IRA. Our advice is go for it.

Tax burdens: Priciest places to smoke and drive Top of page