July 2006

The U.S. Patent and Trademark Office (PTO) has been allowing patents on tax strategies.  So far, the PTO lists 43 issued patents, and 62 patent applications that are under examination.  Each of these patents and patent applications supposedly provide some unique means of complying with the Internal Revenue Code that no one should be allowed to copy.

I find it bizarre that some one could patent a means of complying with federal law.  Personally, I would love to avoid paying taxes by claiming that someone else patented the tax code and I do not have a license necessary to file my tax return … but we all know that will not work.  In any event, it looks like the Select Revenue Measures Subcommittee of the House Ways & Means Committee agrees with me.  They held a hearing on tax strategy patents last week.

The IRS testified at this hearing.  The IRS’ comments were sensible and predictable. Although the IRS was too polite to openly criticize the PTO in their allowance of these patent claims, the IRS noted:

  1. Granting patent protection could limit the use of that approach by other taxpayers that are simply trying to comply with the law.  Taxpayers and their advisors should not have to perform due diligence to determine how they can file a tax return.
  2. The IRS has sole jurisdiction to determine compliance with the Internal Revenue Code.  An issued patent carries absolutely no assurance that the underlying tax strategy is appropriate or compliant with the law.  Taxpayers are likely to get confused about the patent somehow being a U.S. government seal of approval.
  3. So far, the issued tax patents do not involve abusive tax strategies.  This Congressional concern that was one reason for the hearings.  Realistically, if one were to create an abusive tax strategy, why would you ever publish it as a patent so the IRS could review it?
  4. The IRS will be increasing its efforts to educate the PTO to understand the reasons why patents like these should never be allowed in the first place.

Background – How Could This Have Happened?

Until 1998, the PTO typically maintained that a process containing an abstract idea could not be patented.   This changed in July 1998, when a federal court upheld a patent for a method of calculating the net asset value of mutual funds (State Street Bank & Trust Co. vs. Signal Financial Group 149F.3rd 1368 (Fed Cir. 1998) cert denied 199 S. Ct 851 (1999)).  The Court ruled that patent laws were intended to protect any method, whether or not it required the aid of a computer, so long as it provided a “useful, concrete and tangible result”.

Based on this result, numerous businesses have patented a wide range of business methods.  These method patents belong to a wider family of patents called utility patents, which cover formulas and processes.  A business method patent is usually a process, rather than a physical object.

Based on the easy-to-meet requirement that the patent achieve a “useful, concrete and tangible result”, a patent lawyer who does not understand tax requirements could determine that a tax strategy is a method patent.  Like all patents, a method patent must also:

  1. Be a man-made creation.  Laws of nature and natural phenomenon are not patentable.
  2. Be a novel idea, meaning it is different from prior inventions and knowledge.
  3. Not be obvious, meaning that someone with ordinary skill in the specific technology could think of the idea.

Based on these requirements, the PTO is concluding that the tax concepts presented to them meet the patent requirements.

Even if valid, enforcement of a tax strategy patent will be particularly challenging.  The reason is that one’s tax returns are confidential.  Without having a potential infringer’s tax return, the patent holder would have no way of knowing that the tax strategy was being employed.

Fulcrum Inquiry is an accounting and economics consulting firm.  In the intellectual property area, we regularly perform damages analysis in litigation, appraise patents and other intellectual property, and perform royalty audits on behalf of licensors.