When Worlds Collide: Tax Planning Method Patents Meet Tax Practice, Making Attorneys the Latest Patent Infringers

                                                                Richard S. Gruner*

(WORK IN PROGRESS – LAST UPDATED 04/07/08)

Tax planning patents have produced an uproar exemplifying the unexpected conflict that can result, as in science fiction tales, "when worlds collide."[1]  Tax planning patents apply to methods of income and asset management that produce desirable tax results.[2]  These patents exist at the intersection of two specialized and previously separated legal worlds.  The patent world is governed by intellectual property rules and the bedrock principle that certain types of non-obvious innovations are best encouraged by giving their originators broad controls over the innovations for limited periods.[3]  The tax world is governed by a complex set of tax law standards against which the affairs of clients must be evaluated and shaped to aid the clients in lawfully reducing their tax liabilities.[4]  These worlds have collided -- with surprising consequences for both patent and tax specialists within the legal community -- through the issuance and enforcement of patents purporting to create proprietary interests in certain tax planning techniques and thereby limiting the use of these techniques by tax planning lawyers and their clients.[5]

Practitioners from the patent and tax fields have very different opinions of tax planning patents, with each relating these patents to fundamentally different analytic frameworks that have shaped their respective world views to this point.  From the perspective of patent specialists, tax planning patents are new but not surprising, evolutionary rather than revolutionary.[6]  These patents are simply logical successors to both business-method and information-processing patents, having features of both these prior types of patents.[7]  Tax planning patents typically protect computer-based means to manage income and assets in ways that produced advantageous financial results for taxpayers through tax savings.[8] In these respects, tax planning patents are close cousins to financial method patents that have been sought and enforced for some years to protect methods of managing and monitoring financial processes.[9]

However, from the perspective of tax specialists, patents that purport to limit parties' choices about how to structure the sequence and timing of investments and income in ways that produce desirable tax consequences represent unexpected restrictions on client affairs and improperly restrict the ability of tax practitioners to provide valuable tax planning services to clients.[10]  When confronted with these sorts of patents, many of which were issued from the United States Patent and Trademark Office (“USPTO”) as far back as 2003 -- tax practitioners often respond in disbelief, with comments like "surely you can't patent that. . . ." or "are you serious?"[11]  This sense of disbelief is striking to patent practitioners only because it follows the same sense of unreality experienced by software programmers, financial service providers, and internet business persons as their respective fields became targets of increased levels of patent applications and litigation.

Tax specialists also express strong concerns about the impact of tax planning patents on the tax system and the equity of tax liabilities faced by taxpayers.  These include concerns that 1) tax planning patents may encourage undesirable types of innovations in tax-reduction strategies, 2) the USPTO may be unable to adequately review tax planning patent applications and consequently fail to limit the restrictive impacts of patents to innovative tax planning methods, 3) the issuance of tax planning patents may incorrectly suggest to taxpayers that patented methods have special merit or legitimacy, 4) the enforcement of tax planning patents may improperly allow patent holders to gain from taxpayers' efforts to comply with the law, and 5) the enforcement of these patents may improperly impair the equal access of taxpayers to means for complying with tax laws.[12]

This article analyzes the growing controversies over tax method patents, focusing on the latter as the latest example of patent restrictions on intangible information processing innovations and related beneficial services to innovation users.  The analysis presented in this article also serves as a case study of the potential consequences and unexpected impacts of extending patent enforcement into a professional field such as legal practice by tax specialist, illuminating the potential negative interplay between patent enforcement and law compliance. 

The discussions here do not attempt to address all of the legal issues that may stem from the issuance and enforcement of tax planning patents.  Instead, I focus on five principle topics.  First, I describe the steady expansion of patent-law standards concerning intangible inventions, leading to present patentable subject matter standards under which tax planning patents seem evolutionary, not revolutionary.  Second, I assess whether tax planning methods are fundamentally different from prior sorts of useful advances that have been treated as patentable subject matter such that these methods should be excluded from the incentives and enforcement impacts of the patent system.  Third, in order to identify some of the future consequences of patent enforcement regarding tax planning patents, I describe an existing tax planning patent and the manner in which it may be enforced against taxpayers, attorneys, accountants, and financial institutions.  Fourth, I assess the ways that patents may influence the development of tax planning methods, using lessons gained from recent experience with patents on financial methods and other "intangible inventions" that, like tax planning methods, entail the management of information and other intangible items for user gains.  Fifth, I evaluate recent federal legislation purporting to "solve" the problem of tax planning patents and argue that the solution may raise its own unanticipated problems.

Although the focus here is on tax planning patents, such patents (and the enforcement controversies which surround them) are but examples of a broader range of information processing and business-management patents that are likely to emerge and intersect with lawyers' activities and law compliance in the future.[13]  In a time when almost every field is dominated by computer-based practices and devices and when patents covering advances in these sorts of practices and devices are fundamentally important features of numerous business fields, many significant future developments in patent law may entail dealing with innovative "intangible inventions" like tax planning methods.

I.          Introduction

A number of United States patents now apply to steps for managing assets and income in ways that achieve advantageous tax results.[14]  The developers of these methods have claimed that their tax planning steps are significantly new and useful methods for achieving practical results and have obtained patents covering the methods.  If valid, these patents will preclude other parties from using the patented methods without the patent holders' permission.[15]

For intellectual property specialists, tax planning patents are simply the latest business-method patents, reflecting the systemization of tax-reduction methods and services and the ability of computer-enhanced financial management strategies to achieve highly valuable tax results under certain circumstances.  For tax practitioners, tax method patents strike at the heart of their professional services, raising the potential that they will be impeded in aiding clients to pursue lawful strategies for tax minimization because the best course for a given client is patented and cannot be used without the permission of the patent holder.  In short, tax method patents promise to reward and expand efforts to strengthen tax-reduction innovations by large-scale service providers while impeding the client-specific, individualized service activities of traditional tax practitioners.

When tax-planning practitioners are told that the tax planning methods they implement for clients may be covered by restrictive patents, they typically respond with great surprise because the patent system has, up to this point, not even been on the horizon of concern to most tax specialists.[16]  When told further that the attorneys themselves may be liable for patent infringement -- as inducers of the infringement undertaken by clients -- the level of disbelief only rises at the seemingly bizarre notion that these attorneys need to keep track of patents not only to protect their clients but to protect themselves.

Yet, these threats of patent infringement liability are not hypothetical projections of future possibilities.  The USPTO has issued a number of patents on tax planning methods,[17] and has even created a subclassification[18] in its subject-matter records in anticipation of the large volume of such patents to come.[19]  And at least one such patent has been the subject of litigation against a taxpayer who assertedly implemented a patented tax planning method without a license.[20]  Another patent has been the subject of further enforcement threats against attorneys who, according to the patent holder, have offered or were about to offer to aid clients in using the patented method without appropriate licenses.[21]

Patents regarding tax-planning techniques are emerging as significant concerns within the tax-planning community.[22]  Tax attorneys and other tax-planning specialists have raised objections that patents will limit their ability to provide valuable services to their clients and produce unexpected patent-infringement liability for themselves and their clients.[23]  At the same time, parties seeking and obtaining these patents assert that they have developed advances in tax planning methods that are significant departures from earlier methods and deserving of the sorts of patent protections and rewards that have traditionally applied to useful advances.[24]

According to Dennis I. Belcher, an experienced tax counsel writing on behalf of the American College of Trust and Estate Counsel, tax planning patents are problematic because:

1.         Patents on tax planning methods are against public policy since such patents prevent taxpayers from exercising their rights to minimize their taxes within the limits of the law, and avoiding the activity in question -- the payment of taxes -- is not an option;[25]

2.         “Patenting [tax] planning techniques unfairly increases a taxpayer's costs or . . . the taxes payable by [a] taxpayer if patented techniques are not used;”[26] and

3.         “Because a patent on a tax planning technique can add credibility to the technique, patents on objectionable or aggressive tax planning techniques can hurt compliance with the federal tax laws.”[27]

For its part, the USPTO has evidenced its agreement that advances in this field can qualify for patents by issuing a number of patents in this domain.[28]  Responding to concerns that patented tax planning methods might implement abusive tax shelters or other misleading tax planning methods which are illegal of themselves or which promote illegal underreporting of tax liabilities, the USPTO has noted that the mere possibility that a patented method might be used illegally or might be against public policy is not, of itself, a basis for the USPTO to reject a patent on a particular tax planning method.[29]  Rather, according to the USPTO, the responsibility to police the use of tax planning methods lies with the Internal Revenue Service, the Office of Tax Policy in the Treasury Department, and Congress.  The USPTO appears to feel that it has neither the statutory charter nor the expertise to preclude patents for potentially abusive tax planning methods.[30]

Records of published patent applications regarding tax planning methods indicate that the volume of patent applications in this field is growing, meaning that the numbers of issued patents and enforcement disputes concerning tax planning patents are likely to increase in the future.[31] Recently proposed federal legislation may halt this trend, but at the cost of creating other problems as is discussed in Part VI of this article.  These new problems relate to the difficulty of surgically excluding certain types of advances from the patent laws through vague statutory language that is likely to lead to new types of enforcement controversies about the boundaries of patenting opportunities and to potentially over broad exclusion of advances from the patent system.

II.        Applying Patents to Intangible Innovations Such as Tax Planning Methods

A.        Open-ended Extension of Patents to New Technologies and Useful Innovations

The proper scope of patentable subject matter -- and, as a consequence, the range of innovations potentially influenced by the patent system -- has been one of the fundamentally important issues in patent law over the past several decades.[32]  Some parties have argued that historical notions of engineering and patentable subject matter should govern the outer boundaries of the patent system.[33]  Up until a few decades ago, patents were applied almost exclusively to promote the development of physical technologies, including physical devices, materials, and processes.[34]  A continuing emphasis on this history would support a view of the patent system that was limited to the types of advances emerging from useful trades or industrial activities in the past.

However, courts have thus far seen the patent system as far more dynamic than this.  They have interpreted Congress's will in enacting patent laws to be that incentives should exist under those laws to expand the boundaries of what we consider to be technology and useful inventions.[35]  Evolving patterns of innovation and product and service development have produced many major new advances that turn primarily on changes in the intangible information processing.[36]  Persons need reach no further than their purses or pockets for their cell phones to locate a primary example of this new trend in innovation.  Cell phone advances have turned largely on information processing breakthroughs and the associated abilities of companies around the world to implement and manage highly complex communication systems to support cell phone calls.[37]  Many of the key technology breakthroughs in this field were patented under the expanded notions of information processing patents and technologies applied in recent years.[38]

In general, courts have adopted a highly inclusive view of what is a new and useful advance that is potentially patentable.[39]  By viewing the patent system as a forward-looking institution with the aim of encouraging useful designs well beyond our present knowledge, courts have rejected a view of patentable subject matters that would look to the past and limit patents to historically important lines of innovation.[40]  Rather, courts have disengaged definitions of patentable subject matter from old notions of technologies or industrial practices.[41]  Indeed, a failure to take this sort of encompassing view of the potential range of patentable inventions would risk rendering the patent system irrelevant to many modern modes of technological advance.  Actual patterns of technological advance -- whether physical or intangible (that is, information processing) based -- will dictate the directions of valuable additions to consumer products.  If it is to have a continuing influence in encouraging the development of many of our most socially important and commercially valuable innovations, the patent system must keep up with actual patterns of practical innovation by extending patents to the full range of innovations, tangible and intangible, that are broadly replicable, distributable, and, therefore, of widespread public importance.

B.         The Central Role of Patents on New Information Processing Technologies

One result of this open-ended view of patentable subject matter has been a trend towards the patenting of advances that emphasize information-processing methods and devices incorporating such methods.[42]  Examples of fields in which information-processing advances have been highly important -- as vehicles for both commercially significant products and highly valuable patents -- include:

Biotechnology -- Use of genetic information for diagnostic procedures and biological product designs[43]

Computer Controls -- Use of advanced information processing technologies to control older devices and processes[44]

Communications -- Use of new information processing methods to increase the volume and quality of communications systems[45]

Interpretive Systems -- Use of information processing advances aimed at squeezing analytic insights out of existent information (e.g., heart monitor data processing systems or seismic data analysis systems)[46]

C.        The Judicial March Towards Inclusive Patentability Standards Regarding Intangible Innovations

Although there are many other examples of this trend in the case law of federal courts, the following highlights illustrate the broadly inclusive views that federal courts have taken of patentable subject matter.  These cases define a path that leads to patent coverage for numerous information-processing advances, financial-management methods, and, by little or no extension, tax planning processes.

1.         Biotechnology

In Diamond v. Chakrabarty, [47] Chief Justice Berger, writing for the Supreme Court, articulated a broadly inclusive view of United States patent laws that continues to influence our analyses of applications of patent laws to new technologies. In this case, the Court held that patent law covers advances in biotechnology, including a newly bioengineered type of bacteria that was useful in helping to break down oil products and clean up oil slicks.[48]  The Court observed that the patent system authorized by Congress is not limited to older notions of what constitutes technology or engineering.[49]  Rather, the Court felt that Congress intended patentable subject matter to include "anything under the sun that is made by man."[50]  Although this case dealt with a tangible innovation -- a new type of bacteria -- its inclusive approach to patentable subject matter signaled the potential coverage of patents for artificially created information-processing methods with practical value as examples of useful advances "made by man."[51]

2.         Computer Systems for Information Processing

In re Alappat involved a computer system for controlling visual outputs on a video screen.[52] The computer system carefully evaluated electronic signals and determined how to best display the signals on a video screen.[53]  The only new components in computer system were the information processing sequences defined by the applicable computer program.[54]  The Court of Appeals for the Federal Circuit found this invention to entail patentable subject matter because the system was "a specific machine that produces a useful, concrete, and tangible result."[55]

3.         Financial Information Processing Method

State Street Bank & Trust Co. v. Signature Financial Group, Inc. considered a patent on a business method calling for central investment of funds from multiple financial institutions, with frequent investment status reports made to the contributing institutions (a so called "hub and spoke" system of investment and reporting).[56] This method was found to be a patentable process because the information handling involved had practical consequences in managing funds.[57]  The Federal Circuit court specifically noted that, given their practical consequences, business methods should be treated no differently than other practical advances and that innovative business methods should qualify as patentable subject matters like other useful advances.[58]

4.         Business Record Keeping Method

The Federal Circuit court reaffirmed its support for business method patents in AT&T Corp. v. Excel Communications, Inc.[59]  That case involved a new electronic record-keeping method for handling information on long-distance calls,[60] which was found to be patentable subject matter because of its practical usefulness in phone usage record-keeping and associated billing systems.[61]

5.         Medical Information Processing Method

In Arrhythmia Research Technology, Inc. v. Corazonix Corp., the Federal Circuit court considered the patentability of a computer-implemented method for interpreting heartbeat monitor data to detect possible heart problems.[62] This system was patentable because the results it produced were not abstract data but rather information "related to the patient's heart activity."[63] Patentable subject matter was present here because heartbeat monitor signals were "transformed" to produce a practically useful result in identifying heart abnormalities.[64]

D.        General Standard for Patentable Subject Matter in Intangible Innovations

The Court of Appeals for the Federal Circuit has held that patentable subject matter is present in a new composition, device, or process if one of these types of innovations is a specific advance that can be employed to produce “a useful, concrete, and tangible result.”[65]  This standard is aimed at distinguishing inventions involving patentable subject matter from disembodied concepts incorporating unpatentable "abstract ideas."[66]

The key to identifying patentable subject matter -- in intangible advances as well as tangible ones -- is to identify features that distinguish a patentable invention from a mere abstract idea.  To date, inventions involving innovations in intangible information processing have produced sufficiently practical real world effects distinguishable from unpatentable abstract ideas if the inventions have either of two types of physical impacts.[67]

First, new types of information processing sometimes produce useful results by controlling the operation of a physical device or process that is separate from the computer running the software.[68]  This type of invention is present where a computer-implemented information processing sequence is used to control a further device.[69]  Such an invention is simply a computer-controlled machine or process, having many of the same characteristics as an equivalent process or machine that is operated through human manipulation or some other purely mechanical control mechanism.[70]

Second, new types of information processing sometimes produce practical impacts by interpreting real world conditions or processes to produce additional useful information about the conditions or processes.  For example, a computer-based invention can produce useful results by processing data or signals to measure or interpret external physical surroundings.  This type of invention is present where a computer controls a measurement or analysis system for gathering or analyzing data corresponding to physical characteristics, such as a system for analyzing or organizing heart beat monitor data[71] or financial accounting data.[72]

Tax planning methods can fall within either of these categories of information processing advances having practical implications.  Some tax planning methods involve investment or asset management strategies that are aimed at achieving reductions in tax payments.[73]  These sorts of methods involve practical, physical consequences in both the alterations in tax payments they produce and in the altered patterns of investment and asset management that follow as the strategies are carried out.[74]  Other tax planning methods focus on better measurement and reporting of income, loss, or asset features of taxpayers' affairs.[75]  These methods achieve practical utility through better measurement and interpretation of physical conditions in the form of the income, loss, or asset features monitored.[76]

Given that the patent system is aimed at encouraging the development and propagation of new innovations that are useful to substantial segments of the population, the proper scope of patent protections for new types of innovations such as new tax planning methods should be interpreted in light of these goals.[77]  The cases to date -- particularly the rulings of the Court of Appeals for the Federal Circuit -- indicate that a new method of undertaking a useful procedure will have a sufficiently practical impact to be a potentially patentable innovation if the method:

· Fills a user need with identifiable value;

· Addresses a need shared by multiple parties;

· Operates in a regular manner producing consistent results; and

· Is capable of being described clearly so as to permit effective evaluation of the innovation and its results by potential users.[78]

An innovative tax planning method, capable of use by a broad set of taxpayers and producing favorable, valuable tax results would appear to meet this standard for patentable subject matter.[79]

III.       Are Tax Planning Patents a Special Case? -- Distinctive Policy Arguments for Excluding Tax Planning Methods from the Patent System

A number of commentators -- most of them tax specialists concerned about the intrusion of patent rights into their field as a new source of restrictions on services to clients -- have argued that, whatever the merits of patents generally as valuable incentives for the development and dissemination of innovations, patent interests and incentives concerning tax planning methods are undesirable due to special considerations peculiar to the tax field.[80]  The arguments against tax planning patents have generally revolved around five themes: 1) tax planning patents may encourage undesirable types of innovations in tax reduction strategies, 2) the USPTO may be unable to adequately review tax planning patent applications and to limit the resulting patents to properly patentable innovations, 3) the issuance of tax planning patents may improperly suggest to taxpayers that patented methods have special merit or legitimacy, 4) the enforcement of tax planning patents may improperly allow patent holders to gain from taxpayers' efforts to comply with the law, and 5) the enforcement of these patents may improperly limit the means that taxpayers have available to comply with tax laws.[81]  These types of domain-specific arguments against tax planning patents are examined in this section.

A.        Tax Planning Patents May Be Undesirable Because They Promote Unwanted Tax Planning Innovations

Tax planning patents may be undesirable because the types of tax planning innovations they promote are themselves illegal or, at least, not socially beneficial.  Several different versions of this argument have been put forth, each focusing on a different type of undesirable tax planning consequence or other harmful end result that tax planning patents are asserted to promote.  The different variants of this argument are explored in individual subsections below.

1.         Tax Planning Patents May Encourage the Development of Abusive Tax Shelters and Planning Methods

One concern about tax planning patents that is peculiar to the tax planning field is that the incentives or impacts of tax planning patents may encourage parties to develop or market more improper tax planning strategies than would be the case in the absence of these patents.[82]  Abusive tax strategies may be encouraged by tax planning patents for at least two different reasons: first, the patenting of tax planning methods may aid tax shelter developers in avoiding reporting requirements designed by the IRS to curb the use of abusive tax shelters and, second, the promise of patent rewards may cause innovators to develop more abusive tax reduction strategies than would be the case without tax planning patents.  For reasons described in this subsection, neither of these may be a substantial concern.

a.         Circumventing Reportable Transaction Regulations

One objection to patents for tax planning methods is that tax-shelter promoters might use these patents to circumvent certain reporting requirements administered by the Internal Revenue Service (IRS) as means for curbing abusive tax shelters.[83]  Under present tax regulations, certain types of tax shelter arrangements must be described to the IRS in conjunction with the filing of a tax return.[84]  A person (including an individual, trust, estate, partnership, association, company, or corporation) who is required to file a tax return and who participates in a "reportable transaction" is required to file a special disclosure statement in conjunction with that party's tax return.[85]  A "reportable transaction" is one of two types of tax avoidance arrangements[86]: 1) a transaction that is the same as, or substantially similar to, a "listed transaction" specifically identified by the IRS as a tax avoidance transaction and identified as a "listed transaction" by an IRS notice, regulation, or other form of published guidance[87] or 2) one of five specific categories of transactions, including "confidential transactions" offered to a taxpayer under conditions of confidentiality[88] and for which the taxpayer has paid an advisor a minimum fee.[89]

An innovative tax reduction method offered by an innovator to taxpayers under confidentiality restrictions (probably as part of trade secret licenses) obligating the taxpayers using the method not to disclose it publicly would appear to be "a ‘confidential transaction[]’" triggering the IRS's special reporting requirements.[90]  Thus, in the absence of patent protection for a tax strategy, the developer of an innovative tax strategy is faced with a difficult choice:

A tax advisor who wishes to protect a 'proprietary' tax structure from duplication by

other competing tax advisors must, under present law and absent the availability of

patent protection, weigh the cost of public disclosure (if the advisor does not insist

on confidentiality) against the cost of having the transaction characterized as a

reportable transaction and thus subject to heightened scrutiny (if the advisor insists

on confidentiality rendering the transaction a confidential transaction [that is

reportable to the IRS]).[91]

Patent protection for a particular tax-shelter strategy may offer a third option.[92]  A tax advisor can obtain a tax planning patent on a particular strategy, thereby making it public and non-confidential.[93]  Once implemented for particular clients (as licensees of the relevant patent holder), the strategy would arguably not constitute a confidential transaction of the sort required to be specially flagged to the IRS in tax returns because the advisor offering the strategy is not binding taxpayers to confidentiality regarding the strategy.[94]  At the same time, the developer of the tax strategy would retain control over the use of it by others through the enforcement of patent rights concerning the strategy.[95]

This interpretation assumes that the patented strategy is not itself a "listed transaction" or the equivalent and reportable on that ground.  Furthermore, this anticipated impact of tax planning patents ignores the possibility that a particular tax advisor will add certain non-patented enhancements to a patented method and seek to keep the enhanced version confidential, thereby making the enhanced method a confidential, reportable transaction.

However, assuming that confidentiality imposed by a tax advisor (rather than a client taxpayer) must be present before a transaction is required to be reported and that only the patented and therefore public features of a patented tax planning method are implemented on behalf of a particular client, this would appear to place the taxpayer's use of the strategy outside the IRS's present reporting requirements.

This result may not undercut the IRS's efforts to curb abusive tax shelters for several reasons.  First, the tendency of increased patenting to bring the features of new tax shelter arrangements to public light through published patent applications and patents will increase the IRS's opportunities to scrutinize and comment on these shelters relative to a system involving the use of similar shelters under the cloak of confidentiality agreements.[96]  Second, to the extent that the IRS wishes to continue monitoring taxpayers' use of tax shelters, it can simply alter its regulations to require taxpayers to disclose the use of both confidential and publicly disclosed (including patented) types of shelters.  Indeed, this might be a useful way to determine the relative prevalence of different types of tax shelter methodologies and, accordingly, the degree to which the IRS may wish to devote scrutiny and evaluations to any particular type of tax shelter.

Other parties have recognized that changes in tax regulations or patent laws might be sufficient to continue to provide the IRS with information on tax shelter practices and other tax planning methods covered by patents.[97]  Some of these further changes were summarized by the staff of the Congressional Joint Committee on Taxation as follows:

[T]he IRS and Treasury could amend the reportable transaction regulations to

include the application, grant, or use of a tax strategy patent (either of one's own

patented strategy, or pursuant to a license from the patent-holder) as a reportable transaction, or could issue administrative guidance treating certain of these actions

as listed transactions.  Likewise, patent-holders might be required to provide the

IRS with lists of those to whom the patented tax structure has been marketed. 

Further, to the extent the IRS concludes (on a case-by-case basis) that a particular patented tax strategy constitutes an abusive tax avoidance transaction, the IRS can

issue guidance identifying it as a listed transaction.[98]

Given these options for changes in IRS reporting requirements and enforcement practices that seem able to maintain or even increase present efforts to reveal and curb abusive tax shelters, it seems unnecessary to specially restrict the incentives provided by tax planning patents to achieve enforcement benefits concerning the relatively few patented methods that will entail abusive tax reduction strategies.  In short, the exclusion of all tax reduction strategies from patenting does not seem necessary to curb the few (if any) patented strategies that are abusive.

b.         Producing More Abusive Strategies

Rewards associated with tax method patents may also be undesirable because they simply encourage tax method innovators to produce more abusive tax reduction strategies of the sort that are illegal and the targets of IRS enforcement efforts.[99]  Assuming that the USPTO does not detect the purely illegal character of a given strategy and bar a patent for the strategy based on its lack of utility, it is conceivable that the lure of an apparent patent reward might cause a tax innovator to file for and obtain a patent on an abusive method.  However, this type of patent application is unlikely to be pursued as this would simply bring the abusive technique to public light and the attention of the IRS.  It could easily be analyzed and publicly characterized as abusive.  Furthermore, any licensing of the illegal method by the patent holder could lead the IRS directly to all those taxpayers that used the abusive method.  Based on these undesirable features of patent disclosures -- and the low likelihood that taxpayers would pay royalties for and adopt a patented method labeled by the IRS as abusive -- the positive impact of patent incentives on the encouragement and expansion of abusive tax methods seems illusory.

Thus far, tax-method innovators do not seem to view patent applications as an attractive means to protect and gain rewards for potentially abusive tax planning methods.[100]  A review by the IRS of tax method patents and published patent applications as of July, 2006, found no abusive methods in the innovations covered by these patents and patent applications.[101]

2.         Tax Planning Patents May Be Undesirable Because Patent Protection is Not Needed to Encourage Tax Innovation

Tax method patents are also targets of complaints that these patents are not needed to promote innovation in the tax field as there are other incentives encouraging innovation.[102]  Some degree of innovation in tax reduction methods will follow from the economic interests of all taxpayers in reducing their own taxes.[103]  Because they are each subject to these personal incentives to develop new tax reduction methods, taxpayers will be constantly encouraged to produce new methods.[104]  Given the large number of taxpayers with such incentives, personal incentives may drive the creation of sufficiently numerous new ways to reduce tax payments, making the incentives created by tax planning patents superfluous.

Although personal economic incentives related to the advantages of reducing ones own taxes will doubtless encourage some innovation in taxpayers' affairs, there are two reasons to question whether these sorts of personal benefits from innovations in tax reduction methods will advance the field of tax methods to the full extent possible.  First, the incentives presented to individual taxpayers may only produce relatively small, incremental advances in tax methods rather than the sort of significant, non-obvious advances over prior methods that are the objectives of patent incentives.  Second, even if a taxpayer (or an attorney working on behalf of the taxpayer) develops a non-obvious tax reduction method, that taxpayer may have little or no incentive to disclose the new method to the public, meaning that it will not enhance the overall improvement of methods in this area.

Assuming that advances in tax reduction methods are a publicly desirable goal (more about this later), a system of patent rewards may add an increment of special incentives for non-obvious innovations above and beyond the personal incentives presented to taxpayers to do better in their own tax payments.  Furthermore, the public disclosures achieved by patents will ensure that new methods are brought to public attention in a way that may not occur if taxpayers only have incentives to use new methods in their own non-public tax returns.  In short, the type of advances promoted by the patent system are not the same as the small scale, incremental advances encouraged by personal economic interests and the scope of new method dissemination resulting from advances used by taxpayers in personal returns is likely to be far less extensive and beneficial to the tax field than the disclosures achieved through patents.

3.         Tax Planning Patents May Be Undesirable Because They Encourage Actions -- Lesser Payment of Taxes -- That Are Not in the Public Interest

The fundamental -- and most serious -- objection to tax planning patents may be that we simply don't want more strategies for tax payment reductions.  That is, unlike the types of benefits achieved by most patented inventions, tax-planning advances do not achieve net increases in societal benefits.[105]  Rather, tax reductions merely deprive the government -- and hence, to some extent, all of us as potential beneficiaries of government action -- of payments that, dollar for dollar, are kept by the taxpayer who has saved taxes.  In short, there is no new efficiency or gain achieved by tax planning methods; rather, there is simply retention of money by taxpayers rather than transferring the money to the government through tax payments.

This means that improvements in tax planning methods achieve ends that are arguably undesirable in two respects: first, the "benefits" achieved are no more than dollar-for-dollar shifts of control over funds from the government to taxpayers and involve no net gains in total societal well-being; and second, the loser in this wealth transfer is the government and, by extension, the often needy societal members who would otherwise benefit from governmental expenditures of greater tax revenues.

This argument turns on drawing a distinction between social utility enhancing innovations and innovations achieving mere equivalents of economic transfers from one party to another.  In the context of tax planning methods, the distinction between forms of utility normally promoted by patented innovations and those benefits realized through patented tax planning methods was described by one commentator as follows:

[T]he traditional utilitarian rationales for issuing patents [are] that new inventions improve the quality of life for all Americans, stimulate economic growth, and make the U.S. economy stronger.  While those utilitarian rationales may apply in almost all other industries, they fail to support tax-strategy patents because more tax loopholes will not enhance the quality of life for all Americans, stimulate economic growth, or make the U.S. economy stronger.[106]

There are at least three responses as to why this sort of objection to the patenting of tax method patents is misguided.  These responses relate to whether tax reduction strategies should be discouraged, whether the assistance of tax reduction strategies by experts should be discouraged, and whether the dollar benefits achieve from tax avoidance are any different than the wealth transfer benefits achieved by a number of other types of patentable inventions.[107]

a.         The Merit of Tax Reduction

One type of objection to the "benefits" achieved by patented tax planning methods is that the government -- and those of us who might benefit from enhanced governmental action -- are harmed by tax payment reductions and such reductions should be discouraged.[108]  However, if the tax-reduction results achieved by tax method patents are illegitimate (or at least undesirable as a matter of public policy), then not only should governments discourage the development of new tax-reduction strategies, but they should also discourage the use of tax-reduction methods generally. 

This argument disfavoring tax reductions runs afoul of the long-standing view that taxpayers' efforts to reduce their taxes while acting within the bounds of the law are legitimate activities that should be encouraged by expert assistance.[109]  No lesser legal figure than Learned Hand has weighed in on this point, describing the legitimacy of tax-reduction activities in the following glowing terms:

Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible . . . nobody owes any public duty to pay more than the law demands, taxes are enforced extractions, not voluntary contributions.[110]

In short, the law protects the legitimacy of taxpayer control over and furtherance of tax payment reductions for many of the same reasons that the law protects individuals' control over personal financial affairs generally.  That is, such control both encourages personal responsibility for their financial affairs and promotes the various other personal activities that individuals can pursue with the support of financial resources not otherwise spent on payments to the government and others.

A somewhat different argument might be raised in favor of tax payment reductions on governmental size grounds.  If, as opponents of "big government" have argued for some years, governmental entities are relatively inefficient in undertaking many social tasks,[111] it may be desirable to adopt governmental policies assessing low taxes, leaving the funds in private hands that would otherwise be paid as taxes, and relying on the private individuals retaining the funds to apply the funds to desirable social purposes.  If this sort of argument justifies imposing low tax levels, it would seem to also support the maximization of tax reductions -- and maximization of personally retained revenues -- within the bounds allowed by current tax laws.  Hence, tax reduction within legal limits may be a means to promote smaller government and enhanced personal choices regarding allocations of funds, providing a somewhat different ground for the legitimacy of patented tax planning methods that aid taxpayers in tax-payment reductions.

Given the general legitimacy of wealth-maximizing activities of individuals -- and the view expressed by Hand and others that tax reductions within the bounds allowed by law are simply instances of legitimate private wealth maximizing conduct -- it is hard to argue that actions taken in the pursuit of lawful reductions in tax payments -- or, to put it in positive terms, the avoidance of payment of unnecessary taxes not required by law -- are illegitimate activities.  Rather, they are activities aimed at minimizing the disruption and curtailment that tax payments realize in other private conduct that relies on economic resources.  As such, these activities support the many valuable other things that individuals are able to do with the tax revenues that they do not pay to the government through tax-reductions methods.

b.         The Merit of Assistance to Taxpayers in Tax Avoidance

If the legitimacy of tax reductions generally is granted, one might still argue that, although tax reductions are allowed, they should not be encouraged.  As a corollary to this point, perhaps governments should leave taxpayers to their own devices and understanding of the tax laws and let them only achieve the tax savings that they can accomplish through personal (and often unsophisticated) efforts.  The difficultly with this view is that it demonizes all those who would assist taxpayers in reducing taxes.  There is an entire industry of such parties -- we call them "tax attorneys" and consider that they ply an honorable trade.  It is difficult to separate on moral or public-policy grounds the tax attorney who aids a few clients in lawfully avoiding some measure of taxes from the tax-method developer who aids perhaps more parties in avoiding taxes.  Both serve a similarly valuable role and, to this point, society and lawmakers have treated the tax attorneys as providing services with a net positive value.[112]  The same should probably be said for the developers of advanced tax-reduction strategies.

William A. Drennan has attempted to distinguish between tax specialists who aid taxpayers in implementing tax-reduction strategies and developers of new and potentially patentable means of tax reduction, pejoratively labeling the latter a form of "mad scientist.”[113] This type of innovator in tax-reduction strategies should be discouraged, according to Drennan, because their innovative efforts will tend to promote unequal treatment of similarly situated taxpayers.[114]  He asserts that:

[T]he availability of tax-strategy patents will encourage a new breed of "mad-scientist" tax planners, who will pour over every new tax statute, case, or ruling in search of a nascent loophole.  Taxpayers, or their advisors, who independently determine that taking certain steps will reduce their taxes may find that they must either pay license fees or face a possible infringement lawsuit. . . . Other inequities will arise, for example, between taxpayers who pay license fees to the inventor and use the loophole, and taxpayers who decide not to use the loophole because of the license fees.  When similarly situated taxpayers are not treated in a similar manner, respect for the tax system erodes, triggering lower levels of voluntary tax compliance.[115]

Although the differences cited by Drennan in tax payments by licensed users of patented methods and non-licensees will doubtless be real, it is unclear why these differences are any more objectionable than those that result between taxpayers who pay sophisticated tax counsel for legal advice and reduce their tax payments accordingly and other similarly situated taxpayers who do not obtain this advice and pay more taxes.  In both cases, so long as the opportunity to gain access to tax advice or tax planning methods is available to all similarly situated taxpayers, they all have the same opportunity to respond to their tax-payment obligations in a similar manner.  Although the desirability of similar opportunities may suggest a need for tax planning patents to be available to all taxpayers for licensing on equal terms -- that is, provide an argument for forced licensing if a patent holder does not offer up licenses on equal terms -- it does not make a case for rejecting tax planning patents entirely.

c.         The Merit of Patent Rewards for Economic Transfers Without Increased Social Utility

Because there are arguably no net increased societal benefits from innovative tax planning methods because the resulting gains to taxpayers in tax reductions have dollar-for-dollar counterparts in reductions of governmental resources, the benefits resulting from the methods might be seen as lacking the sort of utility needed to qualify the innovations for patenting and patent rewards.  However, these sorts of direct transfer benefits to users -- that is, gains involving no net increase in the overall benefit shared by society, only a transfer of wealth from the government to individual taxpayers -- seem similar to other types of transfer benefits that arise in a wide variety of business settings and that have been sufficient to support a wide range of business-method patents.[116]

To date, courts have not drawn a line between innovations capable of producing net increases in societal benefits and innovations just capable of transferring benefits from one party to another.[117]  The presence of utility needed for patenting is typically measured from the standpoint of the innovation user and whether or not that user was benefited.  The related question of whether another party was hurt or received some detriment from the use of the innovation is not factored into the utility discussion,[118] meaning that the question of whether the use of the innovation creates a net gain in social benefits (taking into account all its positive and negative consequences) is never confronted.  In part, this unwillingness of courts to demand a net "total" utility increase before allowing the patenting of an invention no doubt stems from judicial doubts that the full net utility produced by an innovation can be measured and summed.  Utility assessments as part of patent-law analyses have been much more modest, requiring only that a modicum of positive utility or social benefit be shown in connection with an innovation for the innovation to meet the utility requirements of patent law.[119]

Once this sort of modicum of positive benefit is shown, as measured from the perspective of invention users, an invention can be covered by a patent upon the satisfaction of other patent law requirements.[120]  Whether the overall benefits achieved by the invention -- to users or society in general -- suggest that the innovation should be adopted is left to market and regulatory processes that will subsequently govern the pricing and use of the patented invention.[121]  Market pricing will affect subsequent patterns of use of the patented invention because users will not be willing to pay more for access to the invention than their gains in increased utility from using the patented invention over their benefits from unpatented substitutes.[122]  Regulatory standards -- including, in extreme cases, total bans on the use of the patented invention if it is found by a government authority to be generally harmful -- will constrain the circumstances and practices for use of the patented invention.[123]  The issuance of a patent merely indicates that, if the patented invention is perceived as having a net value, the patent holder will control use of the invention for the life of his or her patent and will be in a position to force the user of the invention to share some of the benefits of use of the innovation with the patent holder.[124]

4.         Tax Planning Patents May Produce Net Societal Losses By Impairing the IRS's Efforts to Collect Taxes

Tax planning methods may be undesirable because, by granting such patents, the USPTO frustrates the efforts of the IRS to collect taxes.[125]  The losses entailed may be two-fold.  If there are more tax-avoidance strategies encouraged by taxpayers and needing review by the IRS, the efforts and resources needed by the IRS to keep up with the latest strategies may be greater than would be the case without tax method patents.  In addition, the IRS may simply do a poorer job in collecting taxes, resulting in a reduction in tax revenues and reduced governmental resources.

This type of objection to tax method patents is an administrative counterpart to the view that tax method patents are bad because the ends that they promote — reductions in tax payments — are bad.  Even if we (grudgingly) accept that the tax savings achieved by lawful tax reduction methods are legitimate, we need not encourage more of these reductions when we are devoting significant administrative resources in opposite directions through the efforts of the IRS to collect more taxes.  The essence of this argument is that the USPTO should not undercut what the IRS is undertaking much to achieve.

This argument somewhat mischaracterizes what it is that the IRS is authorized to pursue.  The activities of the IRS are aimed at ensuring that taxpayers comply with federal tax laws, which means that taxpayers should achieve no greater tax savings than the law allows.  However, this does not mean that the IRS is authorized to discourage persons from realizing the benefits of lawful tax reduction methods.  Hence, as tax method patents produce more and more tax reduction strategies and persons move their affairs into these methods, the individuals pursuing the new strategies will not be undertaking the sorts of abusive, illegal activities that the IRS is authorized to combat.  If anything, the use of patented tax reduction strategies may make the job of the IRS easier by ensuring that the details of the various strategies involved are publicly disclosed and subjected to criticism by IRS experts and other commentators.  This level of critique -- as opposed to the secrecy that might otherwise cloak tax method advances and implementation -- will help to ensure that abusive methods are caught and prohibited earlier and that the lines for taxpayers between legitimate and illegitimate tax reduction methods are clearer.

5.         Tax Planning Patents May Produce a Net Reductions In Innovation Due to Their Stifling Effect on Tax Planning and Curtailment of Analysis and Debate

During the period of enforcement of a particular patent covering a tax planning method, it is likely that the need to obtain a license for the method and the cost of using that method under a license will reduce the frequency of its use relative to the levels of use that would prevail if the method were freely available and no patent applied.[126]  This is a consequence of simple economics -- once a patent allows the patent holder to control the use of an invention and to set the price for its use, supracompetitive prices result.  This elevated price will in turn lessen demand relative to levels found under active competition.  The result is a curtailed use of the patented invention, either because the patent holder refuses to license it to some parties or because the patent holder charges a substantial licensing fee to license it.

While this scenario is doubtless correct, it is the same consequence that always follows from patent enforcement during the temporary period of the life of a patent.  During this period, patent holders are authorized to demand supra-competitive profits (and curtail free use of the patented innovation) in order to provide them with a reward for producing the patented invention.  This payment scheme is viewed as a fair means to restrict the patented innovation since the parties who use the patented invention during the period of licensing in effect "pay back" the innovator for producing his or her advance.

A key point in this analysis is that patent enforcement does not take away any of the techniques of tax reduction that existed prior to the development of the patented method.  Thus, those who do not obtain a license to use the new method are no worse off than if the patented innovation had not been developed and the relevant patent had not issued.  These taxpayers can still use the then existing non-patented substitutes for the patented method.  These substitute methods will be available both as means for taxpayers to realize tax payment reductions and as starting points for the development of additional innovations in tax reduction methods.  Since all of these substitutes for the patented method remain available, the issuance of a patent should not restrict the patterns of tax planning method use and innovation prevailing when the patented method was produced.

In addition, even at the elevated licensing prices dictated by patent enforcement, there will probably still be substantial patterns of use of the patented innovation because the patent holder will have economic incentives to price the relevant licensing royalties at levels that will ensure that taxpayers achieve net gains from the use of the patented method even after paying the necessary licensing fees.  No party will pay a licensing fee that the party expects will cause her to lose money relative to the tax levels that she would achieve through non-patented methods.  Hence, individuals' projected tax savings from using a patented tax planning method will establish a practical ceiling on the royalties that parties will pay and a patent holder will be strongly encouraged to license a patented method at royalty levels that still achieve a net tax savings for the taxpayers who pay the relevant licensing fees.  Hence, royalty arrangements will tend to evolve to levels that are attractive to at least a substantial number of taxpayers, who will use the method and have an opportunity to develop further tax reduction methods that incorporate the method.

The parties who will be incrementally limited in the use of patented tax planning innovations by patent enforcement are parties who would have had access to patented methods absent the issuance of tax planning patents, but who are precluded from such access by patent enforcement.  If patents are generally limited to non-obvious innovations that would have been unlikely to have been developed and publicly disclosed absent the heightened motivations provided by patent incentives, then tax reduction methods that are restricted by tax planning patents will mostly be ones that would not be available to taxpayers absent such patents.  For the most part, the methods that users will be "deprived" of by the enforcement of tax method patents are methods that would not have existed (or at least would not have been publicly disclosed) without the promise of patent rewards.  Thus, assuming that patents encourage an increment of new methods that would not otherwise exist and it is only this increment that is limited by subsequent patent enforcement, taxpayers are not deprived of many (if any) tax reduction methods that they would otherwise have.  Likewise, subsequent development of further tax methods derived from the patented methods is not incrementally limited because the patented methods would not exist as a base for further development absent the patents.

Indeed, under this view, the existence of patents on tax planning methods and the incremental set of methods these patents will tend to produce should enhance, rather than reduce, the availability and development of new tax methods.  Tax planning patents will encourage the development of new and more diverse types of tax reduction methods that are extreme "outliers" in the tax planning field since working with fundamentally new tax planning techniques or technologies will heighten the likelihood that the resulting method will be seen as non-obvious and potentially patentable.  Tax planning patents will also encourage greater public disclosure of previously non-obvious methods, leading to greater dissemination and use of these significantly different techniques.  Access to the broader range of tax planning methods encouraged by these patents will be partially restricted during the period of patent enforcement (that is, available only under licensing constraints) and then unrestricted once the relevant patents have expired.  However, in both periods, the range of tax planning methods available to the public will be greater than would be the case without tax planning patents, provided that such patents are generally granted for types of tax planning innovations that would not have been developed through normal day-to-day efforts of average tax planning experts.

Thus, if the problem of proper tailoring of the scope of tax planning method patents can be solved -- that is, if such patents can be limited primarily to advances that are non-obvious and unlikely to have been produced by the normal day-to-day evolution of tax planning methods by average tax planning experts -- then the net negative impacts of tax method patents on the public's access to desirable tax planning strategies may be small.  Indeed, the incentives created by these patents should increase the range of available tax planning methods over time.

B.         Tax Planning Patents May Be Undesirable Because the USPTO Can Not Properly Review and Limit Such Patents

1.         Special Challenges in Determining the Validity of Tax Planning Patents

Tax planning patents may be properly excluded from the patent system if there are reasons to believe that the USPTO will be unable to adequately review applications for tax planning innovations and that the USPTO's errors will so frequent and continuing that this type of innovation should be precluded from patenting categorically to prevent these sorts of errors.  Two types of problems may be especially difficult as the USPTO seeks to limit the issuance of tax planning patents to advances that are non-obvious extensions of the prior knowledge or "prior art" in this field.

First, because they are often incorporated in the private tax planning practices of individual clients and their disclosure is constrained by confidentiality agreements or professional obligations, the advances in this field may be poorly reflected in the public records used to determine the state of knowledge in the tax planning field as of the time a new innovation is asserted to have been made.  An innovation that is in fact not new (or, alternatively, that is a mere obvious variation from prior methods) may appear to be a significant, patentable leap forward when compared to an incomplete record of prior advances.  To draw an analogy to accumulated knowledge as reflected in a library, a great deal of knowledge would appear to be new and non-obvious if one only had a fraction of the library's books to look to as a point of reference in measuring prior knowledge.

Second, because the methods for extending prior knowledge in this field are either not well understood because they are undertaken behind closed doors in confidential relationships between attorneys and clients or because many of the current means for extending prior techniques involve computerized methods for augmenting earlier tax planning methods in ways that are new to the tax planning field, evaluations of what is a non-obvious advance over prior tax planning knowledge may be particularly difficult.  In this respect, tax planning method patents may suffer from the sorts of problems that are plaguing many fields as computer-enhanced versions of older devices and methods are submitted for patenting and non-obviousness evaluations turn on whether the functionality achieved by bringing computers and related capabilities into already well defined analyses and processes add non-obvious components to the earlier designs in the affected fields.[127]

2.         Potential Steps to Limit the Issuance and Enforcement of Improper Tax Planning Patents

While the problems just described will be real, they may just be transitional as tax method advances are brought within the patent system and prior art records and necessary examiner skills for proper application reviews are identified and expanded.  A number of steps may be useful in ensuring that tax method patents are limited to innovative tax planning methods that are significant, non-obvious departures from prior methods in this field.  This subsection summarizes these possible strategies for future action.

a.         Identify Field-Specific Prior Art Sources for Use in Patent Examination Processes and Enforcement Disputes

Tax specialists might profitably work with the USPTO to identify publicly accessible sources of information about past tax planning strategies so that these known strategies can be taken into account in the processing of applications for patents on tax planning methods.  Prior art sources in the tax field are different in both location and content from many other types of information commonly considered by patent examiners and a complete picture of the prior art against which tax method patent applications should be measured may require personnel in the patent office to gain new information on the sources and meaning of publicly available descriptions of "state-of-the-art" tax planning methods.  This same information on sources and implications of prior art, if made available to the public, would assist defendants in patent cases to challenge the validity of improvidently issued patents on tax planning methods.

b.         Develop Means to Expand the Knowledge of Patent Examiners Regarding Tax Planning Methods and Improvement Patterns

To the extent that methods of tax planning and techniques for extending prior tax planning methods to produce new methods are unfamiliar to patent examiners, presentations by tax practitioners to USPTO personnel on current tax planning techniques may be highly valuable.  These sorts of presentations might be modeled on similar information sessions that the USPTO conducted to learn more about computer software programming methods and advances in the period when software patents and their examination were growing concerns for the Patent Office.

c.         Encourage the Submission of Prior Art References to Support the Examination or Reexamination of Tax Planning Patents

USPTO procedures allow members of the public to submit to the agency prior art references related to published patent applications.[128]  These submissions are intended for use by examiners in the subsequent review of the published applications.[129]  The USPTO also has the ability to reexamine and invalidate issued patents in light of prior art that was not originally considered in the initial examination of the patents.[130]  Given the uncertain state of prior art in the field of tax planning patents, a policy adopted by the Patent Office that encourages the submission of prior art in this field to enhance examination reviews and to trigger reexamination proceedings might be valuable means to ensure that unwarranted patents do not reach the stage of active enforcement.

C.        Tax Planning Patents May Be Undesirable Because They Mislead the Public into Thinking that Patented Tax Reduction Methods are Effective or Approved by the Government

The issuance of a tax planning patent may be taken by taxpayers as a sign of approval by the government of a patented tax planning method or at least a sign that the patent method is particularly effective. [131]  According to this view:

Patents are granted by the federal government, posing a significant risk in the case of tax strategy patents. Taxpayers may be misled into believing that a patented tax strategy bears the approval of other government agencies, such as the IRS, and therefore is a valid and viable technique under tax law.[132]

Indeed, marketing efforts of some tax planning advisors have emphasized their capability to provide a patented method without specifying in detail how the patented method will actually benefit particular taxpayers.[133]  This type of emphasis suggests that the parties marketing the methods hope that taxpayers will automatically believe that patented methods are proper and superior to alternatives.

Unfortunately, neither may be the case.  A patented tax planning method might still be illegal because it violates statutory or regulatory standards.  As noted by the staff of the Congressional Joint Committee on Taxation:

The grant of a patent in no way constitutes government (i.e., IRS) approval of the purported tax treatment asserted by the patent-holder; indeed, the IRS is often unaware of an application for a tax strategy patent until after the patent is granted. While this fact is likely to be readily understood by large and sophisticated corporate taxpayers (many of whom employ a number of in-house and outside legal advisors well-versed in both intellectual property law and tax law), this critical point may not be appreciated by an individual without formal legal training and with limited direct interaction with the Federal government.  It is argued that unscrupulous tax shelter promoters could prey on such unfamiliarity by falsely holding out a patent as evidence that an aggressive tax structure has been reviewed and approved by the government and that it thus 'works' as advertised.[134]

The type of confusion involved in the argument that a patent reflects a government endorsement of a patented method stems not from the features of tax method patents, but rather from a misconception of the scope and goals of patent laws.  These laws are aimed at promoting new means of accomplishing useful tasks.  The issuance of a patent does not give the patent holder an affirmative right to undertake a patented process or indicate governmental approval of the patented process.  Rather, the issuance of a patent merely achieves a negative result -- that is, it gives the patent holder the right to prevent others from using the patented process without gaining the patent holder's permission and paying an associated licensing fee.  If a patented method is (or becomes) illegal, no one can use the method.

The fact that use of a patented device or method may be illegal is not peculiar to the tax field.  Similar issues have arisen in many fields where certain uses or applications of patented devices and methods are banned by legal standards outside the patent laws.[135]  Just a few examples include a patented method of producing alcoholic liquids, which could have been used illegally during Prohibition,[136] a patented radar detector, which could be used to facilitate illegal speeding and is illegal to use in some jurisdictions,[137] a patented device for use in cock fights despite the fact that such fights are illegal in most jurisdictions,[138] and a patented gambling device, the use of which would be illegal in most jurisdictions.[139]  In granting these and other like patents, the USPTO has applied patent law standards without purporting to apply other bodies of criminal or regulatory law.[140]  This approach carries out the USPTO's limited mission as defined by the Patent Act and avoids involving that agency in law enforcement and moral analyses which the agency is poorly equipped to undertake.[141]

Whether the devices or activities governed by a patent should be regulated or even banned due to their negative social impacts is a separate matter which can be addressed by additional legislation if Congress or a state government so wishes.  Prohibitions in a number of areas prevent persons (even those with a patent license or ownership of a patented product acquired from a legitimate source) from using a patented invention.  For example, in states that have prohibited the use of radar detectors, persons possessing radar detectors with patented designs are precluded from using the devices.  The existence of a patent covering features of the radar detectors carries no weight in legitimizing the devices or in providing patent holders or their licensees with a basis or authorization to use the devices.  The same will be true for tax method patents — the issuance of a patent will say nothing about the legal legitimacy of the method covered by the patent.

In addition to being potentially illegal, the use of patented tax planning methods may just be ineffective — that is, little or no better in tax reduction than unpatented alternatives.[142]  Taxpayers may interpret the issuance of a patent as an indication that the patented tax planning method is "better" than its predecessors rather than reaching the correct conclusion that a patent just provides some evidence that the patented method is different than its predecessors or at least was perceived as such by USPTO examiners.

These sorts of potentially harmful effects on taxpayers stem at bottom from misimpressions of the practical meaning of the issuance of a patent for a tax planning method.  Rather than banning or limiting such patents entirely, these sorts of informational problems are probably best solved by increasing countervailing information available to taxpayers about the potential illegality or at least limited utility of specific tax planning methods covered by patents.  With this additional information, taxpayers -- or, more realistically, their tax advisors -- can make intelligent and accurate decisions about whether the adoption of a patented tax planning method (and the payment of an associated royalty to the patent holder) will be in the best interests of the taxpayers.

As a practical matter, concerns over the patenting of abusive tax reduction strategies and the consequent public confusion about the legitimacy of such strategies may be overstated because few, if any, abusive strategies are being patented.  A review by the IRS in mid-2006 found that none of the tax reduction strategy patents issued to that point appeared to cover an abusive tax reduction method.[143]

D.        Tax Planning Patents May Be Undesirable Because They Allow Private Parties to "Capture" or Control Law Compliance Methods

1.         Tax Planning Methods May Improperly "Capture" Certain Law Compliance Methods Under the Temporary Monopoly Control of Patent Holders

A somewhat different problem raised by tax planning patents is that a given patent may allow a patent holder to control or "capture" means of compliance with particular tax law requirements.  These concerns potentially apply to non-aggressive, clearly lawful tax planning methods that are restricted by patents.  The concern here is that:

patent-holders could effectively claim ownership of certain routine planning tools, or even of a method which constitutes the most efficient (or, in the extreme, the only) manner of complying with the requirements of the Internal Revenue Code and administrative guidance thereunder.[144]

This concern seems misplaced since, in almost all cases, a patent holder will only control one means of law compliance, not all means of law compliance.  In many settings, a patented tax planning method will be only one of many means of structuring a taxpayer's affairs in a lawful manner that complies with applicable tax liability and reporting standards.  Where there are numerous, unrestricted alternatives to the patented method, the mere fact that the patented version is particularly attractive should not provide special grounds for precluding patenting of the method to ensure that it is available to all parties who desire it.  Patented devices or methods in various fields — for example, patented devices that are useful for complying with environmental pollution standards — are frequently more attractive than unpatented devices or methods, but this does not provide a valid argument for free use of the patented devices or methods without paying associated royalties.

Another possible objection to the "capturing" of a mode of tax law compliance through a patent is that, because all persons must obey the tax laws, the frequency with which persons could make beneficial use of innovative tax planning methods is particularly great and the costs of withholding those methods through patent rights are more significant than in other fields.  However, if tax planning methods are frequently valuable to numerous parties, these would seem to be methods that we should most want the patent system to cover, thereby ensuring that patent incentives and rewards promote attention to the creation of these sorts of new methods of widespread value.  This is a central principle of patent law generally: the most widely useful inventions are the ones that deserve the strongest patent protections to encourage the most vigorous development efforts, thereby matching the incentives and rewards of the system to the scope of societal benefit an inventor has pursued and achieved. 

It is important to remember in thinking about the consequences of limiting access to patented tax planning methods under patent rights that a patent holder can not force a taxpayer to adopted a patented method and that rational taxpayers will only pay an amount in royalties for use of a patented method that still achieves a net benefit for the taxpayer.  At any higher rate, the taxpayer would simply forego use of the patented method and rely on non-patented substitutes.  Since, under this logic, access to patented tax planning methods will tend to be available to taxpayers on terms that produce net gains to the taxpayers, the development and increased public availability of patented tax planning methods through patent-influenced processes should only expand the range of techniques available to the public and achieve net benefits to taxpayers even after the payment of associated royalties.

A related argument against patented tax planning patents is that, at least if patented tax planning methods include methods used by relatively unsophisticated taxpayers, such taxpayers may inadvertently adopt a patented method without awareness of the patent covering the method and open themselves up to patent infringement liability and disruption of their future tax planning.  The short term answer to this objection is that most if not all of the sorts of tax planning methods that have qualified for patents as yet cover methods that are only helpful to and capable of use by highly affluent individual taxpayers or corporations, all of which are likely to be represented by sophisticated tax advisors.  These tax advisors — probably in conjunction with patent attorneys engaged by the advisors as patents become more important in the tax field — will be able to monitor and properly respond to patented methods as they appear.  To the extent that tax planning patents may extend to techniques used by less sophisticated taxpayers in the future, the USPTO, IRS, or some other governmental agency may wish to initiate special informational practices (such as the operation of a special web site or newsletter service) identifying and describing newly patented tax planning techniques of substantial potential importance to large numbers of relatively unsophisticated taxpayers.  Of course, the patent holders themselves will have substantial motivations to publicize the emergence of these same patents.

If a patented method is the only means to comply with a particular legal requirement — or if the other alternatives are so inferior as to make their adoption economically unreasonable — there is a stronger case for restricting absolute control by the patentee over the patented method.  However, this concern is similar to those in areas other than tax law compliance where rights arising under patent laws intersect with requirements of some regulatory regime.