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Taxation Innovation

John Rowe figured he could handle the IRS. After getting advice from a law firm and a financial planner, the wealthy executive chairman and CEO of Aetna Inc. set up a scheme that would transfer millions of dollars to his family while minimizing the gift taxes the family paid Uncle Sam.

Rowe took nonqualified stock options worth an estimated $28.5 million and placed them in two "grantor retained annuity trusts" (GRATs) in 2003. These trusts would pay Rowe an annual income for a set period, and whatever was left in the trust after that time would go to Rowe's family. This stratagem would produce dramatic gift-tax savings.

Rowe's plan soon ran into legal ?? 1/2 trouble. But not from the IRS.

Wealth Transfer Group, a tiny company based in Altamonte Springs, Fla., informed Rowe that it owned a patent on the tax strategy Rowe had used and it wanted Rowe to pay for using it. Rowe balked, and in January 2006, the company sued Rowe for infringement. Wealth Transfer Group is seeking an injunction, treble damages and attorneys' fees.

The lawsuit has generated an uproar among accountants and tax attorneys. "They are aghast," says John Dauer Jr., a patent attorney in the New York office of Pitney Hardin.

These tax experts are ?? 1/2 worried about far more than just one ?? 1/2 patent. The U.S. patent office already has issued 43 patents on tax strategies, and the agency is processing applications for 62 more.

According to critics, these patents would prevent taxpayers from legally reducing their tax liabilities because patent owners would have exclusive rights to the appropriate tax strategies. "For someone to [patent] this ?? 1/2 and prevent others from doing it, they are claiming ownership of one part of the tax code," says David Handler, a tax and estate planning attorney in the Chicago office of Kirkland & Ellis.

Obvious Strategy

Wealth Transfer's Web site trumpets that, "If you own nonqualified stock options, we have a patented technique to help you increase the value your family will receive." This patent, No. 6,567,790, seems to cover all GRATs that are funded in part by nonqualified stock options. As a result, if anyone wants to use this type of GRAT, they must get permission from Wealth Transfer.

This astonishes tax experts because GRATs are commonly used estate planning devices. "For anyone with an estate tax issue and more than $100 thousand in assets, it's as run of the mill as they come," Handler says.

Wealth Transfer certainly didn't invent GRATs. The company filed for its patent Dec. 1, 1999, but GRATs were around long before that. In 1990, for instance, Congress amended the tax law to approve their use.

Wealth Transfer apparently claims to have invented the method of funding a GRAT with nonqualified stock options, but many tax attorneys assert there's nothing inventive about this. If clients want to transfer some assets to their families, tax advisers routinely consider putting the available assets--including stock options--into a GRAT. "It's not at all original," says Soraya Tabibi Aguirre, an estate planning attorney at Hale Lane in Nevada. She adds that tax advisers and taxpayers were funding GRATs this way prior to 1999.

So how did Wealth Transfer manage to obtain this patent? The answer, critics say, is that the patent office didn't know what it was doing.

Patent Blunder

Tax law is an arcane and specialized field. Patent examiners didn't need to understand it until the applications for tax strategies began arriving at the PTO after the Federal Circuit held in 1998 that business methods could be patented.

Examiners at the patent office are doing their best to evaluate these applications, but it's not easy to become proficient in tax planning. Moreover, the patent office hasn't had the time or resources to build up a large database of prior art in the tax field. As a result, some say, the PTO has issued tax-strategy patents of doubtful validity.

This is only to be expected, according to many patent attorneys. Whenever the patent office starts reviewing applications in a new area, there are some temporary problems while the office increases its expertise and database.

"It's always the same story ?? 1/2 whenever there are new types of patents," says Stephen Schreiner, a patent attorney in the Washington, D.C., office of Hunton & Williams.

"Eventually, the patent office develops a body of prior art, hires people to deal with this area and the system works well. ?? 1/2 This has been the pattern with such things as biotech patents, software patents and business-method patents."

However, tax experts warn that tax- strategy patents are different from other types of patents because they give private parties exclusive control over ways of complying with tax laws.

"Granting patent protection to such strategies could limit the use of that particular tax strategy by other taxpayers and have a negative impact on their ability to comply with the tax law," said Mark Everson, commissioner of the IRS, in his July testimony to the House Subcommittee on Select Revenue Measures. The subcommittee deals with revenue issues the chair of the House Ways and Means Committee selects.

Some believe these patents could be a disaster for taxpayers and tax advisers. "It would shut down tax planning, because all tax plans would be contingent on patents and royalty fees," Handler says.

Making Adjustments

Patent attorneys have a different point of view: Tax-strategy patents are neither unusual nor harmful.

So what if a tax-strategy patent covers the best way to minimize taxes? Other types of patents often relate to legal compliance. An inventor can patent a cleaner-running engine, even if this is the best way for companies to comply with antipollution laws. A pharmaceutical company can patent a better heart medication, even if the drug must meet the standards of the FDA.

"In theory, [a tax-strategy patent] isn't different from getting a patent on something that some other federal agency, such as the FDA, might have a say over," says Arti Rai, who teaches patent law at Duke University School of Law.

If this is right, why is there so much angst over Wealth Transfer's patent? "It's a big deal because it's the first business-method patent that has popped up in the tax field, and everyone is trying to figure out what this means and how to deal with it," Dauer argues.

Such concerns are typical whenever the patent office first begins issuing patents for an industry. Those in the industry fear patents will limit what they can do and will dramatically raise their costs.

These worries eventually go away, and the industry adjusts to the new reality, according to many patent experts. For example, banks were outraged when the patent office began issuing business- method patents affecting the financial service industry in the late 1990s. But those patents remain in effect, and banks are doing fine.

The same will be true in the tax field, patent experts predict. They believe relatively few tax-strategy patents will be issued, and these patents will increase costs only minimally.

Whether or not this is correct, taxpayers and tax advisers may have little choice but to adapt to tax-strategy patents.

"[T]he patent office has issued and will continue to issue patents on tax strategies," Dauer says.

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