Financial Institutions May Be At Risk If Participating In Patented Tax Reduction Techniques

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August 04, 2006

Financial institutions now face a new risk -- patent infringement for suggesting or participating in a tax reduction strategy.

Since a federal appeals court ruled in 1998 that business methods can be patented, the U. S. Patent and Trademark Office has granted 48 patents classified as tax methods, techniques and strategies and 81 patent applications are pending. In response to this development, the House Ways and Means Subcommittee on Select Revenue Measures held a hearing on July 13, 2006 on issues relating to the patenting of tax advice. In announcing the hearing, Committee Chairman Dave Camp stated that a number of patents have been issued for tax reduction strategies, particularly in the area of estate and gift taxation, and the Committee wanted to explore the issues relating to these types of patents. The Committee invited five individuals to testify: the Commissioner of Internal Revenue, the General Counsel of the United States Patent and Trademark Office, academicians Ellen Aprill and Richard S. Gruner, and practitioner Dennis I. Belcher, a member of McGuireWoods’ Fiduciary Advisory Services. The statements of the witnesses are on the House Ways and Means Committee website.

Ways and Means Subcommittee Hearing

During the Congressional hearing, Belcher testified that a patent of one transfer tax reduction technique in particular, the SOGRAT patent, is presenting significant problems to many taxpayers and their advisers. Belcher recommend that if the U. S. Patent and Trademark Office could not prohibit the patenting of tax reduction strategies, then Congress should do so, before the patenting of this type of strategy becomes more widespread and affects more taxpayers.

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The witnesses described the history of tax reduction patents. Until 2003, few estate planning advisers considered patents when advising clients about estate planning. That view changed in 2003 when an individual was awarded a patent for an estate planning technique that the patent holder called a “SOGRAT” ( Patent No. 6,567,790, Establishing and Managing Grantor Retained Annuity Trusts Funded by Nonqualified Stock Options). According to the patent, a SOGRAT involves a grantor retained annuity trust funded with nonqualified stock options. When word of this patent spread through the estate planning community, most estate planning professionals were shocked to learn that it was possible to patent a common estate planning technique used in connection with a specific asset, the purpose of which is to allow taxpayers to minimize their federal estate and gift tax liability, particularly a technique (such as a GRAT) authorized under the Regulations issued by the Treasury Department and approved in many Internal Revenue Service rulings.

Impact of SOGRAT Patent

The existence of the SOGRAT patent is preventing taxpayers from using a government authorized estate and gift tax reduction technique, thereby presenting problems to taxpayers in planning their affairs. As reported at the July 8, 2006, meeting of the Estate and Gift Tax Committee of the American College of Trust and Estate Counsel (ACTEC), the holder of an estate planning patent had recently contacted an estate planning adviser employed by a financial institution and informed the adviser that the patent holder was the owner of the estate planning technique suggested by the adviser in a newsletter to clients. The adviser sought legal guidance on the proper course of action. Notwithstanding that the adviser’s lawyer believed the patent may be invalid, the lawyer recommended that the adviser not risk using the patented technique without permission of the patent holder. The lawyer gave this advice presumably because of the high cost of defending a patent infringement law suit or prosecuting a suit to invalidate the patent. After discussions, the adviser agreed not to suggest the use of the legally authorized estate planning technique in connection with a particular type of asset without informing clients and their lawyers of the existence of the patent so that the client and lawyer would be responsible to make their own judgments about the validity of the patent and the degree to which it should be honored.

Pending Lawsuit Against Estate Planning Client

In addition, there is a lawsuit pending against a taxpayer alleging the infringement of the SOGRAT patent. On January 6, 2006, the SOGRAT patent holder filed suit in the Connecticut United States Federal District Court for infringement of the SOGRAT patent. The defendant in the lawsuit is Dr. John W. Rowe, the Executive Chairman of Aetna, Inc. The lawsuit is in the discovery stage and is expected to go to trial in 2007. Because the lawsuit is being prosecuted vigorously, the lawsuit cannot be considered a nuisance lawsuit. When this lawsuit was discussed at ACTEC’s Estate and Gift Tax Committee, the vast majority of lawyers present (more than 100 experienced estate planning lawyers) indicated that a lawyer should not recommend to any client the use of a GRAT funded with nonqualified stock options without disclosing the existence of the SOGRAT patent and the pending lawsuit. In addition, these lawyers indicated that they would be reluctant to allow a client to use this technique without the permission of the patent holder.

Risk to Financial Institutions

Financial institutions need to be aware that there are patents of tax reduction techniques. Otherwise, a financial institution will risk recommending an estate planning technique that has been patented or participating as a fiduciary in such a technique and becoming embroiled in expensive litigation. It is important that all financial institutions stay abreast of developments in this area so as to better serve their clients and avoid liability. Do not hesitate to contact a member of McGuireWoods’ Fiduciary Advisory Services team for assistance in this area.

McGuireWoods Fiduciary Advisory and Private Wealth Services

McGuireWoods Fiduciary Advisory Services assists financial institutions in a wide array of areas in which questions or concerns may arise. This includes advising corporate trustees on how to avoid litigation before it arises and how to address litigation when it does arise. McGuireWoods Private Wealth Services team is one of the largest in the country and is focused on handling the needs of high net worth clients. Our size, extensive experience, and strong presence in strategic markets set us apart from our competitors.

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