PATENTING STRATEGIES: KILLIN’ THE SNAKE

PATRICK LEWIS O’DANIEL Fulbright & Jaworski L.L.P. 600 Congress Avenue, Suite 2400 Austin, TX 78701 & KEVIN THOMASON Thompson & Knight LLP 1700 Pacific Avenue, Suite 3300 Dallas, TX 75201

State Bar of Texas 25TH ANNUAL ADVANCED TAX LAW COURSE August 30 - 31, 2007 Houston

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Patrick L. O’Daniel Fulbright & Jaworski L.L.P. 600 Congress, Suite 2400 Austin, Texas 78701 (512) 536-5264

Education The University of Texas School of Law J.D., with high honors, 1992 GPA: 4.07/4.3

The University of Texas at Austin – May 1989 Bachelor of Business Administration, Highest Honors Double Major in Accounting and Honors Business

Activities Member, State Bar of Texas (1992 – Present) Member, State Bar of Texas, Tax Section, Chair, Committee on Government Submissions (COGS) (2005 – 2007) Treasurer, State Bar of Texas, Tax Section (2007 – Present) Member, Tax Section, American Bar Association (1993 – Present) Sub-Committee Chairman of Partnership Workouts Committee, American Bar Association (1998 – Present) President, Business, Corporate and Taxation Section of Travis County Bar Association (1997-1998) Treasurer, Texas Law Review (1992-1997) Articles Editor, Texas Law Review (1991 - 92) Editor, Harvard Journal of Law and Public Policy (1991-92) President, Federalist Society, University of Texas School of Law (1990-01) Omicron Delta Kappa – Leadership Fraternity President, Board Member, Catholic Charities of Central Texas (2000- Present) General Counsel, Board Member, Zachary Scott Theatre (2002-Present)

Awards Marvin Key Collie Endowed Presidential Scholarship in Tax Law Carrington, Coleman Award for Academic Performance Jenkens & Gilchrist Tax Note Award Grand Chancellor Order of the Coif National Merit Scholarship Phi Kappa Phi, Golden Key Honor Societies Beta Gamma Sigma Business Honor Society

Experience Fulbright & Jaworski L.L.P., Austin, Texas (Partner, 2007)

Jenkens & Gilchrist, Austin, Texas tax associate, 1993-98; partner, 1999 – 2006

University of Texas School of Law, adjunct professor, Partnership Tax, (2000- Present)

Hon. Clarence Thomas, Supreme Court of United States, law clerk (1998-99)

Hon. William L. Garwood, United States Court of Appeals, Fifth Circuit, law clerk (1992-93)

Miscellaneous Certified Public Accountant

KEVIN THOMASON

Partner, Thompson & Knight LLP 1700 Pacific Avenue, Suite 3300, Dallas, TX 75201 214.969.2561, Fax 214.999.9261 [email protected]

PRACTICE Tax

PRACTICE DESCRIPTION Kevin Thomason focuses his practice on the representation of clients in tax matters. He provides advice and counseling on partnership, corporate, and real estate tax issues, with an emphasis on tenant-in-common syndications, master limited partnerships, and like-kind exchanges.

DISTINCTIONS/HONORS The Best Lawyers in America (Tax Law); 2006-2007 Texas Super Lawyers, Texas Monthly; 2003-2004, 2006

PUBLICATIONS/PRESENTATIONS "Planning Under The Often Overlooked At-Risk Rules, Including The Impact of the Hubert Case," 65th Institute on Federal Taxation, New York University, San Diego, California, November 2006 "What's Hot In Section 1031?," Dallas CPA Society, Dallas, Texas, November 2006 "Partnership Interests for Services: The Proposed Regulations," Dallas CPA Society, Dallas, Texas, November 2006 "Introduction To Petroleum and Mineral 1031 Exchanges: Oil & Gas TIC Boot Camp," Panelist, Panel Discussion, The Inaugural Texas IMN Tenant-In-Common Transactions Forum, Dallas, Texas, November 2006 "What's Hot in Section 1031?," 54th Annual Taxation Conference, University of Texas CLE, Houston, Texas, November 2006 "What Impact are TIC Buyers Having on the Metroplex Investment Market?," Moderator, Panel Discussion, 5th Annual RealShare Dallas, Dallas, Texas, October 2006 "Exchanges of Oil and Gas Properties," Moderator, Panel Discussion, Real Estate Committee Program, Fall Meeting of the Section of Taxation of the American Bar Association, October 2006 "Yield Enhancements in Today's TIC Market," Panelist, Panel Discussion, 2006 Tenants-In-Common Association Annual Conference, Las Vegas, Nevada, October 2006 Sponsors Forum, Panelist, Panel Discussion, 2006 Tenants-In-Common Association Annual Conference, Las Vegas, Nevada, October 2006 "So You Want To Invest In A TIC Deal?," reprinted in Texas Real Estate Business, October 2006 "Proposed Regulations - Sections 83 & 721: Partnership Interests for Services," with Ronald C. Kalteyer, State Bar of Texas Advanced Tax Law Course, Dallas, Texas, September 2006 "Damage Control: When a Deal Doesn't Go as Planned," Panelist, RealShare TIC, San Francisco, California, August 2006 "Black Box or Pandora's Box - What's in Third Party Due Diligence Reports, What Are Their Purposes, Who Are They For and Why?," Panelist, Panel Discussion, OMNI Brokerage Fall Conference, Midway, Utah, August 2006 "Who'd a Thunk it? Pitfalls for New Sponsors," TICTALK, April 2006 "So You Want To Be A Sponsor? ," Moderator, Panel Discussion, Tenant-In-Common Association 3rd Annual Symposium, San Diego, California, March 2006 "Partnership Equity for Services," Tarrant County Bar Association, Tax and Estate Planning Section, Fort Worth Texas, February 2006 "So Your Client Wants to Invest in a TIC Deal," Moderator, Panel Discussion, Real Estate Committee Program, Midyear Meeting of the Section of Taxation of the American Bar Association, San Diego, California, January 2006 "TICs and DSTs: The Cutting Edge of Like-Kind Exchanges," 52nd Annual Texas CPA Tax Institute, San Antonio and Dallas, Texas, November 2005 "TIC Update: The Future of TICs and How They're Helping Solve 1031 Exchange Investors' Replacement Property Challenges," Panel Discussion, RealShare Houston, Houston, Texas, November 2005 "What's Next for the TIC Business," Moderator, Panel Discussion, RealShare Dallas, Dallas, Texas, November 2005 "Alphabet Soup Entities," AICPA National Real Estate Conference, Las Vegas, Nevada, October 2005 "Like-Kind Exchanges: TICs and DSTs, an Update," with William P. Bowers, International Council of Shopping Centers, Phoenix, Arizona, October 2005 "Hot Tax Topics: Understanding the IRS and TICs," 2005 Tenants-In-Common Association Annual Conference, Las Vegas, Nevada, October 2005 "Overview and History of TICs, Basics of TICs," with Louis S. Weller, Anatomy of a TIC, Texas A&M University Real Estate Center, Dallas and Houston, Texas, September 2005 "Like-Kind Exchanges: TICs and DSTs, an Update," August 2005 "Partnership Tax Update," University of Texas CLE, Austin, Texas , July 2005 "Like-Kind Exchanges: Update, TICs and DSTs," State Bar of Texas Advanced Real Estate Law Course, San Antonio, Texas, July 2005 "Tenancy-in-Common Syndications: The Unanswered Questions," Moderator, Panel Discussion, 21st Annual Texas Federal Tax Institute, San Antonio, Texas, June 2005 "The American Jobs Creation Act of 2004 and Circular 230," Program Chair, State Bar of Texas, Dallas, Texas, April 2005 "The Evolution of TICs and Section 1031," Moderator, Panel Discussion, Real Estate Committee Program, Midyear Meeting of the Section of Taxation of the American Bar Association, San Diego, California, January 2005 "Tax Strategies Using Like-Kind Exchanges," Professional Education Systems Institute, Dallas and Houston, Texas, December 2004 "Goodwill Hunting: The Use of 'Personal Goodwill' and Other Planning Techniques in the Sale of Businesses," 2004 Texas Society of CPAs Tax Institute, Dallas and San Antonio, Texas, November 2004 "Hot Topics in Taxation - What a Shopping Center Lawyer Needs to Know About Tenancy-in-Common Exchanges," with William P. Bowers, 2004 ICSC U. S. Shopping Center Law Conference, Hollywood, Florida, October 2004 "The Next Big Thing...The Who, What, Where, Why & How of Tenant-in-Common Investing...and How It Could Impact the Investment Market," Moderator, Panel Discussion, RealShare Dallas, Dallas, Texas, October 2004 "The Life Cycle of a 1031/TIC Transaction," Panelist, Triple Net Properties, LLC, 1031 Symposium, Las Vegas, Nevada, September 2004 "Practical Planning for Tenancy in Common (TIC) Exchanges," with Anthony Thompson and Louis Rogers, Section of Taxation of the American Bar Association Teleconference, July 2004 "Mergers, Acquisitions, and Conversions with Partnerships and LLCs," Current Issues Affecting Partnerships, Limited Partnerships & LLCs, University of Texas CLE, Austin, Texas, July 2004 "Use 1031 Exchanges to Invest In TIC Properties," Commercial Mortgage Insight, May 2004 "Goodwill Hunting," Financial Planning, May 2004 "Current Developments," Moderator, Panel Discussion, Partnership Committee Program 2004 Meeting of the American Bar Association Tax Section, Washington, D.C., May 2004 "1031 Exchange Update: Legal Issues Dealing with 1031 Exchanges," IBA Real Estate Networking Conference, Harvey Hotel, Irving, Texas, February 6-7, 2004 "Partnership Options: The Regulations at Last," 62nd Institute on Federal Taxation, New York University, San Francisco, California, November 2003 "Partnerships/LLC's: Options," Philadelphia Tax Conference, Philadelphia, Pennsylvania, October 2003 "Tax Strategies Using Like-Kind Exchanges," with Bradley C. Borden, Professional Education Systems Institute, LLC, Dallas, Houston, and Austin, Texas, September 2003 "A Practical Guide for the Rest of us on the Tax Treatment of Options in Partnerships and LLCs," University of Texas CLE Law, Austin, Texas, July 2003 "Tax Issues, Including 1031s and Entity Choices," Advanced Real Estate Law Course, San Antonio, Texas, July 2003 "Partnership Options: The Proposed Regulations," Moderator, Panel Discussion, Partnership Committee Program 2003 Meeting of the American Bar Association Tax Section, Washington, D.C., May 2003 "The Triumph of Policy: The Proposed Partnership Options Regulations," Co-Authored with John Maxfield, Journal of Passthrough Entities, March-April 2003 "Partnership Options and Related Instruments," 61st Institute on Federal Taxation, New York University, San Diego, California, November 2002 "Partnership Options," Moderator, Panel Discussion, Partnerships Committee Program, Fall Meeting of the American Bar Association Tax Section, Los Angeles, California, October 2002 "Entity Characteristics," Texas Wesleyan, October 2002 "Navigating the Maze of Partnership Options and Profits Interests," State Bar of Texas Advanced Tax Law Course 2002; Houston, Texas, September 2002 "The Myth of the Capital Shift," Journal of Passthrough Entities, September-October 2002 "Estate Tax Phase Out and Repeal: What It Means for Real Estate Tax Lawyers," Moderator, Panel Discussion, Real Estate Committee Program, 2002 Meeting of the American Bar Association Tax Section, Washington, D.C., May 2002 "Report on Partnership Options Project," Moderator, Panel Discussion, Partnerships Committee Program, 2002 Meeting of the American Bar Association Tax Section, Washington, D.C., May 2002 "Estate Planning for Real Estate after Bush I," Moderator, Panel Discussion, Real Estate Committee Program, 2002 Midyear Meeting of the American Bar Association Tax Section, New Orleans, Louisiana, January 2002 "Remember the Lock Box," Texas Lawyer, December 2001 "The Federal Income Tax Treatment of Partnership Options," Dallas Bar Association Tax Section, October 2001 "Avoid Tax Legally with 1031 Exchanges," Dallas Business Journal, August 10-16, 2001 "Treatment of Options in the Partnership and LLC Context: Report of the LLC Subcommittee on its Government Submission," Panel Discussion, Partnerships Committee Program, 2001 Annual Meeting of American Bar Association Tax Section, Chicago, Illinois , August 2001 "Reverse Like-Kind Exchanges: Analysis of New 'Safe Harbor' Rev. Proc. 2000-37," with William A. Kramer, Advanced Real Estate Law Course 2001, Houston, Texas, July 2001 "Reverse Like-Kind Exchanges: Analysis of New 'Safe Harbor' Rev. Proc. 2000-37," with William A. Kramer, Advanced Real Estate Law Course 2001, Dallas, Texas, June 2001 "The Taxation of Partnership Options," 17th Annual Texas Federal Tax Institute, June 2001 "How Will Estate Tax Repeal or Reform Affect Real Estate?," Moderator, Panel Discussion, Real Estate Committee Program, Meeting of the American Bar Association Tax Section, Washington, D. C., May 2001 "Plays Well With Others: IRS Amends Rules and Eases Reverse-Exchange Game," Co-Authored with William A. Kramer, Texas Lawyer, January 2001 "Reverse Like-Kind Exchanges: Analysis of New 'Safe Harbor' Rev. Proc. 2000-37," with William A. Kramer, Dallas Bar Association Tax Section, Dallas, Texas, December 2000 "Redefining Income from Discharge of Indebtedness," 9th Annual Advanced Institute for Partnership and Real Estate Tax Planning, Dallas, Texas, January 1993 "Federal Tax Deductions," Warren Gorham & Lamont, 1983

ACTIVITIES Member, Dallas Bar Association, Tax Section; Chair, 2003; Vice Chair, 2002; Council Member, 2002-2003 Member, American Bar Association, Taxation Section; Real Estate Committee, 2000-present; Chair, 2007; Vice Chair, 2003-present; Subcommittee on Estate Planning Issues, Chair, 2000-2004; Partnerships and LLCs Committee, 2000-present; Subcommittee on Continuing Legal Education, Chair, 2002-2003 Member, State Bar of Texas, Taxation Section; Chair, 2007; Chair-Elect, 2006-2007; Secretary, 2005-2006; Treasurer, 2004-2005; Council Member, 1994-1997, 2002-2004; Partnerships and Real Estate Tax Committee, Chair and Vice-Chair, 1994-1997 Vice Chair and Moderator, Texas Federal Tax Institute, 1997-present Director, Central Dallas Ministries, 2007 Director, Dallas For Children, 1995-2005; Chairman of the Board of Directors, 1995-1998 Trustee, Miracle at Pentecost Foundation, 2000-present Member, Tenant-in-Common Association, 2004-present; Vice Chair, Legislative and Regulatory Committees, 2006- present

EDUCATION J.D., 1979, cum laude, SMU Dedman School of Law, Hatton W. Sumners Scholar; Order of the Coif B.S. in Accounting, 1976, summa cum laude, Oklahoma Christian College

ADMISSIONS Texas, 1979 U.S. Dist. Ct., N. Dist. Texas, 1982 U.S. Tax Ct., 1982

PRIOR EXPERIENCE Attorney-Advisor to the Honorable William A. Goffe, United States Tax Court, 1979-1981

Patenting Tax Strategies: Killin’ the Snake Chapter 5

TABLE OF CONTENTS

I. INTRODUCTION...... 1

II. BACKGROUND...... 1 A. Some Basics...... 1 B. Obtaining a ...... 1 1. Eligible for Patent...... 1 2. Useful ...... 2 3. New and Not Obvious ...... 2 4. Difficulty of Judging and Obviousness ...... 3

III. TAX STRATEGY ...... 3 A. The PTO’s Classification of Tax Reduction Techniques ...... 3 1. Class 705 and Subclass 36T Numbers...... 3 2. Three General Classes of Known Subclass 36T Tax Strategy Patents...... 4 B. Concerns Regarding Patented Methods Consistent with the Code...... 4 1. The SOGRAT Case ...... 4 2. Ramifications of the SOGRAT Patent Litigation...... 4 C. Areas of Concern ...... 4

IV. PROPOSED LEGISLATION ...... 5 A. Bar Efforts...... 5 B. Two Methods for Limiting the Scope of the Patent Laws by Legislation...... 5 C. The Texas Tax Section Proposal...... 5 1. Substance of the Texas Tax Section Proposal ...... 5 D. Legislative Progress...... 5 E. Congressional Bills...... 5 1. Senate Bill S.681 ...... 6 2. House Bill H.R. 2365 ...... 6 3. House Bill H.R. 1908 ...... 6 F. Remaining Legislative Issues...... 6

V. ETHICAL ISSUES ...... 6 A. Conflicts of Interest...... 6 B. Confidential Client Information...... 6 C. Inducement Issues...... 7 D. Attorney Fees...... 7 E. Circular 2.30 Issues...... 7 F. Advertising Issues...... 7 G. Infringement Litigation...... 7 H. Patent Ownership Issues...... 7

VI. CONCLUSION ...... 8

i

Patenting Tax Strategies: Killin’ the Snake Chapter 5

PATENTING TAX STRATEGIES: KILLIN’ THE Financial, Inc., 149 F.3d 1368 (Fed. Cir. 1998) (State SNAKE Street Bank).

I. INTRODUCTION a. State Street Bank This seminal case is a tax method patent case Tax strategy patents have been making headlines based on the provisions of the Internal Revenue code recently due to the legislation being considered in the of 1986, as amended (the “Code”), couched as an Congressional House and Senate. If the bills are applied algorithm. It was a patent on section 704(b) passed, they would ban the patenting of tax strategies and 706 compliance by a hub-and-spoke mutual fund and make tax strategy patents unenforceable. In this structure having a partnership at the center and article we give an overview of the process behind regulated investment companies (“RICs”) as partners. patenting a tax strategy and the problems tax strategy The patent involved daily book-ups and book-downs patents create, we discuss pending legislation that under section 704(b), reverse section 704(c) could remedy the tax strategy patent problem, and we allocations, and allocation of profits and loss according raise the ethical issues that tax attorneys may face to capital. See id., at 1371. when confronted with a patented or patentable tax The Federal Circuit treated the patent as a method strategy. for open-ended funds to process data in order to determine share price. The signature patent claimed a II. BACKGROUND computerized method of managing “master feeder” stock funds. See id., at 1371-77. However, the claims A. Some Basics and the Internal Revenue Service (the “Service”) Patents must be issued by the Patent and regulations were very similar. Trademark Office (“PTO”). Patents arise out of The district court held the patent invalid because it federal law under Title 35 of the U.S. Code. Patents was not patentable subject matter: it was merely a last twenty years and provide robust protection for the business method and/or an abstract mathematical invention during that term. Specifically, a patent algorithm. See id., at 1370. provides the right to exclude others from making, The Federal Circuit reversed the district court, using, selling, offering to sell or importing into the stating that the district court “erred by applying the United States, the thing that has been patented. A Freeman-Walter-Abele test to determine whether the patent holder brings a lawsuit in federal court and all claimed subject matter was an unpatentable abstract appeals go to the Court of Federal Claims. idea.” Id., at 1373. The Federal Circuit said that test was no longer applicable after Diehr and In re Alappat, B. Obtaining a Patent 33 F.3d 1526 (Fed. Cir. 1994), because “the mere fact To obtain a patent, an must invent that a claimed invention involves inputting numbers, something that is: calculating numbers, outputting numbers, and storing •Eligible for patent numbers, in and of itself, would not render it non- •Useful statutory subject matter, unless, of course, its operation •New; and does not produce a ‘useful, concrete and tangible •Not obvious. result.’” Id., at 1374 (citing, in part, In re Alappat, 33 Diamond v. Chakrabarty, 447 U.S. 303 (1980). F.3d at 1544). The Federal Circuit held in In re Alappat, that 1. Eligible for Patent algorithms, which at one time were thought non- Traditionally, products eligible for patent were patentable, may be patented if they are practically new and inventive products and processes involving applied, such as by programming them into a computer industrial technology. As noted by the Supreme Court, to provide a useful result. See State Street Bank, 149 eligibility for patent protection is meant to extend to F.3d at 1373. “[a]nything under the sun that is made by man.” Reviewing many of its earlier patent cases, the Diamond v. Chakrabarty, 447 U.S. at 309. There were court said that the business method exception had only a few exceptions which included, laws of nature, never been used by that court to deem an invention natural phenomena, abstract ideas and pure algorithms. unpatentable. Id., at 1375. The court ultimately held See Diamond v. Diehr, 450 U.S. 175, 185 (1981) that business methods may be patented as long as they (Diehr). meet the general requirements for . See id. Historically, business methods were considered Because this case was couched as an applied pure algorithms Today, however, business methods algorithm—a software program for computing are eligible for patents based on the State Street Bank allocation calculations—the tax bar unfortunately did case. See State Street Bank & Trust Co. v. Signature not perceive it as a patent of a tax strategy.

1 Patenting Tax Strategies: Killin’ the Snake Chapter 5 b. The State of the Law After State Street Bank c. The KSR Case: The Supreme Court’s More After State Street Bank, business method patents Flexible Obviousness Test are just as available as other patents: if the invention In KSR International Co. v. Teleflex Inc., 550 U.S. achieves a concrete, tangible, useful result, then it is ___ (2007) (KSR), the Supreme Court adopted a more patentable. flexible standard for judging the obviousness of an invention when the invention is compared to . 2. Useful In its unanimous ruling in KSR, the Supreme The useful requirement has always been easy to Court reversed the Federal Circuit and held that the meet. See Juicy Whip, Inc. v. Orange Bang, Inc., F.3d Federal Circuit applied the TSM test—a test for 1364 (Fed. Cir. 1999). It is important to note that judging whether an invention is obvious based on patent examiners are engineers and are not specially comparisons to prior art—too narrowly and rigidly. trained in tax matters. See id. Thus usefulness does not mean an inquiry into Teleflex sued KSR for infringement of a patent whether the invention is against public policy or that Teleflex had on a certain type of adjustable whether it is permissible under the tax law. Patent automobile gas pedal. In defense, KSR asserted that examiners traditionally cannot consult others outside of the Teleflex patent was “invalid under the , the PTO, not even other federal agencies, in examining 35 U.S.C. § 103, because its subject matter was particular patent applications. obvious.” Id., at *1. The district court applied the This was the Service’s initial concern that tax- TSM test and granted summary judgment to KSR, shelter promoters would patent their shelters and claim stating that there was “little difference” between the that the patent gave such a shelter a seal of government prior art’s teachings and the patented invention. KSR, approval. In the preamble to the proposed Treasury 550 U.S. at *9. Regulations under Code Section 6011 issued just a few The Federal Circuit reversed, saying that the months ago, Treasury raised the issue of making district court did not apply the TSM test strictly patented techniques listed transactions. The Texas Tax enough. See id. Section submitted comments to Treasury supporting In reversing the Federal Circuit’s decision, the this proposal. Supreme Court said that if a technique has been used to However, the usefulness requirement is not the improve one device, and a person of ordinary skill in cause of the greatest concerns surrounding patenting the art would recognize that it would improve similar tax strategies. devices in the same way, using the technique is obvious unless its actual application is beyond his or 3. New and Not Obvious her skill.” Id., at *13. a. Novelty However, the Court also emphasized that when The basic premise behind the novelty requirement determining the obviousness of an invention, a court is that if a person or entity has known about, used, must ask whether the improvement of prior art written about, or otherwise disclosed an idea before an resulting in this invention is more than the predictable individual invents something or applies for a patent, use of elements of prior art according to their those acts may, depending on timing, preclude the established functions. See id., at *12. The Court individual from obtaining a patent. The novelty expanded the definition of an ordinary person such that requirement is supposed to prevent patenting “[a] person of ordinary skill is also a person of techniques that have been known or used for years. ordinary creativity.” Id., at *17. b. Obviousness The Court also described several factors that An invention is obvious if it would have been should be considered when a court evaluates the obvious to a person having ordinary skill in the art at obviousness of an invention created by using elements the time the so-called invention was made. A “person of prior art: “Often, it will be necessary for a court to of ordinary skill in the art” is neither a novice nor an look to interrelated teachings of multiple patents; the expert. An obviousness inquiry may not rely on effects of demands known to the design community or hindsight bias, and the inquiry must consider only the present in the marketplace; and the background state of the art at the time of the invention. knowledge possessed by a person having ordinary skill Recently, the Supreme Court redefined the in the art.” Id., at *14. “teaching, suggestion, or motivation” (“TSM”) test for This more flexible approach to the TSM test may obviousness. make courts more likely and able to find an invention obvious, but it may not help PTO examiners to see when a tax strategy is truly obvious.

2 Patenting Tax Strategies: Killin’ the Snake Chapter 5

4. Difficulty of Judging Novelty and Obviousness • Click on “Advanced Search” and enter: In general, it is likely very difficult for a PTO ccl/705/36T. examiner to judge the novelty and obviousness of a tax strategy, because no examiner is a tax lawyer. However, if a lawyer does a patent search, the Typically, novelty and obviousness are judged by lawyer increases the possibility of treble damages for looking at published and publicly available prior art, knowingly inducing infringement if the lawyer advises particularly in databases. However, examiners only a client later to engage in a tax strategy that is already have an average of 32 hours per application in which to under a valid patent. One suggestion is to add a make this determination. sentence to the standard tax disclaimer legend saying Additionally, examiners frequently do not know that no patent search has been conducted concerning how to do tax research to access prior art. The Service the advice, if any, given. has given PTO examiners training regarding pension, estate and gift, and financial products and the 1. Class 705 and Subclass 36T Numbers American Bar Association (“ABA”) has organized a After the State Street Bank decision, business pilot session for the PTO on how to do tax research, method applications rose from 1,500 in 1998 to around but compared to the average patent examiner’s 7,000-8,000 applications per year in the last few years. expertise in researching prior art in organic chemistry, There are currently 59 issued tax patents in the average patent examiner’s skill in researching tax is Subclass 36T and 80 known pending applications. For severely lacking. example, we know that the PTO has granted patents for Moreover, the pool of prior art for tax strategies is “System and method for automating investment very limited. Patent regulations permit submission of planning,” No. 7,149,713, and “Financial methods prior art to the PTO within two months of an using a charitably integrated business operation,” application’s publication. Consideration is being given Application No. 20070088582. to extend this window to six months. However, the must be disclosed a. System and Method for Automating Investment only if the applicant intends to seek patent protection Planning abroad. This is unnecessary for most tax patents, and This patent is for a computerized scheme that thus most tax patent applications will likely be automates investment planning for a client. The undisclosed. Further, other tax practitioners will be scheme uses client data regarding desired asset reluctant to demonstrate such prior art because of allocation, current asset portfolio, and preferred lawyer-client confidentiality and the confidentiality of domain to generate specific financial transaction tax returns. recommendations. No. 7,149,713. Though fully training patent examiners in conducting tax research would help them to better b. Financial Methods Using a Charitably Integrated judge novelty and obviousness, the limited availability Business Operation of prior art would still be an obstacle to accurately This application is intended to patent the use of judging the invention. charitable trusts to achieve a business goal. More specifically, the patent application describes the III. TAX STRATEGY PATENTS process as: 1) establishing either a charitable remainder trust or a charitable lead trust, to achieve at least part of A. The PTO’s Classification of Tax Reduction a business objective; 2) transferring one or more assets Techniques to the trust; 3) disposing of at least one asset within the The PTO already has a specific subclass of trust in furtherance of the business objective; and 4) business method patents for tax reduction techniques. passing benefits resulting from disposition of the asset The PTO classifies patents and patent applications into from the trust while shielding the business from a tax classes and subclasses based on the technology field. liability due to the disposing step, if the tax liability is Generally, the PTO classifies all business method owing. Application No. 20070088582. patents under Class 705, and it classifies patents concerning tax strategies in Subclass 36T. Another However, as we mentioned above, since many tax sub-category is 31. These are the numbers by which strategies do not need foreign protection because they one would search on the PTO website. are correlated to specific United States tax laws, the applications relating these strategies need not be • To search the PTO website: disclosed. Thus, we do not know what types of tax • Go to: strategy patent applications may be pending. http://www.uspto.gov/patft/index.html.

3 Patenting Tax Strategies: Killin’ the Snake Chapter 5

2. Three General Classes of Known Subclass 36T 2. Ramifications of the SOGRAT Patent Litigation Tax Strategy Patents Certainly, some might argue that this patent The patents of which we know break down into should have been invalidated in the litigation because three general categories. First, many of the patents funding a GRAT with an appreciating asset is arguably concern algorithms for compliance and reporting—tax a basic planning technique. Indeed, there exists the software and the like—which do not raise particular statutory “first inventor” defense. 35 U.S.C. § 273. concerns regarding tax policy or tax administration. This defense provides an infringement defense to any Second, a few patents may constitute abusive tax tax practitioner who “acting in good faith, actually shelters, but, not surprisingly, few people have actually reduced the subject matter to practice at least 1 year risked publicizing these tax shelters by patenting them. before the effective filing date of such patent, and Finally, a substantial number of patents have been commercially used the subject matter before the issued for methods consistent with the Code. effective filing date of such patent.” 35 U.S.C. § 273(b)(1). B. Concerns Regarding Patented Methods However, the “first inventor” defense provides no Consistent with the Code protection from the costs of litigating a patent The main concern with patented tax strategies that infringement case. In 2005, the America Intellectual are consistent with the Code is that these patents may Property Law Association reported that the average allow for the private capture of public law. There is a case typically costs $650,000 for risk that a patent holder could claim ownership of each party when the amount at risk is less than certain routine planning tools, or a method which $1,000,000 and $2,000,000 for each party when the constitutes the most efficient manner of complying amount at risk is between $1,000,000 and $25,000,000. with the Code. That is tantamount to granting a patent holder an ownership right over the relevant provisions C. Areas of Concern of the tax law and allowing the holder to collect Based on the information we can find about the economic rent from other taxpayers whose transactions types of tax strategy patent applications that might be or activities fall within that area. The best example of pending, we have identified several possible areas of this disturbing trend is the so-called SOGRAT patent. concern. Because the Service is offering PTO examiners 1. The SOGRAT Case training in estate and gift tax, several of those types of On January 6, 2006, the Wealth Transfer Group patent applications must be in the pipeline. Also, it is LLC sued , Inc.’s executive chairman, John W. no coincidence that the first filed complaint in this area Rowe, alleging infringement of U.S. Patent No. involves estate and gift tax planning. 6,567,790 (the “’790 patent”). See Wealth Transfer Another concern is the patent on tenant-in- Group LLC v. Rowe, No. 3:06-cv-00024 (D. Conn. common (“TIC”) replacement property in a section Filed 1/06/06). The ‘790 patent claims a method of 1031 transaction where the TIC property is under a “establishing and managing grantor retained annuity master lease. Questions have been raised regarding trusts funded by nonqualified stock options” hence the whether this patent is compliant with Rev. Proc. 2002- moniker, SOGRAT. The patent was secured by an 22, 2002-1 C.B. 733, Doc 2002-6847, 2002 TNT 54- insurance broker—not a lawyer. Wealth Transfer 12. That kind of consideration is irrelevant, though, found Dr. Rowe because they were monitoring the because, as noted above, the PTO and the Service quarterly filings by public companies, looking for a operate in mutual administrative vacuums so that one footnote indicating that an executive had transferred agency’s rulings do not affect the other. Public policy nonqualified stock options to a GRAT. This appears to concerns are not the PTO’s concern in granting a be the first and only case involving a tax patent. patent. The case was in the discovery phase which was There is also a patent on the use of blocker scheduled not to close until June of this year, but it corporations to prevent tax-exempt investors in private recently settled. The settlement was confidential, equity funds from incurring unrelated business taxable however, we know that the patent “is presumed to be income (“UBTI”) with respect to their investments in valid,” that the parties stipulated that “there are facts such funds. This, too, is a well-known and popular from which a trier of fact could conclude that the ‘790 structuring device. Further, there are questions on patent is not valid and is not enforceable,” and that the whether such blocker corporations have any non-tax- defendant, Dr. Rowe, entered into a confidential patent motivated purpose and would be respected for tax license. See id. Neither side admitted any liability. purposes. That, though, is again irrelevant for purposes of granting a patent.

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IV. PROPOSED LEGISLATION the patent. This statute, therefore, does not make medical processes ineligible subject matter for a patent, A. Bar Efforts but it does prevent the patent holder from enforcing the First, the tax bar approached the ABA. However, patent against those parties most likely to infringe it. the ABA cannot support an initiative if one substantive There are, however, several carve-outs for patented group is opposed to it—that would be the ABA patent medicines and medical devices. bar. So the ABA has remained neutral on this issue. Second, Treasury visited with the PTO. At the C. The Texas Tax Section Proposal ABA meeting several months ago, Treasury Tax The Texas Tax Section proposal has adopted a Legislative Counsel, Michael Desmond relayed that his variation of the medical option. The language, talks with PTO counterparts have been nonproductive, however, can be expanded to embrace the nuclear and the PTO has been unreceptive to any fixes in this option – thereby rendering all covered tax matters area. “Their reaction was basically: ‘get over it. This unpatentable. is another business method and we’re going ahead with it,’” Desmond told practitioners. 1. Substance of the Texas Tax Section Proposal Finally, the Texas Tax Section came up with its The amendment eliminates the ability to obtain own proposal. First, due to retroactivity concerns, the injunctive relief or money damages with regard to legislative fix will not apply to any patents issued patent infringement involving either a taxpayer’s or a based on an application filed prior to the date that the tax practitioner’s (including that tax practitioner’s legislation was introduced. So the patents granted and “related professional organization’s”) utilization of a in the pipeline are here to stay—no statutory fix for “tax planning method.” SOGRATs. Fortunately, many attorneys came to “Tax Planning Method” means a “plan, strategy, recognize that tax attorneys are merely the “canaries in technique or structure that is designed to or has, when the coal mine” and that other attorneys will be affected implemented, the effect of reducing, minimizing or soon by these developments. Indeed, there is already a deferring a taxpayer’s tax liability, but shall not include patent for “a computer-based system for determining the use of tax preparation software or other mechanical whether certain items of evidence prove a conclusion” tools used solely to perform or model mathematical to model or select a jury. calculations or prepare tax of information returns.” The “tax preparation software” exception is a very B. Two Methods for Limiting the Scope of the important carve-out for entities such as TurboTax. Patent Laws by Legislation Also note that “tax” covers not just federal but also There are two methods for limiting the scope of State, county, city, municipality or other governmental the patent laws by legislation. First, there is the tax levy. The American Institute of Certified Public nuclear option (literally). Congress has the power to Accountants (“AICPA”) also as a lobbying push and is declare particular types of technologies unpatentable. looking to adopt what it calls the “Texas Solution.” It has done this in one area—not surprisingly, for nuclear devices. Under 42 U.S.C. § 2181(a), D. Legislative Progress inventions useful solely in connection with special The Texas Bar is the first bar in the country to nuclear material or atomic weapons are exempted from formally endorse a legislative fix for the patenting of patent protection. tax strategies, and the Colorado Tax Section recently Second, there is the medical option. A few years approved a resolution in support. The President of the ago, doctors and surgeons began patenting medical Texas Tax Section, Kevin Thomason, has been leading procedures. Not surprisingly, infringement litigation the charge. followed. In Pallin v. Singer, 36 U.S.P.Q.2d 1050 (D. Vt. 1995), Dr. Singer was sued for infringing a E. Congressional Bills patented surgical technique, a stitch-free incision, Currently, the Senate and the House of developed for use during cataract surgery. The Representatives are each considering bills that would American Medical Association (“AMA”) criticized the limit tax strategy patents. Senate bill S.681 would granting of the patent because it patented a common essentially ban patents on tax strategies. House bill procedure “used by an estimated 40% of H.R. 2365 essentially adopts the language proposed by ophthalmologists.” the Texas Tax Section. House bill H.R. 1908 parallels The result was the creation of the Physicians S.681 in part and would make tax planning methods Immunity Statute, under which patent holders are “unpatentable.” deprived of all remedies, both monetary and injunctive, against licensed medical practitioners or related health care facilities with respect to the performance of a “medical activity” that constitutes an infringement of 5 Patenting Tax Strategies: Killin’ the Snake Chapter 5

1. Senate Bill S.681 Second, there are concerns regarding the World Senators Carl Levin, Barak Obama and Norm Trade Organization Agreement on Trade-Related Coleman have introduced Senate bill S.681 which Aspects of Intellectual Property Rights (“TRIPS”). would curtail patents on certain inventions, where “the The United States could violate some of its treaties if invention is with respect to a tax planning method, the the United States made unenforceable patents that predominant purpose of which is to minimize, avoid, would be respected by foreign countries. manipulate, or defer an individual taxpayer’s tax Finally, someone has to address whether and how liability; provided, however, that this limitation does to give immunity to tax practitioners and their firms not include tax preparation software or other tools used with respect to practitioners giving advice regarding solely to perform or model mathematical calculations the enforceability of tax patents. or prepare tax or information returns.” Note, however, that S.681 would have no effect on tax strategy patents V. ETHICAL ISSUES already granted. Tax attorneys may have more to worry about than 2. House Bill H.R. 2365 whether or not they will get immunity for giving H.R. 2365, introduced by Rick Boucher, Steve imperfect advice regarding the enforceability of tax Chabot, and Bob Goodlatte and supported by AICPA, patents; they have to worry about the ethical issues would amend the limitations on damages provision of surrounding tax strategy patents. This outline details the Patent Act to essentially ban infringement actions many of the ethical issues raised by the ABA in its against tax payers, tax practitioners and related May 2007 Section of Taxation meeting. Further, professional organizations for use of a patented tax although these issues have no answers given the recent planning method (i.e., the nuclear option). While developments in this area, it is important to present the S.681 would have no effect on tax strategy patents myriad of ethical questions in order to encourage tax already granted, H.R. 2365 would essentially make the lawyers to think about the ethical issues they may face patents unenforceable. in the course of their practices. “Tax Planning Method,” according to the bill, “means a plan, strategy, technique, or structure that is A. Conflicts of Interest designed to reduce, minimize, or defer, or has, when Regarding conflicts of interest, under what implemented, the effect of reducing, minimizing or circumstances can a lawyer advise the client to use a deferring, a taxpayer’s tax liability, but does not patented tax planning strategy where the lawyer is the include the use of tax preparation software or other patent holder or owns an interest in the patent? tools used solely to perform or model mathematical First, the lawyer may want the client to use the calculations or prepare tax or information returns.” lawyer’s patented tax strategy to validate the patent, even if the lawyer is unsure of whether the desired tax 3. House Bill H.R. 1908 consequences will result. In this situation, the lawyer The House adopted H.R. 1908, introduced by would not be weighing all possible tax strategy options Rick Boucher, on July 18, 2007. The section of the bill and choosing the best one for his client; he would be that amends Section 101 of the Patent Act would make putting his own interests ahead of his client’s. tax planning methods “unpatentable.” The bill defines The lawyer might be further discouraged from a “tax planning method” almost exactly as H.R. 2365 considering other tax strategies for his client because does, the only change is that H.R. 2365 substitutes of the license fees the lawyer could charge if the client “scheme” for the word “structure.” The bill also states used his patent. The lawyer might be more interested that it cannot be construed as validating patents issued in his financial gain than in his client’s needs; the before the date of the bill’s enactment. Though this lawyer would again be putting his interests ahead of bill will stop future patenting of tax planning methods, the client’s. it will have no effect on existing tax strategy patents. Even if the lawyer truly believes that his patented tax strategy is the best option for his client, the lawyer F. Remaining Legislative Issues could be violating the Model Rules of Professional Nevertheless, both bills leave open several Conduct (“MRPC”) if he does not disclose his interest important legislative issues that should be discussed. in the patent to his client and obtain the client’s First, there is the issue of how to word the software informed consent to “waive” the conflict. exclusion. If worded carelessly, the software exclusion could allow a patent applicant to change almost any tax B. Confidential Client Information patent into a by saying that the strategy Will a lawyer be protecting the confidentiality of is implemented through a software format. client information if the lawyer uses client information to apply for a patent at the PTO?

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Because MRPC 1.6 does not provide an exception attorney has charged the client for work that will for information provided to the PTO, it is unlikely that ultimately require the client to pay an additional a lawyer will be able to disclose confidential client license fee if the client wishes to continue to reap the information to obtain a patent without getting written benefits of the work. Is this an ethical violation? client consent. If a lawyer requests the client’s Suppose that an attorney already holds a tax informed consent by offering to reduce the client’s fee, strategy patent and wishes to have his client use that MRPC 1.7 may raise ethical issues. In this situation, tax strategy. Does MRPC 1.5 impose any limit on how the lawyer wants to disclose the information in order to much a lawyer holding a patent on a tax planning obtain the patent, while the client may prefer strategy may charge a client for the use of the patented nondisclosure. strategy? Additionally, what happens if patented tax In other words, are the license fees that the strategies become a new class of “reportable attorney charges the client to use the patented tax transactions” under IRC § 6011, with those who hold strategy considered legal fees subject to MRPC 1.5? patents and license them to others classified as “material advisors”? E. Circular 2.30 Issues This could be an exception to MRPC 1.6. Submission of requested information to Internal Revenue Service under Circular 2.30, § 10.20 raises an C. Inducement Issues issue. Moreover, when does a patent application or Must tax advisors inform their clients of the risk advice with regard to a patent trigger application of of infringement of an existing patent? Circular 2.30? Although MRPC 1.4 does not specifically address Does application for a patent on a tax planning this issue, it does require that a practitioner “explain a strategy constitute practice before the Internal Revenue matter to the extent reasonably necessary to permit the Service under Circular 2.30, § 10.3? client to make informed decisions regarding the If so, what are the consequences if the person representation.” Essentially, when a lawyer knows that obtaining the patent is not admitted to practice before a client’s proposed course of action may result in the Internal Revenue Service? If the patent applicant is adverse legal action, such as an infringement suit, the admitted to practice before the Service, do the covered lawyer may have a duty under MRPC 1.4 to inform opinion and written advice rules of Circular 2.30, §§ and advise the client regarding the possibility of 10.35 and 10.37 apply to the submission of the patent infringement. application? When can lawyers or clients be held liable for Do these rules apply with respect to other written active inducement to infringe another’s patent if the advice provided to users of the patent? lawyers do a patent search for a tax strategy that they’d like to use? F. Advertising Issues In DSU Medical Corp. v. JMS Co. Ltd., 471 F.3d Will publicizing a tax strategy patent constitute 1293 (Fed. Cir. 2006), en banc, the Federal Circuit misleading advertising in violation of ethical rules? held that in order to recover for inducement the patentee must show that the defendant intended to G. Infringement Litigation cause infringement of the patent, in addition to having When handling infringement litigation for a client intended to cause the acts which happened to infringe. that has infringed on the lawyer’s tax strategy patent, This result will likely make inducement harder to how should the lawyer deal with confidentiality of prove. However, this result might also deter persons client information and the conflict of interest between with potential inducement infringement liability from the lawyer and the client? learning about existing patents. Should the lawyer withdraw from representing the client, under MRPC 1.16? D. Attorney Fees Suppose an attorney creates a tax strategy for a H. Patent Ownership Issues client and then wishes to patent the strategy. Can a How should a tax attorney address a situation lawyer charge a client for work that benefits the client where a client seeks a patent on a tax strategy that the and is integrated into a patent application covering the attorney developed for the client? planning technique used for the client? How can an attorney prevent a client from This raises two additional issues: First, if the patenting a tax strategy the attorney has created? client and the attorney both benefit from the work, then Perhaps the attorney can reserve the rights to how should the attorney allocate the cost of that work patent any tax strategies he develops for the client in to reflect the shared benefits? Second, if the attorney the engagement letter. charges a client for work done in creating a tax strategy and then uses that same work to patent the strategy, the 7 Patenting Tax Strategies: Killin’ the Snake Chapter 5

Finally, suppose that a lawyer creates a tax strategy for a client and then seeks to patent the strategy. Who ultimately owns the patent? The lawyer or the lawyer’s firm? If the lawyer joins another firm, can the first firm prevent the lawyer from using the patent for a client’s benefit at the second firm?

VI. CONCLUSION

Though patenting tax strategies poses a significant problem for the future of tax law, legislation seems to be moving toward preventing that problem from becoming unmanageable. With the House’s adoption of H.R. 1908, the privatization of the public tax laws will likely come to a halt, and if H.R. 2365 is eventually enacted, all existing tax strategy patents will become unenforceable, reversing any privatization of the tax law that may have already taken place. However, should legislative progress move in a different direction, the ethical issues discussed above will become more pronounced as the pool of tax strategy patents grows.

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TABLE OF AUTHORITIES

Cases Diamond v. Chakrabarty, 447 U.S. 303 (1980)...... 1 Diamond v. Diehr, 450 U.S. 175, 185 (1981) ...... 1 In re Alappat, 33 F.3d 1526 (Fed. Cir. 1994) ...... 1 Juicy Whip, Inc. v. Orange Bang, Inc., F.3d 1364 (Fed. Cir. 1999) ...... 2 KSR International Co. v. Teleflex Inc., 550 U.S. ___ (2007)...... 2 Pallin v. Singer, 36 U.S.P.Q.2d 1050 (D. Vt. 1995) ...... 5 State Street Bank & Trust Co. v. Signature Financial, Inc., 149 F.3d 1368 (Fed. Cir. 1998) ...... 1, 2, 3 Wealth Transfer Group LLC v. Rowe, No. 3:06-cv-00024 (D. Conn. Filed 1/06/06)...... 4 Statutes 35 U.S.C. § 103...... 2 35 U.S.C. § 273...... 4 42 U.S.C. § 2181(a) ...... 5

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