Tax-Strategy Patents and the Tax Gap

By Jeffrey R. Hoops, CPA

Two tax policy topics have recently been getting increased attention: tax-strategy patents and the tax gap. The AICPA has been taking an active role in the debate on each topic. This column summarizes the issues and the AICPA’s involvement.

Tax-Strategy Patents

The patentability of tax strategies is a growing concern among tax practitioners and taxpayers. The AICPA believes that such patents undermine the integrity, fairness and administration of the tax system and are contrary to sound public policy.

Under the law, patents may be granted for innovations that are useful, novel and nonobvious; see 35 USC Sections 101–103 and 112. Under 35 USC Section 271, a patent gives the holder the exclusive right to make, use and sell the patented invention. The consequences of infringing a patent can be substantial. Issued patents are presumed valid; an accuser must overcome this presumption with clear and convincing evidence to invalidate a patent; see 35 USC Section 282. Even if an accused infringer is not found liable, defending a lawsuit can be costly. The total cost to litigate a patent infringement suit with $1 million–$25 million at risk ranges from $1.25–$3.5 million (from $3.1–$9.4 million when more than $25 million is at risk); see American Intellectual Property Law Association, Law Practice Management Committee, “Report of the Economic Survey 2005,” pp. 23 and I-109–110, available at
Publications_Available_for_Viewing/Publications_Available_for_Viewing.htm. These costs cover a “typical case with no unusual complications” involving only one patent; see id. at pp. 2–3.

Number issued:  In 1998, the Federal Circuit, in State Street Bank & Trust v. Signature Financial Group, Inc., 149 F3d 1368, held that business methods could be patented. (Business methods include business practices in many fields, including healthcare management, insurance and insurance processing, reservation and booking systems, financial market analyses, point-of-sale systems, tax processing and inventory and accounting and financial management.) The U.S. Patent and Trademark Office now classifies tax-strategy patents as subclass 36T in Class 705, “Data Processing: Financial, Business Practice, Management, or Cost/Price Determination”; see As of Jan. 3, 2007, its website lists 51 patents issued in that subclass, and 83 such applications are pending (published applications are those not yet examined/granted); see
1&f=S&l=50&Query=ccl/705/36T&d=PTXT and

Tax-strategy patents have already been granted in a variety of areas, including the use of financial products, charitable giving, estate and gift taxes, pension plans, tax-deferred exchanges and deferred compensation. Many more such patents will likely be issued, directly targeting average taxpayers in a host of areas, including income tax, alternative minimum tax and itemized-deduction maximization.

Concern: A primary catalyst for the AICPA’s concern, and the concern of other tax advisers, was an infringement suit over “the SOGRAT patent.” On Jan. 6, 2006, Wealth Transfer Group L.L.C. filed a complaint in a Federal district court in Connecticut against John W. Rowe, alleging that he infringed its SOGRAT patent for establishing and managing grantor retained annuity trusts (GRATs) funded with nonqualified stock options (see Wealth Transfer Group L.L.C. v. John W. Rowe, Dkt. No. 3:06-cv-00024-AWT). Wealth Transfer Group L.L.C. sought an injunction and damages. On Feb. 6, 2007, the parties filed a joint motion to stay the case, stating that they have agreed in principle to resolve the matter and are negotiating a formal settlement agreement. Tax professionals were surprised that a patent could be granted for a variation of such a common transfer-tax-planning technique.

Congressional tax writers have also become concerned with patenting tax strategies. On July 13, 2006, the Subcommittee on Select Revenue Measures of the House Ways and Means Committee (subcommittee) held a hearing on the topic. The AICPA voiced its concerns about tax-strategy patents to Congressional staff prior to the hearing. It also generally concurred with the statements and reasoning against tax-strategy patents of IRS Commissioner Mark Everson, Ellen Aprill and Dennis Belcher, who testified at the July 13, 2006 subcommittee hearing, and with the New York State Bar Association Tax Section’s Aug. 17, 2006 letter to the leadership of the tax-writing committees and subcommittee (available at  and

Position: Recently, the AICPA’s Tax Patent Task Force, chaired by Justin Ransome, issued a paper opposing tax-strategy patents (available at
Tax+Patents/AICPA+Urges+Congress+to+Address+Tax+Strategy+Patents.htm), stating that they:

  • Limit taxpayers’ ability to use fully tax law interpretations intended by Congress;
  • May cause some taxpayers to pay more tax than Congress intended, or more than others similarly situated;
  • Complicate the provision of tax advice by professionals;
  • Hinder compliance;
  • Mislead taxpayers into believing that a patented strategy is valid under the tax law; and
  • Preclude tax professionals from challenging the validity of tax-strategy patents.

The paper concludes that administrative solutions are not sufficient to solve these problems, and encourages Congress’s tax-writing and judiciary committees to develop legislation to eliminate the harmful consequences of such patents, by either (1) restricting their issuance or (2) providing immunity from patent-infringement liability for taxpayers and tax practitioners. The AICPA sent its paper to the chairs of these committees, along with an offer to work with Congress on this issue.

The Tax Gap

The tax gap has been generally viewed as the difference between the amount taxpayers should legitimately pay under the tax law and the amount the IRS ultimately collects. While estimates of the gap vary, it is generally thought to be around $300 billion. The causes of the tax gap are debatable and include ignorance of the law, income underreporting by individuals and small businesses and use of aggressive tax shelters. What is not debatable is that the tax gap is too large and unfair to the majority of taxpayers who are responsible in paying their tax.

Participation: Recently, the AICPA participated in two government forums on this issue. The first was an IRS Oversight Board public meeting on the role of stakeholders in reducing the tax gap. The second was a joint Treasury-IRS roundtable discussion. These forums focused on several possible solutions, including:

  • Reducing opportunities for evasion;
  • Funding additional research;
  • Improving computer technology;
  • Improving compliance and enforcement;
  • Increasing taxpayer services;
  • Simplifying the tax law; and
  • Coordinating with partners and stakeholders.

Comments: The AICPA’s submitted comments to both of these forums are available at
Administration/AICPA+Offers+Congress+Comments+on+the+Tax+Gap.htm. The comments reiterated its position that Congress should fully fund the Service’s budget request. This would give the IRS the opportunity to obtain the personnel and technology it needs to focus on the problem areas. The AICPA also committed to surveying its Tax Section members to get their views on practical ways to close the tax gap.

Conference: The AICPA is cosponsoring a national conference on the tax gap in June 2007 in Washington, DC, with the American Bar Association, the Tax Executives Institute, the American Tax Policy Institute and the American College of Tax Counsel. The conference will be held over two days and will involve the presentation of papers, commentary and debate by leading practitioners and academics; a full report of the proceedings will be published.

Get Involved!

As a senior technical committee of the AICPA, the Tax Executive Committee (TEC) is authorized to speak for the AICPA on tax matters, and is also designated by governing Council as a standard-setting body. However, numerous other committees, technical resource panels (TRPs) and task forces initiate and develop proposed solutions to policy issues and technical and tax administration problems, for consideration and approval by the TEC. They also initiate proposals for valuable products and services for members in tax practice, and administer the AICPA’s tax ethics program (Statements on Standards for Tax Services).

Through its various task forces, TRPs and committees, the TEC continues to monitor numerous projects. The Tax Division is committed to providing the best service possible to AICPA members. Leadership and membership appointments for committees and TRPs for the current committee year, which started October 2006, have been completed. However, members who would like to volunteer to assist in Tax Division activities should contact Ed Karl at (202) 434-9228 or Members having suggestions for new services or products should contact Bill Stromsem at (202) 434-9227 or

Mr. Hoops chairs the AICPA Tax Division’s Tax Executive Committee. DC Currents heightens awareness of the Tax Division’s activities and apprises readers of tax policy, technical issues and other practice support matters.

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