William A. Drennan, The Patented Loophole: How Should Congress Respond to this Judicial Invention?

59 Fla. L. Rev. 229 (2007) | | | |

INTRODUCTION :: An IRS spokesperson “questioned whether the [Patent Office] staff has adequate background in tax law . . . to properly rule on those patent applications [for tax strategies].”

In response, a Patent Office spokesperson said, “The [Patent Office] has a long tradition of evaluating the unfamiliar . . . . ‘We’ve been dealing with emerging technologies for 200-plus years.’”

Welcome to the Age of the Patented Loophole! The Patent Office is issuing patents on tax loopholes. Although the IRS remains ultimately responsible for the administration of the federal tax laws, the Patent Office now will decide whether tax-saving strategies work. Patent examiners are attending special workshops to learn tax law. A taxpayer may be sued for patent infringement, even if the taxpayer was completely unaware of the patent. Before giving tax advice, tax practitioners need to research the Patent Office records. Law firms and CPA firms may require that their tax practitioners assign all rights to tax strategies they develop to the firm. Since a patent is basically a seventeen-year monopoly over the market for the invention, the availability of patent protection provides a tremendous economic incentive for tax gurus to find and exploit new loopholes.


At the end of the millennium, the Federal Circuit eliminated the key barrier to inventive tax practitioners seeking patent protection, and since this decision the Patent Office has put out a “Welcome” sign. While testifying before the U.S. Senate Finance Committee on “tax-strategy” patents in 2004, the Commissioner of Patents mentioned no negative consequences from patenting tax strategies, and instead asserted that “there shall be no disparate treatment for different categories of inventions.” As a result, it is not surprising that the Patent Office has issued patents for many tax inventions.

The Federal Circuit has stated that neither the courts nor the Patent Office should deny patent protection because an invention violates public policy; instead, only Congress can prohibit patent protection for a class of inventions on public policy grounds. This Article analyzes the current status of tax-strategy patents, the authority of Congress to prohibit or restrict tax-strategy patents, and the way in which Congress should respond.

First, this Article will discuss when tax loopholes qualify for patent protection under existing law. Although the Patent Office is issuing tax-strategy patents, the courts have not squarely addressed all the potential problems involved in patenting tax loopholes. For example, certain patentability requirements-e.g., novelty and nonobviousness-will be difficult to apply to tax-strategy inventions. One issued patent has already triggered controversy in the tax-planning world.

Second, this Article argues that Congress has the authority to prohibit or restrict tax-strategy patents notwithstanding the TRIPS Agreement, an international intellectual property treaty.

Third, this Article considers whether Congress should prohibit patents on tax strategies. As justification for tax-strategy patents, the Patent Commissioner referred to the traditional utilitarian rationales for issuing patents, namely 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.

Also, by granting tax patents, the Patent Office is frustrating the efforts of the Treasury Department, which has adopted regulations to reduce the economic rewards for inventing tax loopholes.

Additionally, the 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. Thus, the “mad-scientist” tax inventor will profit when other taxpayers merely follow the patented procedures that comply with federal tax rules and pay the same amount of tax as similarly situated taxpayers. 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.

Other social costs will result from the Patent Office issuing “bad” tax patents and tax patent holders behaving like patent “trolls.” Those problems are not unique to tax strategy patents, however, and Congress may reform the patent system generally to reduce those costs.

Fourth, this Article will consider the counterargument: Congress should not take any action regarding tax strategy patents. In other contexts, courts and commentators stress the importance of maintaining a unitary patent system that does not discriminate against classes of inventions. It has been suggested that the patent statutes could become as complex and confusing as the Internal Revenue Code if different patent rules apply to each industry. Also, if Congress, the Treasury Department, or the IRS dislike a particular patented loophole, they can simply amend the law, close the loophole, and render the patent worthless.

Fifth, this Article weighs the normative arguments and suggests a nuanced approach. Patent protection is appropriate only when an item otherwise will be produced at sub-optimal levels and there is no compelling need for more loopholes. However, this Article does not recommend prohibiting patents on every tax-related invention. Rather, this Article argues that Congress should prohibit the collection of damages based on tax savings available from using a patented invention.

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