WASHINGTON Texas lawyer Stanley Blend was stunned when someone mentioned tax patenting, the practice of declaring a tax strategy as a new invention and collecting royalties on it, at an American Bar Association meeting two years ago.
"This can't be," Blend, who's specialized in tax law for 40 years and heads the association's 19,000-member tax section, said he thought to himself. "It just didn't seem like tax strategies are things that can be patentable."
Critics of the practice say more tax-filers may be caught unaware. Since there are standard steps they follow to file their taxes, they risk unwittingly using a patent and having to pay royalties later.
Or, as Blend put it: "Tax lawyers will have to become patent lawyers."
Tax patent supporters say those who come up with original finance ideas should be able to protect their intellectual property, like those who create a unique piece of scientific equipment or a copyrighted song.
Some lawmakers, though, worry patents may render tax breaks useless. If you have to pay someone for a patent related to a tax break, then you lose the incentive to take advantage of that break, they say. And they fear the patents mean money that should go to the government goes to private citizens instead.
"Our government should not be in the business of patenting new and inventive ways to bilk the Treasury at the expense of law-abiding taxpayers," said Congressman Lloyd Doggett, a Texas Democrat who has drafted legislation against tax havens.
The federal government's reaction has so far been mixed, even as it debates patenting in general. The House of Representatives banned claiming strategies as property in a panoptic patent bill it passed in September. But the Senate has not mentioned it in the version of the bill it is expected to debate soon.
Meanwhile, the Internal Revenue Service has proposed requiring tax filers and others to tell the agency the patented methods they've followed. This would enable IRS agents to "heighten their examination of the technique," said John Swindseid, a bond lawyer.
"People fear the IRS is going to look at it hard," he told Reuters, adding that for municipal debt issuers, using a patented tax strategy might flag a bond issue for audit.
That would cause filers to avoid the strategies, which in turn would make applying for a patent not worthwhile, he said.
The comment period for the proposed regulation ends December 26.
TREND STARTED A DECADE AGO
The idea of owning ways for Americans to avoid paying federal taxes has been around since 1998, when an appellate court decided business methods could be patented.
The U.S. Patent Office has granted around 60 patents on tax strategies over the last nine years, with another 101 applications pending. Some believe even more tax strategies are tacked onto broader patent applications.
This is a small portion of all the patents issued -- 184,377 just last year, according to a spokeswoman for the patent office. But Mark Peterson of the American Institute of Certified Public Accountants said his group has seen the number of tax patent applications tick up each year.
More than a third of current patent applications address municipal bonds, which pay interest that is exempt from federal and some state and local income taxes, including one on financing for transportation buildings and another on multifamily housing debt sales. About 20 existing patents relate to municipal bonds.
Private individuals and financial firms such as Morgan Stanley own tax patents, as does the government-sponsored mortgage giant Fannie Mae FOLIOfn, the brokerage started by former Securities and Exchange Commissioner Steven Wallman, holds four, more than anyone.
Peterson is concerned that people may have to pay a patent holder while simply following the law, for example, when turning their tax-free company-sponsored 401ks into an untaxed Individual Retirement Account. The U.S. Constitution, after all, requires people to pay taxes, and if a filing method is patented, citizens will have to choose between paying royalties or breaking the law.
"It's a process you're required to comply with," Peterson said.
Because tax filings are anonymous, patent-holders may not know who used their methods. But they can guess. For example, Peterson noted, an owner of a retirement strategy sent legal warnings to those attending a retirement conference.
For municipal bonds, it's easy for patent holders to catch those using a strategy without paying royalties because, by law, public projects must openly disclose their financial structures, Swindseid said.
(Reporting by Lisa Lambert, Editing by Chizu Nomiyama)