Sorry, that Tax Plan Is Patented

Got a great tax-saving strategy? Watch out. You could get sued

Widgets, soft-drink formulas, new drugs: They can all be protected by patents. But did you ever think the clever tax-saving strategy your financial adviser is offering up could be patented as well? Don't dismiss the notion. Unauthorized use of a patented method might get you into hot water.

John Rowe, executive chairman of health insurer Aetna, knows that all too well. Within the past three years, at the suggestion of his advisers, Rowe set up two trusts and funded them with nonqualified stock options. An independent options valuation expert estimated their value for BusinessWeek at $28.5 million. Rowe's so-called grantor retained annuity trusts (GRATs) would pay him an annual income for a specific time and reserve whatever is left for family members. Plus, he could achieve dramatic gift-tax savings, says Carlyn McCaffrey, a lawyer with Weil, Gotshal & Manges in New York who is an expert on GRATs, though not involved in the case.

But in January, Rowe was sued in U.S. District Court in New Haven for patent infringement by Wealth Transfer Group, an Altamonte Springs (Fla.) firm that obtained a patent on this strategy in 2003. Apparently, the plaintiff learned of Rowe's GRATs when, as a corporate insider, he reported the transfer of the options.


  The lawsuit, for an unspecified sum, seeks royalties, triple damages, and attorneys' fees. Rowe's attorneys wouldn't say who advised him to set up the GRATs, but said a law firm and a financial planner were involved. Neither has been named in the suit, which experts say is the first of its kind and is scheduled for trial next year. Rowe, 61, who plans to retire on Oct. 1, declined to comment on the case.

Tax strategies fall within a special subset of patents known as the business method type. Such patents are designed to protect a unique process or series of steps for executing a service or business strategy. The case establishing that financially oriented business methods are patentable was a 1998 decision by the U.S. Court of Appeals for the Federal Circuit. It involved the "hub and spoke" system Signature Financial Group developed in its business of pooling mutual fund assets in an investment portfolio organized as a partnership.

Lawyers are trying to get the law changed so that it will no longer be possible to patent tax strategies. Right now, there are only 41 such patents, according to the U.S. Patent & Trademark Office, but 61 applications are pending. The strategy of using stock options to fund a GRAT is actually not uncommon, says Dennis I. Belcher, a trusts and estates lawyer with McGuireWoods in Richmond, Va. He says lawyers who knew about the patent on the stock option GRAT "did not take it seriously" because this is such a widely used technique. An issue in the Rowe case, court papers suggest, will be whether the GRATs funded an annuity for Rowe by using a special technique covered by the patent.

There are a number of things you can do to protect yourself from liability over creative tax-saving methods. Closely question advisers to determine whether a strategy is mainstream. Ask how many times they've used it before, who else is recommending it, and whether there are any laws or court decisions approving the approach.

Then you should request written assurance that no one else has a patent on it, says Robert O. Lindefjeld, a patent lawyer with Jones Day in Pittsburgh. Lindefjeld also favors securing an indemnity agreement. The best kind requires the advisers to defend the case on your behalf if you're sued for patent infringement.

    Before it's here, it's on the Bloomberg Terminal.