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Statement of Dennis I. Belcher, Partner, McGuireWoods LLP
Richmond, Virginia
Testimony Before the Subcommittee on Select Revenue Measures
of the House Committee on Ways and Means
July 13, 2006
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| Chairman Camp and distinguished members of the Subcommittee, I am Dennis I. Belcher, a partner in the Richmond, Virginia office of the law firm McGuireWoods LLP. I have been in the private practice of law for more than thirty years and have spent my career representing clients in estate planning. In my law practice, I advise clients on how to minimize federal and state estate, gift and generation-skipping taxes (“transfer taxes”) using estate planning techniques so as to maximize the assets passing to family members and other beneficiaries.
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| I am currently an officer in the American College of Trust and Estate Counsel (“ACTEC”). ACTEC is a non-profit professional association comprised of approximately 2,600 lawyers who are selected on the basis of professional reputation and ability in the field of trusts and estates and having made substantial contributions to those fields through lecturing, writing, teaching, and bar leadership activities. I am the past Chairman of the American Bar Association’s Real Property, Probate and Trust Law Section, which has approximately 30,000 members who are interested in the areas of probate, trust law, and real estate law. I am also a member of a Task Force, called the Patenting Estate Planning Techniques Task Force (the “Task Force”), created by ACTEC in 2005.
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| I am testifying today on my own behalf and on behalf of ACTEC and the Task Force. My testimony represents my own views, the views of ACTEC and the Task Force, but not those of my firm, any of its clients, or the American Bar Association.
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Summary
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| From my experience and discussions with other estate planning professionals, I believe that:
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Patents for tax reduction strategies in the area of transfer taxation are creating problems for many taxpayers;
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If patents for transfer tax reduction strategies are not prohibited, this type of patent will in all likelihood expand and create problems for more taxpayers; and
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Patents for tax reduction strategies should be prohibited either by the U.S. Patent and Trademark Office or by legislation.
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Background
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| Until 2003, few estate planning advisors[1] gave consideration to patents when advising clients about estate planning. That view changed in 2003 when an individual was awarded a patent for an estate planning technique that the patent holder called a “SOGRAT”.[2] (Although the SOGRAT patent was awarded in 2003, anecdotal evidence suggests there are still a significant number of estate planning advisors who are not aware that patents can be awarded for transfer tax reduction techniques.) According to the patent, a SOGRAT involves a grantor retained annuity trust funded with nonqualified stock options. (A grantor retained annuity trust, referred to as a GRAT, is an estate planning technique authorized by Congress, the Treasury Department, and the Internal Revenue Service.[3]) When word of this patent spread through the estate planning community, most estate planning professionals were shocked to learn that an individual could patent a common estate planning technique used in connection with a specific asset, the purpose of which is to allow taxpayers to minimize their federal estate and gift tax liability, particularly a technique authorized under the Regulations issued by the Treasury Department and approved in many Internal Revenue Service rulings.
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| In response to concerns about the impact of using patents to restrict the availability of commonly used estate planning techniques, such as GRATs, experienced estate planning lawyers discussed the ramifications of such patents at a meeting of ACTEC’s Estate and Gift Tax Committee in October 2004. I had the privilege of chairing that meeting. Because of the serious nature of the concerns expressed at this meeting, ACTEC created the Task Force to study this issue[4]. Once the existence of the Task Force became generally known to the estate planning community, other professional organizations joined the Task Force. Organizations with members on the Task Force now include the American Bar Association’s Real Property, Probate and Trust Law Section, the American Bankers Association, and the AICPA.[5] Members of the Task Force agree about the seriousness to taxpayers of the issues presented by the patenting of estate planning techniques. Although the Task Force has not completed its study or issued findings or a formal report as of this date, the Task Force has authorized me to testify on its behalf. Because ACTEC agrees with the Task Force’s concern, on July 8, 2006, ACTEC also authorized me to speak on behalf of ACTEC.
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| The purposes of my testimony are to (1) inform Congress that a patent of one transfer tax reduction technique, the SOGRAT patent, is presenting significant problems to many taxpayers, and (2) recommend that either the U.S. Patent and Trademark Office or Congress prohibit the patenting of tax reduction strategies before the patenting of this type of strategy becomes more widespread and affects more taxpayers.[6]
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The SOGRAT Patent
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| In some instances, Congress, the Internal Revenue Service, and the Treasury Department have authorized tax reduction techniques which taxpayers may take advantage of to reduce their federal tax liability. Examples of government authorized tax reduction techniques in the estate planning area include the federal estate and gift tax marital and charitable deduction, the gift tax annual exclusion, charitable remainder and lead trusts, and GRATs. A GRAT is an irrevocable trust in which the grantor retains an annuity for a fixed term (usually two or more years) and at the end of the term the remaining trust assets pass to beneficiaries selected by the grantor (usually the grantor’s family). The grantor transfers assets to the GRAT that the grantor believes will appreciate significantly over the term of the trust. Under Internal Revenue Code section 2702, the Regulations issued by the Treasury Department under section 2702, and rulings issued by the Internal Revenue Service, the grantor is able to deduct for gift tax purposes the value of the grantor’s retained annuity, thereby reducing the amount of the gift to the grantor’s family.[7] Because of the taxpayer’s ability to transfer appreciation on assets in the GRAT to family members at a reduced gift tax cost, the GRAT is a frequently used estate planning technique.
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| On May 20, 2003, the U.S. Patent and Trademark Office awarded Mr. Robert C. Slane of Wealth Transfer Group, L.L.C. a patent for a GRAT funded with nonqualified stock options, which Mr. Slane calls a SOGRAT (a stock option granter retained annuity trust).[8] The first claim in the SOGRAT patent is:
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| A method for minimizing transfer tax liability of a grantor for the transfer of the value of nonqualified stock options to a family member grantee, the stock options having a stated exercise price and a stated period of exercise, the method performed at least in part within a signal processing device and comprising:
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| Establishing a Grantor Retained Annuity Trust (GRAT);
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| Funding said GRAT with assets comprising stock options,
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| The stock options have a determined value at the time the transfer is made;
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| Setting a term for said GRAT and a schedule and amount of annuity payments to be made from said GRAT; and
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| Performing a valuation of the stock options as each annuity payment is made and determining the number of stock options to include in the annuity payment.
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Problems Created by the SOGRAT Patent
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| The existence of the SOGRAT patent is preventing taxpayers from using a government authorized estate and gift tax reduction technique, thereby presenting problems to taxpayers in planning their affairs. During one of the Task Force discussions, one Task Force member reported that the holder of an estate planning patent recently contacted an estate planning advisor employed by a financial institution and informed the advisor that the patent holder was the owner of the estate planning technique suggested by the advisor in a newsletter to clients. The advisor sought legal guidance on the proper course of action. Notwithstanding that the advisor’s lawyer believed the patent may be invalid, the lawyer recommended that the advisor not risk using the patented technique without permission of the patent holder. The lawyer gave this advice presumably because of the high cost of defending a patent infringement law suit or prosecuting a suit to invalidate the patent. After discussions, the advisor agreed not to suggest the use of the legally authorized estate planning technique in connection with a particular type of asset without informing clients and their lawyers of the existence of the patent so that the client and lawyer would be responsible to make their own judgments about the validity of the patent and the degree to which it needed to be honored.
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| There is a lawsuit pending against a taxpayer alleging the infringement of the SOGRAT patent. On January 6, 2006, the SOGRAT patent holder filed suit in the Connecticut United States Federal District Court for infringement of the SOGRAT patent. The defendant in the lawsuit is Dr. John W. Rowe, the Executive Chairman of Aetna, Inc. The lawsuit is in the discovery stage and is anticipated to go to trial in 2007. Because I understand that the lawsuit is being prosecuted vigorously, the lawsuit cannot be considered a nuisance lawsuit. When this lawsuit was discussed at ACTEC’s Estate and Gift Tax Committee on July 8, 2006, the vast majority of lawyers present (more than 100 experienced estate planning lawyers) indicated that they would not recommend to any client the use of a GRAT funded with nonqualified stock options without disclosing the existence of the SOGRAT patent and the pending lawsuit. In addition, these lawyers indicated that they would be reluctant to allow a client to use this technique without the permission of the patent holder.
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| Because I am not trained in intellectual property law, I cannot comment on the validity or non-validity of the SOGRAT patent. But, I am qualified to address the taxpayer problems created by patenting estate tax reduction techniques because of my thirty years’ experience in representing taxpayers. Like most experienced practitioners, I am troubled by the SOGRAT patent for several reasons. First, an individual has been allowed to privatize a tax reduction technique authorized by the United States government. Second, because GRATs can be and are used for any type of asset[9] , there is nothing unique about coupling a GRAT with nonqualified stock options. Because nonqualified stock options have desirable features affecting the valuation of the options for transfer tax purposes, the use of nonqualified stock options in a GRAT may be considered rather obvious. In summary, the SOGRAT patent is creating problems with taxpayers because of the chilling effect on the use of this authorized technique.
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Patenting of Transfer Tax Reduction Techniques Should Be Prohibited
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| Because patents of transfer tax reduction techniques present problems to many taxpayers, the U.S. Patent and Trademark Office or Congress should prohibit these types of patents for the following reasons:
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It should be against public policy for a private individual to patent a technique used to reduce a taxpayer’s tax burden;
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Patenting estate planning techniques unfairly increases a taxpayer’s costs or the federal estate and gift taxes payable by the taxpayer if patented techniques are not used; and
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Because a patent on a tax planning technique can add credibility to the technique, patents on objectionable or aggressive tax planning techniques can hurt compliance with the federal tax laws.
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| It is not the function of the Internal Revenue Service or the Treasury Department to curtail patents of tax planning techniques. Because of the nature of transfer tax reduction techniques, it may not be possible for the U.S. Patent and Trademark Office to make an adequate review of these techniques. Accordingly, a legislative solution may be the appropriate response to protect taxpayers and to curtail the patenting of all tax planning techniques before these patents become more widespread.
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It should be against public policy for a private individual to patent a technique used to reduce a taxpayer’s tax burden.
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| A patent of a tax reduction technique is unlike other business method patents because it relates to taxes. If there is a business method patent in a particular area of business, a citizen has the choice to either pay for the right to use the technique, to engage in that business activity in a different way, or not to engage in that business activity at all. A taxpayer who complies with the tax laws does not have that choice – the taxpayer must pay his or her tax burden. In the familiar of words of Judge Learned Hand, however, “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”[10] It should be against public policy to allow a patent of a tax reduction technique because the patent prevents taxpayers from exercising their right to minimize their taxes within the limits of the law, and avoiding the activity in question, the payment of taxes, is not an option.
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