United States: Retroactivity Revisited: Has Anything Changed?

Last Updated: April 22 2015

Article by Erica L. Horn, Madonna E. Schueler and Gregory A. Nowak*

The U.S. Supreme Court's decision in United States v. Carlton turned 20 last year, but the core issue within the case remains embattled. In this article, authors Erica Horn, Madonna Schueler and Gregory Nowak discuss the Carlton decision and several 2014 cases on which it had an impact.

Introduction

Last year marked the twentieth anniversary of the U.S. Supreme Court's decision in United States v. Carlton,1 but the battle continues over the constitutionality of retroactive tax legislation. Taxpayers continue to fight state efforts to amend tax legislation retroactively based on the Due Process Clause of the Fourteenth Amendment, which provides that no state shall deprive any person of ''life, liberty, or property without due process of law.''2 States have fought back with equal zeal, and the results have been anything but uniform. This article revisits the Court's decision in Carlton and then discusses 2014 state cases applying the Court's decision.

Carlton Sets the Stage for Evaluating Retroactive Tax Legislation

Rendered in 1994, United States v. Carlton remains the seminal case on retroactive tax legislation. Carlton involved an amendment to the federal estate tax statute that limited the availability of a recently enacted deduction for proceeds of sales of stock to employee stock ownership plans (''ESOPs''). The Court held that retroactive application of the amendment satisfied the requirements of due process in what has been described as the ''death knell'' for due process challenges to retroactive legislation.3

As part of the Tax Reform Act of 1986, Congress enacted a new estate tax provision applicable to any estate filing a return after Oct. 22, 1986.4 Codified at 26 U.S.C. §2057, the new provision granted a deduction for half of the proceeds of ''any sale of employer securities by the executor of an estate'' to ''an employee stock ownership plan.''5 Under §2057, the sale of securities had to be made prior to the date on which the estate tax return was required to be filed.6

The respondent, Jerry Carlton, was the executor of an estate who sought to utilize the §2057 deduction. Nineteen days prior to the due date of the estate tax return, Carlton used estate funds to purchase shares of a corporation. Two days later, Carlton sold the shares at a loss to the corporation's ESOP. When Carlton filed the estate tax return on Dec. 19, 1986, he claimed a deduction under §2057 of $5,287,000, which was half of the proceeds from the sale of stock to the ESOP. The deduction reduced the estate tax by $2,501,161.7 Carlton stipulated that he engaged in the stock transactions solely to take advantage of the §2057 deduction.8

Shortly thereafter, on Jan. 5, 1987, the IRS announced that pending the enactment of clarifying legislation, it would treat the §2057 deduction as only available to estates of decedents who owned the relevant securities immediately before death. A bill to this effect was introduced in Congress, and on Dec. 22, 1987, an amendment to §2057 was enacted.9 As amended, §2057 provided that ''to qualify for the estate tax deduction, the securities sold to an ESOP must have been 'directly owned' by the decedent 'immediately before death.' ''10 The §2057 amendment was made effective as of October 1986, the date §2057 originally was enacted.11

The IRS disallowed the §2057 deduction taken by Carlton on the ground that the stock he purchased had not been owned by his decedent ''immediately before death.''12 Carlton paid the contested tax liability, filed a claim for a refund, and then instituted a refund action in the U.S. District Court for the Central District of California. Carlton acknowledged he did not qualify for the §2057 deduction under the 1987 amendment, but argued that retroactive application of the amendment to 1986 transactions violated the Due Process Clause of the Fifth Amendment.13 The District Court granted summary judgment in favor of the U.S., but the Ninth Circuit reversed, holding retroactive application of the amendment was unduly harsh and unconstitutional.14 The Supreme Court granted certiorari.15

The Court began its analysis by noting that ''[t]his Court repeatedly has upheld retroactive tax legislation against a due process challenge.''16 The Court noted that the due process standard to be applied to retroactive tax legislation is the same as that generally applicable to retroactive economic legislation, i.e., retroactive application of the legislation must be justified by a rational legislative purpose.17 The Court found there was little doubt the 1987 amendment to §2057 was adopted as a curative measure. Because the pre-amendment version of §2057 contained no requirement that the decedent have owned the stock in question to qualify for the deduction for ESOP proceeds, any estate could claim the deduction by purchasing stock and immediately reselling it to an ESOP, resulting in a potential dramatic reduction, and perhaps elimination, of estate tax liability.18 Although Congress estimated a revenue loss of approximately $300 million over a five-year period when it originally enacted §2057, because the pre-amendment version of §2057 was not limited to situations where the decedent owned the securities immediately before death, it became evident that the revenue loss from §2057 could be as much as $7 billion.19

In concluding retroactive application of the 1987 amendment satisfied the requirements of due process, the Court made several observations.20 First, the Court noted that ''Congress' purpose in enacting the amendment was neither illegitimate nor arbitrary.''21 The Court noted that Congress acted to correct what it reasonably viewed as a mistake in the original provision that ''would have created a significant and unanticipated revenue loss.''22 Second, the Court stated, ''Congress acted promptly and established only a modest period of retroactivity.''23 The Court noted that the retroactive effect of the amendment extended for a period only slightly greater than one year.24

In response to Carlton's argument that he detrimentally relied on the pre-amendment version of §2057 in structuring his stock transactions in 1986, the Court found that his reliance alone was insufficient to establish a constitutional violation.25 The Court stated, ''Tax legislation is not a promise, and a taxpayer has no vested right in the Internal Revenue Code.''26 Similarly, the Court found Carlton's lack of notice of the amendment was not dispositive.27 The Court also noted that the 1987 amendment could not be characterized as a ''wholly new tax,'' and its period of retroactive effect was limited.28 The Court concluded by stating, ''Because we conclude that retroactive application of the 1987 amendment to §2057 is rationally related to a legitimate legislative purpose, we conclude that the amendment as applied to Carlton's 1986 transactions is consistent with the Due Process Clause.''29

Although she concurred in the majority's opinion, Justice O'Connor wrote separately to express her view that there must be some limits to Congress' ability to enact retroactive legislation. She noted, ''the Court has never intimated that Congress possesses unlimited power to 'readjust rights and burdens . . . and upset otherwise settled expectations.''30 ''The governmental interest in revising the tax laws must at some point give way to the taxpayer's interest in finality and repose.''31 She further stated, ''A period of retroactivity longer than the year preceding the legislative session in which the law was enacted would raise, in my view, serious constitutional questions.''32

In a concurrence by Justice Scalia in which Justice Thomas joined, the Court's opinion was criticized as mistakenly focusing on the period of retroactivity, because the test of substantive due process unconstitutionality in the field of retroactive tax legislation is whether the result is ''harsh and oppressive,'' and ''the critical event is the taxpayer's reliance on the incentive, and the key timing issue is whether the change occurs after the reliance; that it occurs immediately after rather than long after renders it no less harsh.''33 Scalia went on to observe:

The reasoning the Court applies to uphold the statute in this case guarantees that all retroactive tax laws will henceforth be valid. To pass constitutional muster the retroactive aspects of the statute need only be ''rationally related to a legitimate legislative purpose.'' Revenue raising is certainly a legitimate legislative purpose, see U. S. Const., Art. I, §8, cl. 1, and any law that retroactively adds a tax, removes a deduction, or increases a rate rationally furthers that goal.34

Scalia happily concurred in the result despite his criticism of the majority's reasoning, observing wryly, ''If I thought that 'substantive due process' were a constitutional right rather than an oxymoron, I would think it violated by bait-and-switch taxation.'';35 but, Scalia concludes, ''I welcome this recognition that the Due Process Clause does not prevent retroactive taxes, since I believe that the Due Process Clause guarantees no substantive rights, but only (as it says) process.''36

In the years following Carlton, courts across the nation have come to various conclusions when understanding and applying the Court's decision. This has led courts to approve statutes with a retroactive effect of up to 10 years,37 and to strike down statutes with a retroactive effect of approximately 16 months.38 The decisions rendered in 2014 were no different.

2014: A Year of Ups and Downs

The past year has been a tumultuous one for rulings addressing retroactive tax legislation. The year started off promising enough when two New York tribunals ruled that retroactive application of an amendment to New York's tax laws regarding recognition of gain on the sale of intangible assets by nonresidents was unconstitutional.39 But, in the second half of the year, a pair of cases—one from Washington and the other from Michigan40—brought disappointing news to tax practitioners who hoped the recent New York decisions signaled a welcome change.

To read this article in full, please click here.

Originally published by Tax Management Weekly State Tax Report, Bloomberg BNA.

Footnotes

* Gregory Nowak is a Principal at Miller Canfield in Detroit.

1. 512 U.S. 26 (1994).

2. U.S. Const. amend. XIV, §1.

3. Faith Colson, Constitutional Law—Due Process—The Supreme Court Sounds the Death Knell for Due Process Challenges to Retroactive Tax Legislation, 27 Rutgers L.J. 243 (1995-1996).

4. Carlton, 512 U.S. at 28.

5. Id. (quoting 26 U.S.C. §2057(b)).

6. Id.

7. Id.

8. Id. at 28-29.

9. Id. at 29.

10. Id. (quoting Omnibus Budget Reconciliation Act of 1987, §10411(a), 101 Stat. 1330-432).

11. Id. (citing §10411(b)).

12. Id.

13. Id.

14. Id. at 29-30.

15. Id. at 30.

16. Id.

17. Id. at 30-31.

18. Id. at 31.

19. Id. at 31-32.

20. Id. at 32.

21. Id.

22. Id.

23. Id.

24. Id. at 33.

25. Id.

26. Id.

27. Id. at 34.

28. Id.

29. Id. at 35.

30. Id. at 37-38 (O'Connor, J., concurring), citing Connolly v. Pension Benefit Guaranty Corp., 475 U.S. 211, 229 (1986) (concurring opinion) (brackets omitted), quoting Usery v. Turner Elkhorn Mining Co., 428 U.S. 1, 16 (1976).

31. Id. at 37-38.

32. Id. at 38.

33. Id. at 40 (Scalia, J., concurring).

34. Id. (emphasis in original, internal citations omitted).

35. Id. at 39.

36. Id. at 40 (emphasis in original) citing TXO Production Corp. v. Alliance Resources Corp., 509 U.S. 443, 471 (1993) (Scalia, J., concurring in judgment).

37. See Miller v. Johnson Controls, 296 S.W.3d 392 (Ky. 2009).

38. See James Sq. Assoc. LP v. Mullen, 993 N.E.2d 374 (N.Y. 2013).

39. See Caprio v. New York State Dep't of Taxation and Finance, 117 A.D.3d 168 (N.Y. Sup. Ct. 2014); In the Matter of the Petition of Jeffrey M. and Melissa Luizza, Determination DTA No. 824932 (N.Y. Div. Tax App. Aug. 21, 2014).

40. See In re Estate of Hambleton, 335 P.3d 398 (Wash. 2014) and Yaskawa America, Inc. v. Dep't of Treasury, Case No. 11-000077-MT (Mich. Ct. of Claims Dec. 19, 2014).

Originally published by Bloomberg BNA, Weekly State Tax Report, April 17, 2015

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.