CAN AN ESTATE TAX BE RETROACTIVE?
by Jay Starkman, CPA
Jay Starkman comments on the expired estate tax and discusses the constitutionality of a retroactive estate tax. He writes that if Congress passes a retroactive estate tax later this year, history suggests that the courts will do their best to uphold it.
Copyright 2010 Jay Starkman.
All rights reserved.
The estate tax expired on January 1, 2009. The House on December 3, 2009, passed legislation that would have extended the 2009 estate and gift tax law indefinitely.1 Embroiled in healthcare legislation, the Senate was unable to consider the measure, and Democrats announced they would try to reenact it retroactively.2
Congress is expected to reinstate the estate tax this year. Most expect any change will indeed be retroactive to January 1, affecting the tax liability of estates of people who died before the law was enacted. Is a retroactive tax law constitutional? Absolutely!
Although the Constitution prohibits ex post facto laws, that applies only to criminal cases. So there's no impediment for our courts when tax revenue is involved. A Civil War income tax increase enacted July 4, 1864, was an emergency war measure that retroactively applied to calendar-year 1863 income.3 The Supreme Court upheld it, ruling:
Ruth S. Dinsmore died on April 14, 1993, when the maximum federal estate tax rate was 50 percent. On August 20, 1993, President Bill Clinton signed the Omnibus Budget Reconciliation Act, which increased the highest rates to 53 and 55 percent, retroactive to January 1, 1993. The result was a $175,137 estate tax increase. The district court dismissed the case by Dinsmore's estate for failing to specify proper grounds in its claim for refund. The estate's argument that the retroactive tax increase was "unconstitutional and invalid" was so vague and ambiguous that the IRS could not reasonably be required to know, let alone defend, such a claim. The court ruled alternatively that the retroactive increase in the tax rate was not unconstitutional and did not violate the apportionment clause, the due process clause of the Fifth Amendment, or the takings clause under the Fifth Amendment, and that it did not contravene the prohibition against ex post facto laws.6
Ellen Clayton Garwood died in March 1993. With a gross estate of more than $28.1 million, the additional tax was $1,320,190. The appeals court rejected the argument that the retroactive increase was an ex post facto law because that prohibition applies only to criminal enactments, and NationsBank avoided any possibility of criminal sanctions by paying the tax. Judge S. Jay Plager dissented: "There are times when the gap between law and justice is too stark to be ignored. This is one of them. . . . I believe it should be unconstitutional." An appeal to the U.S. Supreme Court was denied.7
Courts similarly rejected refund claims by the estates of Angele C. Quarty, Elizabeth B. Cherne,8 and J.A. Peter Strassburger.9 The 1993 retroactive estate tax law was condemned by Senate Minority Leader Bob Dole and in op-ed articles.10 The Congressional Research Service correctly predicted the law "would likely be found constitutional if taken to court."11 Dole pointed out that article 57 of the Constitution of the Russian Federation prohibits retroactive tax increases.12
New Jersey has a reputation as a notoriously difficult state for taxpayers to prevail in disputes with the Division of Taxation. The state enacted a law on July 1, 2002, increasing the estate tax retroactive to January 1, 2002. Cynthia Oberhand died on March 28, 2002, and her estate was assessed an additional $25,915.49 estate tax as a result of the retroactive law. The New Jersey Tax Court held that the retroactive law was constitutional. Yet, in a big surprise, it ruled in favor of the estate. The court applied the equity principle of manifest injustice to prevent application of a tax law that did not exist at Oberhand's death. The appeals court reversed, saying that "the doctrine of manifest injustice has no place in the judicial evaluation of retroactive tax laws." The New Jersey Supreme Court sided with the taxpayer, agreeing with the tax court that retroactive application was manifest injustice.13
Oberhand v. Director was based strictly on equity relief because the same New Jersey Tax Court judge, Harold A. Kuskin, ruled three months later under slightly different facts that the retroactive law was not manifest injustice when the estate tax resulted from a disclaimer by the beneficiary. That retroactive tax was not triggered merely by the decedent's death.14
When the 1894 income tax was before the U.S. Supreme Court the second time, the justices considered whether the tax was unconstitutional or manifest injustice.15 They opted for unconstitutional.
Why does the Constitution not protect us against a civil ex post facto law? Back in 1798, the U.S. Supreme Court considered a retroactive Connecticut probate law. The sole issue was whether that law should be overturned as ex post facto. Justice Samuel Chase (who would later be impeached for sentencing a tax protester to death, among other charges) wrote that the ex post facto prohibition applies only to laws that are "manifestly unjust and oppressive." He then opined that the prohibition applied only to cases that made an innocent action criminal.16
This criminal ex post facto doctrine "is so well settled as to have become one of the commonplaces of American constitutional law," declared a 1921 Michigan Law Review article.17 That is why the Supreme Court gives short shrift to civil ex post facto arguments. The contention that an act is an ex post facto law "hardly merits serious consideration."18 "The construction of the ex post facto provision which has been followed by this Court from earliest times . . . always has been considered that that which it forbids is penal legislation which imposes or increases criminal punishment for conduct lawful previous to its enactment . . . [has] been considered closed for many years and a body of statute and decisional law has been built upon" it.19
Harsh and Oppressive
The equity doctrine of manifest injustice may not be an acceptable test for the Supreme Court, which created a "harsh and oppressive" test in 1938 for its tax deference rule and later diluted that test. The case involved a 1935 Wisconsin statute that repealed the income tax exemption for dividends received from corporations doing a majority of business in that state and, retroactive to 1933 and 1934, taxed dividends received for the two years before passage.20 The Court found that the retroactive tax could not reasonably have affected the taxpayer's actions and was thus not harsh and oppressive. Even if the taxpayer had anticipated the tax, it could not be assumed that he would have refused to accept the dividend income merely to avoid the tax. According to the court, the taxpayer's only complaint was the inconvenience of carrying his share of a government burden that he did not anticipate when the income was received.
The harsh and oppressive test involved the Court's consideration of "the nature of the tax and the circumstances in which it is laid before it can be said that its retroactive application is so harsh and oppressive as to transgress the constitutional limitation." The standard is grounded on three factors: past legislative practice, legislative need, and retroactive periods of relatively short duration.21 Because the Wisconsin Legislature met only biennially, making 1935 its first opportunity to revise laws for 1933, the relatively short duration standard was met.
Later cases refined the retroactive tax deference rule to the detriment of taxpayers.
On October 4, 1976, President Gerald Ford signed the Tax Reform Act of 1976, increasing the rate of the minimum tax on items of tax preference and decreasing the allowable exemption, retroactive to January 1, 1976. E.M. Darusmont found himself subject to an unexpected tax. The Supreme Court held that he had "ample notice" of the increase in the effective minimum rate because the rate increase had been under public discussion for almost a year before its enactment. It could not be challenged as a new tax, because the minimum tax had been in effect since 1969.22
The 1976 act also replaced the $30,000 gift tax exemption and the $60,000 estate tax exemption with a "unified credit" to reduce gift tax or estate tax liabilities. A transition rule reduced the unified credit by 20 percent of the specific gift tax exemption allowed under prior law for gifts made after September 8, 1976, the date the law was approved by the conference committee. This resulted in an additional $6,000 estate tax for Charles Hirschi, who on September 28, 1976, had made gifts in contemplation of death. Upholding the tax, the Supreme Court concluded that the transition rule involved "changes in operation of the tax laws, rather than the creation of a wholly new tax."23
There are four pre-New Deal cases in which the Supreme Court invalidated the taxation of gifts made before and fully vested before the enactment of the taxing statute.24 Those cases are sometimes cited when arguing the unconstitutionality of retroactive estate and gift laws, but they were decided during an era characterized by exacting review of economic legislation. "That due process authorizes courts to hold laws unconstitutional when they believe the legislature has acted unwisely -- has long since been discarded."25
United States v. Carlton
A retroactive estate tax will assuredly be challenged by taxpayers. Courts historically have denied those efforts. Getting the Supreme Court to hear such a case would be very difficult unless a lower court tries to overturn the retroactive tax. That last happened after a December 22, 1987, law changed an estate tax deduction, retroactive to October 1986. The Supreme Court heard the case in 1994 and overturned the Ninth Circuit, which had ruled in favor of the taxpayer.26 The case involved an estate tax deduction for the sale price of employer securities to an employee stock ownership plan. Taking advantage of a loophole in the 1986 statute, the estate purchased the stock after death and sold it to an ESOP before a new law closing the loophole was even proposed. A retroactive law limited the deduction to estates of decedents who had owned the stock at death.
The significance of this case is not that the court once again sustained a retroactive estate tax amendment. It's that the Ninth Circuit, in holding the retroactive law unconstitutional, meticulously applied all the tests required by prior Supreme Court decisions, yet was overturned.
The appeals court concluded that the retroactive tax was harsh and oppressive, and that there had been a lack of "actual or constructive notice that the tax statute would be retroactively amended." Dissenting, Judge William A. Norris suggested a novel approach: "In regulating economic activity, Congress enjoys wide latitude to legislate retroactively." And the Supreme Court jumped at this approach, using Judge Norris's citations27 in announcing that "the due process standard to be applied to tax statutes with retroactive effect, therefore, is the same as that generally applicable to retroactive economic legislation."
The Supreme Court thereby overturned its prior standards of harsh and oppressive and ample notice. In so holding, it eliminated the distinction between retroactive income tax and estate and gift tax laws. The Court replaced the harsh and oppressive test with the more lenient "legitimate legislative purpose" standard traditionally applied only in due process claims involving general retroactive economic legislation.28
Justice O'Connor recognized the serious problem with this approach: "Every law touching on an area in which Congress has previously legislated can be said to serve the legislative purpose of fixing a perceived problem with the prior state of affairs -- there is no reason to pass a new law, after all, if the legislators are satisfied with the old one."29 The unanimous holding (with 2 concurring opinions, one by Justice O'Connor and one by Justice Scalia in which Justice Thomas joined) was heavily influenced by the claim that failure to close the loophole would cost the government as much as $7 billion. This clinched Justice O'Connor's concurrence, as she declared, "Congress must be able to make such adjustments in an attempt to equalize actual revenue and projected budgetary requirements."30
Concurring, Justice Scalia called this "bait-and-switch taxation" and accused his colleagues of "policymaking rather than neutral legal analysis." But he was satisfied that "the reasoning the Court applies to uphold the statute in this case guarantees that all retroactive tax laws will henceforth be valid."31
The logic behind American jurisprudence upholding retroactive tax increases was explained in a 1996 study by the New York City Bar Association:
1 H.R. 4154; Chuck O'Toole, "House Votes to Make 2009 Estate Tax Law Permanent," Tax Notes, Dec. 7, 2009, p. 1047, 2009 TNT 231-1.
2 O'Toole, "Estate Tax Expiration Imminent After Congress Fails to Complete Action," Dec. 17, 2009, 2009 TNT 240-4.
3 13 Stat. 417.
4 Stockdale v. Atlantic Ins. Co., 87 U.S. 323, 331 (1874).
5 Brushaber v. Union Pacific R. Co., 240 U.S. 1, 20 (1916).
6 U.S. Bank N.A. v. United States, 74 F.Supp.2d 934 (D. Neb. 1999), 2000 TNT 37-15 .
7 NationsBank of Texas v. United States, 269 F.3d 1332 (Fed. Cir. 2001), Doc 2001-27391, 2001 TNT 211-11, aff'g 44 Fed. Cl. 661 (1999), Doc 1999-28564, 1999 TNT 171-4, cert. denied, 537 U.S. 813 (2002). See "Brief for the United States in Opposition," available at http://www.justice.gov/osg/briefs/2001/0responses/2001-1584.resp.pdf.
8 Quarty v. United States, 170 F.3d 961 (CA-9, 1999), 1999 TNT 65-9 .
9 Kane v. United States, F.Supp. 233 (E.D. Pa., 1996), 96 TNT 180-12, aff'd without opinion, 118 F.3d 1576 (3d Cir. 1997), Doc 97-20038, 97 TNT 131-9.
10 "Dole Attacks Retroactivity of Clinton Tax Plan," 93 TNT 170-114.
11 Marie B. Morris, "Constitutionality of Retroactive Tax Provisions in 1993 Reconciliation Bill," CRS, Aug. 5, 1993, Doc 93-8885, 93 TNT 174-14 .
13 Oberhand v. Director, 940 A2d 1202 (N.J. 2008), , 2008 STT 41-14, rev'g 907 A2d 428 (N.J. Tax 2006), , 2006 STT 196-17, rev'g 22 N.J. Tax 55 (2005), , 2005 STT 68-24 .
14 Rappeport v. Director, 22 N.J. Tax 422 (2005), , 2005 STT 152-15.
15 Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601, 703 (1895).
16 Calder v. Bull, 3 U.S. 386 (1798).
17 Oliver P. Field, "Ex Post Facto in the Constitution," 20 Mich. L. Rev. 315 (1921).
18 Johannessen v. United States, 225 U.S. 227 (1912).
19 Harisiades v. Shaughnessy, 342 U.S. 580, 594 (1952).
20 Welch v. Henry, 305 U.S. 134 (1938).
21 Id. at 148-151, as enumerated by the New York City Bar Association, infra note 28, at 858.
22 United States v. Darusmont, 449 U.S. 292 (1981).
23 United States v. Hemme, 476 U.S. 558 (1986).
24 Nichols v. Coolidge, 274 U.S. 531 (1927); Untermeyer v. Anderson, 276 U.S. 440 (1928); Blodgett v. Holden, 275 U.S. 142 (1927), modified, 276 U.S. 594 (1928); Coolidge v. Long, 282 U.S. 582 (1931). However, in Milliken v. United States, 283 U.S. 15 (1931), the Supreme Court upheld an estate tax on gifts made in 1916 in contemplation of death to the estate of one who died in 1920 at higher tax rates in effect since 1918, because the gift was made after enactment of the 1916 Revenue Act in which Congress adopted the well-understood system of taxation of transfers of property at death, which was already in force in 42 states.
25 Ferguson v. Skrupa, 372 U.S. 726 (1963).
26 United States v. Carlton, 512 U.S. 26 (1994), 94 TNT 114-1, rev'g 972 F.2d 1051 (9th Cir. 1992).
27 Judge Norris's approach was based on a nontax case, Pension Benefit Guaranty Corp. v. R.A. Gray & Co., 467 U.S. 717 (1984).
28 New York City Bar Association, "Retroactive Application of Federal Legislation," 51 The Record 836, 861 (Dec. 1996).
29 Carlton, 512 U.S. at 36.
30 Id. at 38.
31 Id. at 40. Italics in original.
32 New York City Bar Association, supra note 28, at 836.
END OF FOOTNOTES
Jay Starkman, CPA is a sole practitioner in Atlanta. This article was originally published in Tax Notes, February 22, 2010.