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Home The Likelihood and Enforceability of a Retroactive Tax

The failure of Congress to act before the end of 2009 means that there are currently no Federal estate or GST taxes in effect for 2010. Although several bills have been introduced to address the repeal of the estate and generation-skipping transfer (GST) taxes, no definite action has been taken. During the first quarter of 2010, the U.S. House of Representatives voted 225-200 to indefinitely extend the 2009 transfer tax rates into 2010 and beyond, but the bill has not progressed further. Senate Finance Committee Chairman Senator Max Baucus has stated, though, that Congress will seek to restore the estate and GST taxes in 2010. This week, Sander Levin, chairman of the House Ways and Means Committee, indicated that he expects to reenact the 2009 estate tax level to indeed be retroactive as of January 1st, 2010. Information provided to us through lobbyists has not been very helpful to clarify matters either, with some lobbyist suggesting that retroactive legislation will likely be passed in full by mid-year, and another emphatically stating there will absolutely be no estate tax legislation passed this year whatsoever.

To the extent any legislation is indeed passed in 2010, the general consensus is that it would attempt to be retroactive to January 1, 2010. As a reminder, if Congress does not act this year, under the Economic Growth and Tax Relief Reconciliation Act of 2001 (the “2001 Act”), the entirety of the 2001 Act will sunset in 2011, restoring all transfer taxes to the 2001 wealth exemption level ($1 million lifetime exemption) and tax rate schedule (top rate of 55%).

In light of these unprecedented events, the question being raised is whether a retroactive estate and GST tax would violate the U.S. Constitution. If retroactive taxation takes effect, it is almost certain that some taxpayers will come forward and challenge its application. The authors alone are aware of two ultra high net worth taxpayers who passed away in January in of this year; with the dollars at stake, a contest seems inevitable. Historically, most courts have generally found that the retroactive application of Federal tax legislation is constitutional. However, case law in this area gives us an indication of the possible arguments, and their likelihood of success, if taxpayers challenge a 2010 retroactive transfer tax.


The Due Process Clause of the Fifth Amendment presents the most likely basis for a constitutional challenge. Courts have long recognized taxpayers have an economic right under this Clause which may be violated if retroactive legislation is enacted that is not rationally related to a legitimate legislative interest.

The definitive case regarding Due Process challenges to retroactive tax application is United States v. Carlton, in which the Court considered whether the retroactive denial of an estate tax deduction violated Due Process.4 To encourage the transfer of stock to company employees, Congress enacted a law that provided an estate tax deduction for an estate’s sale of employer securities to an ESOP. Congress intended the deduction only be available to the estate if the decedent owned the stock on the date of death, but it failed to include explicit language to that effect. Fourteen months after the law was enacted, Congress amended it to add in this requirement and applied it retroactively. The executor in Carlton relied on the pre-amendment law when making a purchase and resale of stock on behalf of the estate (after the decedent’s death). After the estate tax deduction was denied for the sale, the executor challenged the retroactive application of the amended law on Due Process grounds.

The Supreme Court “repeatedly has upheld retroactive tax legislation against a due process challenge”. Indeed, the Supreme Court in Carlton rejected the executor’s Due Process argument and upheld the retroactive application of the tax law based upon a two-part test that emerged from its analysis. The test upholds retroactive tax application if: (1) the legislation has a rational legislative purpose and is not arbitrary; and (2) the period of retroactivity is not excessive. The Court reasoned that Congress meant to correct a mistake that afforded an unjustified tax loophole and applied the revision retroactively for a “modest” period extending back fourteen months, thereby satisfying both prongs of the test.

In another case relevant to retroactive tax legislation, the Court in Estate of Cherne v. United States followed the Carlton test and upheld a retroactive increase in the Federal estate tax rate from 53 percent to 55 percent, finding that the increase was rationally related to the legitimate legislative interest of raising revenue.  How will these precedents affect a 2010 retroactive tax? Under the Carlton test, Congress appears to have fulfilled both parts of the test. Raising revenue certainly is a legitimate legislative purpose, and a retroactive application of, at most, twelve months is still less than the fourteen months approved of by the Court in Carlton.


The argument that may be the most germane to a 2010 retroactive tax, however, is another Due Process argument relied on by the estate in Estate of Cherne. The estate emphasized the distinction between retroactive application of an existing tax versus a “wholly new tax” (this distinction was also discussed by the Court in Carlton), and asserted that a rate increase was akin to the imposition of an entirely new tax. The Ninth Circuit rejected the estate’s argument, characterizing the rate increase as an amendment, rather than a wholly new tax.

The “wholly new tax” argument was first considered under Blodgett v. Holden and Untermyer v. Anderson.  When the federal government first enacted gift tax, both of these decisions considered the retroactive application of the gift tax to gifts made before the law was enacted. The Court held in both cases that the retroactive application of the gift tax violated Due Process, insofar as it was the imposition of a wholly new tax in which the taxpayer has “no reason to suppose that any transactions of the sort will be taxed at all.” However, subsequent cases have narrowed the application of this argument, holding generally that Untermyer, in particular, is of limited value in determining the constitutionality of amendments that bring about changes in the operation of certain tax laws, since an amendment is not the imposition of a wholly new tax.

More recent cases have repeated this distinction, stating generally that a “wholly new tax” is one that “could not reasonably have been anticipated by the taxpayer at the time of the transaction”, while other tax changes, such as rate increases, are more properly characterized as amendments to an existing tax. Since Untermyer and Blodgett, case law has generally dealt only with tax rate increases or the closing of a loophole in a tax law, and there have not been any cases that consider the application of a tax that could be classified as “wholly new”.

The “wholly new tax” argument seems to be the strongest basis for bringing a 2010tax challenge. Case law makes a strong distinction between amendments to tax laws, such as rate increases or curative changes, and the imposition of wholly new taxes, such as the gift tax that was imposed for the first time at the beginning of the 20th century. Since Congress allowed the estate and GST taxes to be completely repealed in their entirety beginning in 2010, taxpayers may be able to effectively argue that the proposed retroactive estate tax is a new one. It may be difficult to constitutionally uphold the retroactive application of a law not in existence at the time it could potentially be enacted. The argument on the other side, however, is that an estate tax “could reasonably have been anticipated by the taxpayer” since taxpayers are aware under the current law that the estate tax will resume in 2011.


Another premise asserted in Blodgett and Untermyer is that the lack of notice to taxpayers causes the retroactive tax to be unconstitutional. The Supreme Court agreed with the taxpayers in both cases, stating that imposition of the tax retroactively would be unreasonable considering that the taxpayers had no notice when the gifts where made that they may be subject to tax in the future. This argument was also presented in Carlton, insofar as the executor had no notice that the deduction would be denied when he relied, to his detriment, on the version of the law in place at the time of the transaction. The Carlton Court did not find this argument to be dispositive, though, stating that a taxpayer “should be regarded as taking his chances of any increase in the tax burden which might result from carrying out the established policy of taxation.” While the Court did not expand on its analysis of the notice argument, it should be pointed out that the Court was considering an amendment to a tax law, rather than a wholly new tax, and this may have affected its conclusion.

With respect to a retroactive estate tax, taxpayers have some reason to believe that their transactions may be taxed – if not presently, then at some point in the future. But it is arguable whether taxpayers have had enough notice as to the future of the estate and GST taxes in 2010 – although there has been debate in Washington recently, there is anything but a consensus as to what the exemption levels and tax rates should be, and when the changes will take effect.


In the past, taxpayers have challenged retroactive tax laws as ex post facto laws. The Constitution does, in fact, prohibit enactment of an ex post facto law, which is a law intended to apply to events that occurred before its enactment. However, this limitation applies solely to the enactment of criminal laws. Although the tax code does contain many provisions that subject delinquent taxpayers to criminal liability, the entire tax code is not considered criminal in nature. Consequently, this doctrine is not likely to be applicable in a challenge to a 2010 retroactive tax law.


There is also some case law supporting the argument that a retroactive tax is an uncompensated taking barred by the Fifth Amendment; however, case law establishes that the taking must be “so arbitrary and capricious as to amount to a confiscation” and extends beyond the “short and limited periods required by the practicalities of producing national legislation.” Based on the latter standard, the retroactive period in Carlton of fourteen months was not found to be an unconstitutional taking, so this argument will likely have little success if applied to a 2010 retroactive tax.


Despite the many possible arguments that could be advanced by a taxpayer, it is unlikely that the enactment of retroactive estate and GST taxes would be defeated on a constitutional challenge. Since there has been no case law directly addressing a case involving the imposition of a wholly new tax since the gift tax case in the 1920’s, it is difficult to predict how a modern court will interpret the issue regarding a 2010 retroactive tax, but the authors are not optimistic especially in with the knowledge that the estate tax regime is knowingly resurrected next year. There is also the prospect that Congress will decide to not enact such a law retroactively at all, if only to avoid the time and expense of defending against the inevitable challenges to its constitutionality. Unfortunately for taxpayers, this is truly a time where nobody knows what will happen. Stay tuned…