Can an Estate Tax Be Retroactive?

CAN AN ESTATE TAX BE RETROACTIVE?

by Jay Starkman, CPA

The estate tax expired on January 1, 2010. Congress is expected to reinstate it later this year. Most expect the reinstatement will 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!

Though the Constitution prohibits ex post facto laws, that only applies to criminal cases. So there's no impediment for our courts when tax revenue is involved. The 1864 Civil War income tax increase was an emergency war measure, which retroactively applied to 1863 income. The Supreme Court upheld it, ruling:

The right of Congress to have imposed this tax by a new statute, although the measure of it was governed by the income of the past year, cannot be doubted; much less can it be doubted that it could impose such a tax on the income of the current year, though part of that year had elapsed when the statute was passed. The joint resolution of July 4th, 1864, imposed a tax of 5 per cent upon all income of the previous year, although one tax on it had already been paid, and no one doubted the validity of the tax or attempted to resist it.

The 1913 Tax Act was enacted on October 3, and took effect on November 1, retroactive to March 1, four days after the Sixteenth Amendment was ratified. The Supreme Court dismissed the challenge:

[T]his limited retroactivity is assailed as repugnant to the due process clause of the Fifth Amendment, and as inconsistent with the Sixteenth Amendment itself. But the date of the retroactivity did not extend beyond the time when the Amendment was operative, and there can be no dispute that there was power by virtue of the Amendment during that period to levy the tax, without apportionment.

Even death won’t stop a retroactive tax increase. Ruth S. Dinsmore died on April 14, 1993, when the maximum federal estate tax rate was 50 percent. On August 20, 1993, President 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 for failing to specify proper grounds in its claim for refund. Claiming 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. Alternatively, the court ruled that the retroactive increase in the tax rate was not unconstitutional, and did not violate the apportionment clause, due process clause of the Fifth Amendment, or the takings clause under the Fifth Amendment, and did not contravene the prohibition against ex post facto laws.

Ellen Clayton Garwood died in March 1993. With a gross estate of $28,108,968.72, 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 only applies 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.

MANIFEST INJUSTICE

New Jersey has a reputation as a notoriously difficult state for a taxpayer to prevail in a dispute 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 state 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 which did not exist at her death. The appeals court reversed in favor of the state, saying “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.

Oberhand was based strictly on equity relief because the same NJ Tax Court Judge Harold A. Kuskin ruled three months later that this retroactive law was not manifest injustice under slightly different facts where the estate tax resulted from a disclaimer by the beneficiary. That retroactive tax was not triggered merely by the decedent's death.

When the 1894 income tax was before the U.S. Supreme Court the second time, it considered whether the tax was unconstitutional or manifest injustice. It opted for unconstitutional.

Why does the constitution not protect us against a civil ex post facto law? Back in 1798, the Supreme Court considered a retroactive Connecticut probate law. The sole issue was whether that state law should be overturned as ex post facto. Justice Samuel Chase (who would later be impeached for sentencing a tax protester to death, another story in the book) wrote that the ex post facto prohibition applies only to laws which are “manifestly unjust and oppressive.” He then opined that such prohibition only applied to cases which made an innocent action criminal. 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.

A retroactive estate tax will assuredly be challenged by taxpayers. Courts historically have denied such efforts. Getting the Supreme Court to hear such a case nowadays would be very difficult unless a lower court tries to overturn it. 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 appeals court decision which had ruled in favor of the taxpayer.

Excerpted from The Sex of a Hippopotamus: A Unique History of Taxes and Accounting. This article was published by the Georgia Society of CPAs in Current Accounts, January/February 2010, and by the Texas Society of CPAs in Today's CPA, January/February 2010. ©2008, 2009 by Jay Starkman.