Lawmakers may have thought they dodged a bullet last week when passing a retroactive death tax “fix” to a state Supreme Court ruling which would have required refunds but with additional litigation pending due to the retroactive nature of the tax increase the state may still end up paying those court ordered refunds.
Here is the Washington State Bar Association’s testimony about such retroactive tax increases likely being unconstitutional.
While saying we don’t want to be like the other Washington (D.C.), policy makers appear to have taken a page out of the Congressional playbook by utilizing retroactive tax policy. But even for Congress (which is no stranger to retroactive taxes) making retroactive tax changes apply longer than during the current fiscal year is tempting fate.
“Period of Retroactivity – The most common potential concern with respect to substantive due process is the length of the retroactivity. The Supreme Court has made clear that a modest retroactive application of tax laws is permissible, describing it as a ‘customary congressional practice’ required by ‘the practicalities of producing national legislation.’ As a result, tax legislation that is retroactive to the beginning of the year of enactment has routinely been upheld against due process challenges. There does not seem to be any serious question as to whether such a period of retroactivity is constitutional.
What then happens with periods of application that go beyond the year of enactment? The Court has upheld several tax laws where the period of retroactivity extended into the preceding calendar year. For example, in United States v. Carlton, the Court upheld the retroactive application of a federal estate tax provision that limited the availability of a recently added deduction for the proceeds of sales of stock to employee stock ownership plans. The deduction was added by the Tax Reform Act of 1986, which had not included a requirement that the taxpayer own the stock immediately prior to death. The lack of such a requirement essentially created a loophole that Congress fixed with the 1987 amendment. The Tax Reform Act of 1986 was enacted in October 1986, and the amendment was enacted in December 1987, to apply as if incorporated in the 1986 law. In upholding the 1987 law, the Court explained that the period of retroactivity was permissible since it was only slightly more than one year, as well as noting that the IRS had announced its concern with the original law as early as January 1987 and a bill to make the correction was introduced in Congress the very next month.
However, it does appear that due process concerns may be raised by a more extended period of retroactivity. In Nichols v. Coolidge (one of the few cases where the Supreme Court struck down a retroactive tax on due process grounds), the Court disallowed the retroactive application of an estate tax provision that changed the tax treatment of a transfer 12 years after the transfer had occurred. The Court later unfavorably compared the 12-year period with periods where the ‘retroactive effect is limited.’ This suggests that due process concerns are raised by an extended period of retroactivity. However, it is not clear how long a period might be constitutionally problematic. The Court has recognized retroactive liability for periods beyond one or two years in non-taxation contexts, but it is not clear how a similar situation arising under the tax laws would be addressed.”
It’s a bit ominous that the one example the Congressional Research Service gave of the courts striking a retroactive tax increase was for a change to the treatment of an estate transfer years after it happened – very similar to what our lawmakers just did by making their death tax change retroactive to deaths back to 2005.
As time goes on and this issue works its way through the courts lawmakers may come to realize the better course of action would have been to make prospective changes to the state’s death tax law rather than empower the hands of the taxman to reach back in time.