Problems With Retroactively Enacting the Estate Tax

While the buzz among the rich and old may be that this is a good year to die (because there is no estate tax), eternal tax freedom in the hereafter may prove elusive for 2010 decedents.  Under current law, it appears that Congress can and, per many tax experts, most likely will reinstitute the estate tax retroactively.[i]  Thus, wealthy taxpayers "lucky" enough to have died in 2010 may end up with a posthumous tax bill payable by their beneficiaries.

Although retroactive tax enactment may seem extraordinary to typical tax filers, it's nothing new; courts have a long history of upholding retroactive tax legislation against due process challenges.  In the seminal case on the issue, United States v. Carlton, 512 US 26 (1994), the U.S. Supreme Court upheld a retroactive cure to an unintended estate tax loophole.  The Court held that taxpayers' due process rights were not violated because "Congress' purpose . . . was neither illegitimate nor arbitrary . . . [since] Congress acted to correct what it reasonably viewed as a mistake in the original 1986 provision . . ."  In addition, the Court noted that "Congress acted promptly and established only a modest period of retroactivity."

While the Court's holding was unanimous, two concurrences (one by O'Connor and the other by Scalia with Thomas joining) highlight potential pitfalls of the Court's analysis.  Per O'Connor, the Court's focus on the curative purpose of the legislation was misplaced.  She noted that "[e]very law touching 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."  For their part, Justices Scalia and Thomas were concerned that, under the Court's analysis, "all retroactive tax laws will henceforth be valid" since any retroactive tax law will be "rationally related" to the "legitimate legislative purpose" of raising revenue.

If Congress does retroactively revive the estate tax, Carlton and its concurrences will likely loom large.  If a challenge of the retroactive reenactment reaches the Supreme Court, the Scalia/Thomas prediction will be tested.  And though overcoming the precedent will be an uphill battle, there is, at least, a glimmer of hope for the beneficiaries of 2010 decedents.

In its analysis, the Carlton Court distinguishes its facts from a line of cases that prohibited the retroactive imposition of the gift tax[ii] on the grounds that those cases involved "the creation of a wholly new tax."  And while the estate tax itself is hardly new, an estate tax effective in 2010 would be.  Thus, Carlton's attempt to distinguish itself from the retroactive gift tax cases may prove to be an accidental lifeline for would-be 2010 taxpayers.  If "wholly new" taxes cannot be retroactively applied, the Court may extend that proposition to "wholly new" estate taxes for the current year.  Indeed, from a decedent's point of view, the tax would be wholly new and not unlike the gift tax cases: an event (the transfer of assets at death) that was non-taxable when it occurred, becomes taxable (and how!) after it has occurred.

Posted by Jamie Delman, Associate Editor, Wealth Strategies Journal.

i. See Paul Sullivan, A Bizzare Year for the Estate Tax Will Require Extra Planning, NY Times, Jan. 8, 2010. 
ii. Blodgett v. Holden, 275 U.S. 142 (1927); Untermeyer v. Anderson, 275 U.S. 440 (1928)