FULL TEXT: CRS MEMORANDUM FINDING RETROACTIVE TAX INCREASES IN OBRA 1993 CONSTITUTIONAL.

                        AMERICAN LAW DIVISION

It is generally conceded that Congress may raise income tax rates retroactively. In United States v. Darusmont, 449 U.S. 292, 297 (1981), the Supreme Court recognized that retroactive application of tax laws is sometimes required by the practicalities of producing national legislation and deemed it a customary congressional practice. The Court upheld the constitutionality of this practice. We have no reason to believe that a retroactive increase in income tax rates, such as that proposed in the reconciliation legislation, would violate the Fifth Amendment of the Constitution.

Several older Supreme Court cases found the retroactive imposition of estate and gift taxes to be unconstitutional. See Untermyer v. Anderson, 276 U.S. 440 (1928); Blodgett v. Molden, 276 U.S. 142 (1928); and Nichols v. Coolidge, 274 U.S. 531 (1927). The existence of these cases, and language contained in them suggesting that a tax is unconstitutional under the Fifth Amendment unless the taxpayer can foresee the exact burden which will be imposed by legislation, has caused several requesters to ask whether the principles outlined in CRS Report No. 87-440A also apply to the retroactive increases in estate tax rates. [See The 1987 Tax Reform Act: Constitutionality of the Retroactive Application of Certain Provisions, by Thomas B. Ripy and Marie B. Morris.]

We believe that an increase in estate tax rates retroactive to the beginning of the tax year would probably be found constitutional, if reviewed by a court. The basis for this conclusion is twofold. First, in United States v. Hemme the Supreme Court limited the authority of the Untermyer line of cases. Second, taxpayers are on notice that estate tax rates may be raised. Congress has twice before extended the higher estate tax rates (in 1984 and 1987) and proposed doing so last year in H.R. 11 which was vetoed by President Bush.

In United States v. Hemme, 476 U.S. 558 (1986), a unanimous Supreme Court upheld the retroactive disallowance of part of the $30,000 lifetime exemption for gifts made between September 8, 1976 and December 31, 1976. The taxpayer in question made gifts after the Conference Committee approved the transition rule but before the October 4, 1976 signing of the 1976 Tax Reform Act. The general estate tax changes of the TRA 1976 were effective beginning in 1977. When the taxpayer died two years later, the fact that he made gifts during the transition period meant that his unified credit was reduced by $6,000.

Relying on Untermyer, the District Court found that the retroactive transition rule was so arbitrary and capricious that it was unconstitutional. The Supreme Court reversed. The Supreme Court distinguished Untermyer, saying that it involved the levy of the first gift tax; that its authority is of limited value in assessing the constitutionality of subsequent amendments that bring about certain changes in operation of the tax laws, rather than the creation of a wholly new tax. 476 U.S. at 568.

The Court's analysis was to "consider 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," citing Welch v. Henry, 305 U.S. 134, 147 (1938). Under the specific facts of the case, the taxpayer was better off under the transition rule than he would have been if the law had never changed, but not as well off as he would have been without the existence of the transition rule. Under those facts, the Court found the provision to represent a fair judgment by Congress, and not unconstitutional.

Carlton v. United States, 972 F.2d 1051 (9th Cir. 1992), cert. applied for, applied the Hemme analysis and found on the specific facts of its case that applying certain retroactive estate tax legislation was unconstitutional. In Carlton, the executor of an estate took advantage of a provision adopted in the Tax Reform Act of 1986 which allowed estates to exclude 50 percent of the value of stock sold to an ESOP. TRA 1986 was signed in October 1986. In January 1987, the IRS realized that the ESOP provision had created a giant revenue loser and announced that it was not going to interpret the provision as written. In February a bill was introduced to adopt the IRS interpretation. The 1987 legislation was adopted in December retroactive to the date of the 1986 legislation. The decedent died in 1985. In December 1986, the executor bought stock and sold it to an ESOP at a loss of $631,000. The executor alleged he relied on the TRA 1986 provision in both buying the stock and in selling it at a loss.

The 9th Circuit found the estate's reliance on the plain language of the law was reasonable, and that the amendment did not simply restore status quo before TRA 1986 because the estate was $631,000 poorer. (There was no discussion of why an estate should get the benefit of a law passed after the death of the decedent.) The court gratuitously commented that it did not doubt the power of Congress to apply legislation retroactively to the time such legislation was introduced, or even to the time such legislation was proposed by the executive branch. "During this time the taxpayer is on notice that a change in law is forthcoming. . . . Our conclusion would likely be entirely different if Carlton had engaged in his transaction after January 5, 1987." 972 F.2d 1051, at 1062. The court noted that Ferman v. United States, 790 F. Supp. 656, upheld the constitutionality of the retroactive provision as applied to the same kind of transaction performed in February 1987. Ferman was upheld by the 5th Circuit in 993 F.2d 485 (1993). In that case, the IRS announcement of its intention not to apply the law was sufficient notice to the taxpayer that the law might change.

The 9th Circuit does not necessarily have problems with retroactive rate increases. In Licari v. Commissioner, 946 F.2d 690 (9th Cir. 1991), the court upheld a retroactive increase in the penalty rate for underpayment of taxes. The increase applied to tax returns filed before the date of enactment. The 9th Circuit would appear to strike retroactive legislation down where (1) the taxpayer had no actual or constructive notice of the proposed change and (2) the taxpayer reasonably relied on the pre-existing law to his detriment.

Many other circuits have adopted looser language to discuss and analyze the retroactivity issue. For example in Reed v. United States, 743 F.2d 481 (7th Cir. 1984), cert. denied 471 U.S. 1135, the court states that a mere change in an existing tax, is not unconstitutional per se, that retroactive features are applied to revenue statutes as a matter of customary congressional practice, and that a taxpayer assumes the risk that the tax burden on a particular transaction may increase pursuant to Congress's continual responsibility to carry out the necessary policies of taxation. Similarly, the first Circuit also upheld retroactive estate tax changes, citing among other cases Darusmont. Estate of Ceppi, 698 F.2d 17 (1st Cir. 1983), cert. denied 462 U.S. 1120. Both Estate of Elkins v. Commissioner, 797 F.2d 481 (7th Cir. 1986), and Fein v. United States, 730 F.2d 1211 (8th Cir. 1984), cert. denied 469 U.S. 858, upheld the retroactive repeal of an estate tax exclusion for life insurance policies.

A review of cases involving retroactive estate tax changes reveals that there have been quite a few retroactive changes in the estate taxes and that, at least in recent times, the retroactive changes are usually found to be constitutional. The cases we have reviewed do not distinguish between retroactive estate tax changes and retroactive income tax changes. Darusmont and other income tax cases are freely cited in analyzing the constitutionality of retroactive estate taxes. Untermyer seems to be cited mainly to show how limited its holding has become.

Carlton is a cautionary case. Although the Supreme Court has yet to agree to hear the case, Carlton stands for the proposition that on facts showing no actual or constructive notice and actual detrimental reliance on pre-existing law, retroactive legislation may violate the due process clause.

However, even if Carlton is the standard by which the retroactive increase in estate tax rates should be judged, it may be argued that the retroactive estate tax rate increases in the reconciliation bill would not violate the Carlton standard. Congress has been proposing to retain the higher estate tax rates for over a year now. Section 3006 of H.R. 11 in the 102d Congress would have extended the estate tax rates if the bill had not been vetoed by President Bush. Taxpayers are on notice that higher estate tax rates are potential revenue raisers. Because of this notice, it would be difficult for estates and beneficiaries to argue detrimental reliance on a specific set of rates.