Retroactivity Revisited: Has Anything Changed?

Article by Erica L. Horn, Madonna E. Schueler and Gregory A. Nowak*

The U.S. Supreme Court's decision in United States v. Carlton turned 20 last year, but the core issue within the case remains embattled. In this article, authors Erica Horn, Madonna Schueler and Gregory Nowak discuss the Carlton decision and several 2014 cases on which it had an impact.

Introduction

Last year marked the twentieth anniversary of the U.S. Supreme Court's decision in United States v. Carlton,1 but the battle continues over the constitutionality of retroactive tax legislation. Taxpayers continue to fight state efforts to amend tax legislation retroactively based on the Due Process Clause of the Fourteenth Amendment, which provides that no state shall deprive any person of ''life, liberty, or property without due process of law.''2 States have fought back with equal zeal, and the results have been anything but uniform. This article revisits the Court's decision in Carlton and then discusses 2014 state cases applying the Court's decision.

Carlton Sets the Stage for Evaluating Retroactive Tax Legislation

Rendered in 1994, United States v. Carlton remains the seminal case on retroactive tax legislation. Carlton involved an amendment to the federal estate tax statute that limited the availability of a recently enacted deduction for proceeds of sales of stock to employee stock ownership plans (''ESOPs''). The Court held that retroactive application of the amendment satisfied the requirements of due process in what has been described as the ''death knell'' for due process challenges to retroactive legislation.3

As part of the Tax Reform Act of 1986, Congress enacted a new estate tax provision applicable to any estate filing a return after Oct. 22, 1986.4 Codified at 26 U.S.C. §2057, the new provision granted a deduction for half of the proceeds of ''any sale of employer securities by the executor of an estate'' to ''an employee stock ownership plan.''5 Under §2057, the sale of securities had to be made prior to the date on which the estate tax return was required to be filed.6

The respondent, Jerry Carlton, was the executor of an estate who sought to utilize the §2057 deduction. Nineteen days prior to the due date of the estate tax return, Carlton used estate funds to purchase shares of a corporation. Two days later, Carlton sold the shares at a loss to the corporation's ESOP. When Carlton filed the estate tax return on Dec. 19, 1986, he claimed a deduction under §2057 of $5,287,000, which was half of the proceeds from the sale of stock to the ESOP. The deduction reduced the estate tax by $2,501,161.7 Carlton stipulated that he engaged in the stock transactions solely to take advantage of the §2057 deduction.8

Shortly thereafter, on Jan. 5, 1987, the IRS announced that pending the enactment of clarifying legislation, it would treat the §2057 deduction as only available to estates of decedents who owned the relevant securities immediately before death. A bill to this effect was introduced in Congress, and on Dec. 22, 1987, an...