Retroactivity – Yes, Tax Laws Can & Will “Set Back the Clock”

Last year, one of my blog posts addressed the issue of retroactive tax legislation – the sometimes (often times) maddening event that occurs when a tax law is passed that, in effect “sets back the clock”.  Retroactivity makes a law effective as if it had been enacted at an earlier point in time and in doing so, can wreak havoc on taxpayer expectations and prior tax planning.  Case law has shown time and again, however, that retroactive tax laws are not only permissible, but that retroactive tax measures will rarely be held to violate the US Constitution.

Am I Still a US “Tax Citizen”?

Nowhere have I seen greater fear resulting from the possible retroactive application of a tax law than in the area of continued US citizenship for tax purposes in the case of individuals who relinquished their US citizenship many years ago. I have done a series of blog posts on this issue and interested readers can obtain full information in those posts (the final post in the series links to the two earlier posts).  This blog post will not focus on the issue of continued US citizenship for tax purposes due to a retroactive application of the law. The example merely serves to point out in the extreme, the violent disruptions that can occur when retroactive application of a tax law might possibly occur.

Constitutional Challenges

The Due Process Clause of the Fifth Amendment of the US Constitution is the most likely (although not the only) base for a constitutional challenge to a retroactive tax. Under the Due Process Clause, taxpayers have a right to fairness as well as an economic right which may be violated if retroactive legislation is enacted that does not meet certain standards. The United States Supreme Court has upheld retroactive tax legislation against a Due Process challenge in numerous cases.

Recent Events: Dot Foods Inc.

Last year, the United States Supreme Court was asked by Dot Foods Inc. by writ of certiorari to hear an appeal involving the question as to what circumstances will constitutionally permit retroactive tax legislation. The Supreme Court receives over 10,000 petitions of certiorari each year, and of these petitions a scant 80-100 are generally granted. The Supreme Court has the discretion to grant certiorari only for cases it deems appropriate. Just last month, the Court announced (to the disappointment of many tax professionals) that it would not grant certiorari in the Dot Foods case.

In Dot Foods, Inc. v. State of Washington Department of Revenue, 372 P.3d 747 (Wash. 2016),  the Washington State Supreme Court upheld a state law that retroactively removed a corporate income tax exemption. In justifying the retroactive removal, the state legislature argued that its action was merely intended to “conform” to its “original intent”.  The facts, however, indicated this could not possibly be the case. Not only was it clear that the exemption had been consciously adopted by the legislature, but Dot Foods position of entitlement to the exemption under its plain statutory language had been upheld previously by the State Supreme court in a 2009 decision.

Behind the Scenes

So, what was really going on behind the scenes in Dot Foods?  What really happened in Dot Foods, was this: the 2009 court decision scared the Washington State legislature.  Once it realized the financial drain on State coffers that would result when additional refund claims were submitted by other taxpayers similarly situated to Dot Foods, the legislature changed the law retroactively a scant six months after the court decision was reached.   As a result of the law change, the Department of Revenue denied Dot Foods’ claims for tax refunds that it had previously filed for years that were now covered by the retroactive law change. Dot Foods challenged the denials, but the Washington State Supreme Court held that retroactive application of the tax law was not an unconstitutional violation of the Due Process Clause.  The court determined that raising money for the state was a “legitimate legislative purpose” that justified enforcing the law retroactively.

Writ of Certiorari Denied

Dot Foods then asked the United States Supreme Court by writ of certiorari to hear an appeal challenging the State of Washington on the circumstances that would constitutionally permit retroactive tax legislation.  The period of retroactivity as determined by Dot Foods involved a time frame of 27 years, which among other things, it maintained was constitutionally impermissible. In making this claim, the taxpayer placed reliance on a concurring opinion of Justice O’Connor in the landmark retroactivity case United States v. Carlton, 512 U.S. 26 (1994), discussed in my earlier post.  Justice O’Connor agreed with the majority opinion in Carlton, but noted that the decision was correct because the retroactivity period of only approximately one year involved a “relatively short period.”  Her concurring opinion proclaimed that a period of retroactivity extending past one year would raise “serious constitutional questions.”

On May 22, 2017, the United States Supreme Court denied Dot Foods’ writ of certiorari along with six other petitions involving retroactive tax legislation.  In refusing to hear these cases, we can expect retroactive tax laws to continue being enacted unabated as State legislatures and Congress struggle to fill both State and Federal coffers.

Where Do We Go From Here?

The Court’s denial of Dot Food’s writ of certiorari is certainly disappointing. For many years, taxpayers have urged the Supreme Court to review a retroactivity case.  Practitioners felt that Dot Foods was very important and believed the Washington Supreme Court misapplied the US Supreme Court’s earlier guidance concerning the constitutional boundaries of retroactivity.

In filing an amicus curiae brief, practitioners expressed their belief that raising additional revenue, by itself and without regard to the circumstances, is not sufficient to justify a retroactive change in a tax law. The amicus curiae brief mentioned that “State legislatures throughout the United States are increasingly resorting to retroactive tax legislation to meet fiscal needs”.

The trend is not limited to State actions. We have also seen retroactive federal tax laws and Treasury Regulations.  The time was clearly ripe for the matter to be addressed by America’s highest Court, but sadly, it did not take on the challenge. Maybe it will do so if a “tax citizen” case emerges.



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