Tax Analysts Blog

Retroactive Tax Laws Are Just Wrong

Posted on Aug 19, 2015

What one word comes to mind when you hear "due process"? It should be fairness. We inherently know what's right and wrong. We know when someone is being treated unfairly. And the Constitution reflects those beliefs. We think it is wrong to beat a confession out of someone. We think it is wrong to deny a person his right to worship. I bet that if you polled the American public, a vast majority would say that retroactive tax laws are wrong.

There has been a lot of discussion lately in State Tax Notes regarding retroactive tax laws. Timothy Noonan, Daniel Kelly, and Joshua Lawrence wrote an intriguing viewpoint on the New York Court of Appeals decision in Caprio. The New York Legislature enacted a law in 2010 and applied it retroactively to transactions that took place years before. The article went into great detail on how all this came about, but the bottom line is that the Caprios acted on the laws in place in 2007, the state decided in 2010 to change the law for 2007, and the Caprios challenged that, alleging that it violated the due process clause.

The court cited the three factors to be weighed in determining whether a retroactive tax law violates due process:

  • whether the taxpayer reasonably relied on the law as it existed when structuring the transaction and whether the taxpayer had forewarning of the change;
  • the length of the period of retroactivity; and
  • the strength of the public purpose behind the retroactive application of the law.

The state's highest court held for the government. However, a fair reading of the facts suggests that the Caprios relied on the existing law. The law changed several years later -- that's a long time. And the state did not really identify a public purpose to justify retroactive application of the law. Apparently, due process has nothing to do with fairness in the New York court system.

In Raising the Bar in State Tax Notes, Joe Crosby, Kendall Houghton, Stephen P. Kranz, and Diann L. Smith examined retroactive tax laws in the context of Hambleton v. Washington and Michigan's IBM v. Department of Treasury. Hambleton involved a retroactive change to the state estate tax. IBM involved the retroactive repeal of the Multistate Tax Compact.

As readers know, these four commentators are among the best in the business. Smith said:

      We have this issue all of the time as to whether or not legislatures can retroactively change the law. What I like about this case [Hambleton] is it brings up two issues. One, the general concept of: Can a legislature retroactively change the statute? And two, can it retroactively overrule an existing decision from its highest court?
It should depress all of us that the issue of retroactivity arises all the time. There are two fundamental problems with changing the rules retroactively. First, it is patently unfair. People who follow the rules should not be penalized later. We would never stand for it in the criminal context. Why should we accept it for taxes? Second, retroactively changing the rules undermines confidence in the tax system. Most people try to do the right thing. Often they spend a lot of money paying lawyers and accountants to guide them to the right result. The good taxpayers might not be diligent in following the rules if those rules might change.

Kranz said, "As a voter, it is shocking to me that elected officials would change the rules retroactively." We should all feel that way. The legal standards the courts should adopt when evaluating retroactive tax law are simple. First, retroactive taxation should be upheld when a legislature makes a mistake and immediately changes the law before citizens have relied or acted on it. That happened to some extent in the Supreme Court's Carlton decision. But retroactive tax laws should be held in violation of the due process clause unless the government can show that the previous law was so ambiguous as to create an incentive for fraud and abuse and that the taxpayer was engaging in fraud and abuse.

The government should have a heavy burden in convincing a court of the legality of retroactive taxes. The due process clause is, after all, about fairness.


This is an excerpt of a column that will appear in this week's State Tax Notes.

Read Comments (6)

edmund dantesAug 19, 2015

"People who follow the rules should not be penalized later. We would never
stand for it in the criminal context. Why should we accept it for taxes?"

Moral relativism has infected our reasoning. This is a black and white issue,
yet the Court of Appeals cast it in shades of gray with their three prong
analysis.

Legislators create retroactive tax changes because they can do it, and the
number of taxpayers affected will be very small, too small to have much
political weight. It's the same motivation behind keeping death taxes, even
though the public overwhelming opposes death taxes--unfair taxes are just fine
if most people don't have to pay them.

There should be an outcry over retroactive taxation, and I believe any fair
minded person would agree that it is unconstitutional. If it's not, it should
be.

Guy NeversAug 20, 2015

David: I wrote a nice article on the IBM decision for the Journal of State
Taxation; that went into the same issue relative to the Contracts Clause.
Basically the States got their deal under US Steel, but when it comes time for
the taxpayer to benefit, the agreement no longer exists.

amt buffAug 20, 2015

Modern courts follow a fully consistent philosophy on legal questions,
illustrated as follows:

"When I use a word," Humpty Dumpty said, in rather a scornful tone, "it means
just what I choose it to mean—neither more nor less."

"The question is," said Alice, "whether you can make words mean so many
different things."

"The question is," said Humpty Dumpty, "which is to be master—that's all."

david brunoriAug 20, 2015

Guy I read your article. It was great. Edmund and AMT I obviously agree. DB

vivian darkbloomAug 24, 2015

David,

I'm all with you on the inappropriateness, if not unconstitutionality, of
"retroactive tax laws"; however, I think your summary of the facts of Caprio
have been much too simplified to do justice to the issue decided in that case.

I don't think the facts incontestably support the simple idea that the "tax
law" was "retroactive". At the very least, there's a lot of nuance being
glossed over here. I know the Court of Appeals itself referred to the change
as a retroactive one, but this warrants more attention.

Here's, in brief, a chronology of what happened:

1. In 2007 taxpayers entered into a transaction and then took a position on
their tax returns, presumably in absence of any advice, on the meaning of NY
state tax law (an interpretation that applied NY state law in a manner
differently than federal law);

2. *Subsequent* to that transaction, a couple of NY Tax Appeals Tribunal cases
involving other taxpayers interpreted that statute in a manner supportive of
the taxpayer's (Caprio's) earlier position (if I understand the NY State system
correctly, that Tribunal is not a "court", as such, but it's decisions are
binding on the Tax Department, although the Taxpayer can appeal. But, query,
given this is a "tribunal" and not a "court" are its decisions even precedent
here in the sense that they can establish "the law"?.

3. The NY State legislature then stepped in and passed a "curative" statute
due to the fact that they (the legislature) believed the Tribunal had
misconstrued the meaning of the original law and had overturned a
"long-standing policy".

So, in effect, the NY legislature really didn't believe they were making a
"retroactive change" to the original *statute*, so much as clarifying the
statute and correcting what they believed to be an error by the Tribunal. They
were, in effect, making a retroactive change to a couple of Tribunal decisions
not directly involving the taxpayer in question here. The taxpayer here was
not relying on the later decision of the NY Tribunal in those other cases,
because those cases had not yet been decided and they were not party to them.

I'm not sure I disagree with your overall conclusion, but I don't think you are
doing the New York Court of Appeals justice in your summary of that case.

Of course, this is a blog. Nonetheless, in cases like this, I think "due
process" would at least warrant linking to the text of the decision so people
can better judge for themselves. That decision can be found here.

david brunoriAug 24, 2015

Viv, yes, you are right, the case was more complicated than I made it out to be.
Blogs are not always the best place to present complications. That being said,
the NY legislature still changed the rules (even if curative) after the
taxpayers had done their business. I am not sure it is any better for the
government to say, here is what we really meant ten years ago. In any event,
my point was that as a matter of principle, retroactive tax laws should be a
rarity. Thank you!

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