Why is October 1st Significant for the Estate Tax Debate?

My original goal was to finish my series on administering an estate in the Virginia Probate Court system before turning to other topics but the turn of seasons and Congress’s inaction changed that. October 1st is a significant date impacting the federal estate tax debate that has gone on for the last year. In a normal tax year, estate tax returns, without extensions are due 9 months from the date off death. October 1st is the first date for estate tax returns to be due for people who died on January 1st of 2010.  But with no federal estate tax, no returns are due.

In 2010, someone with a taxable estate in past years would owe no estate tax if that person died this year. There are numerous articles (here, here, and here) on the 5 billionaires (Mary Janet Cargill, Dan Duncan, Walter Shorenstein, George Steinbrenner and John Kluge) that have all died this year and will not pay any federal estate tax.  You can also read my take here on how, unlike Georgia Frontiere’s family being forced to sell the St Louis Rams to pay the federal estate tax because she died in 2008; Steinbrenner’s dying in 2010 saved his heirs from selling the Yankees. Because these billionaires, along with other wealthy individuals have died in 2010 owing no federal estate tax, numerous politicians have been trying to create an estate tax that would be retroactive back to the beginning of the year.  In addition to the numerous legal arguments made about being able to make the estate tax retroactive, the passing of October 1st, also augments the legal arguments with a fairness position against retroactivity.

I don’t want to get deeply into the constitutional arguments about the possibility of a retroactive estate tax but I’ll provide a brief summary.  Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) eliminating the estate tax in 2010. There are two cases that most deal with applying taxes retroactively: United States v. Carlton, 512 U.S. 26 (1994) and Nationsbank of Texas, N.A. v. U.S, 269 F3d 1332 (Fed.Cir.2001).

Carlton dealt with a man dying in September of 1985. On December 10, 1986, his estate purchased shares of a corporation which it two days later sold to an ESOP. The estate claimed a deduction on its estate tax return under IRC § 2057 for half the proceeds of the sale that was filed on December 29, 1986.  On January 5, 1987, the IRS announced that it would grant the deduction only when the securities were owned before the person’s death. On December 22, 1987, an amendment to this effect was enacted and made effective as if it were contained in the statute enacted on October 1, 1986. The Supreme Court agreeing with the IRS’s stated a two-part doctrine for upholding the constitutionality of retroactive tax legislation if (1) the legislation has a rational legislative purpose and is not arbitrary; and (2) the period of retroactivity is not excessive.

Nationsbank case applied the Supreme Court’s test several years later. On January 1, 1993, the 55% top estate and gift tax rate lapsed to 50%. President Clinton signed OBRA on Aug. 10, 1993, raising the top rate back to 55%, retroactive to Jan. 1, 1993. The decedent died in March 1993 with a taxable estate when the top rate was 50% and the estate challenged the constitutionality of the retroactive tax legislation applicability to the estate. The Federal Circuit held that the retroactive rate increase was constitutional under the two-part Carlton test: (1) it had a rational legislative purpose (to apply the same rate to all decedents dying in 1993, regardless of the month of death); and (2) the 8-month period of retroactivity was not excessive (because the Supreme Court had approved a 14-month period of retroactivity in Carlton).

It is Judge Plager’s dissent that is most interesting:

I cannot dispute that the weight of judicial opinion, though not the weight of either history or logic, currently argues for affirming the judgment of the trial ct; the majority dutifully rounds up the usual judicial suspects. But there are times when the gap between law and justice is too stark to be ignored. This is one of them. It is simply unfair, and I believe it should be unconstitutional, in these circumstances to enact a statute that imposes a tax on a citizen based on an event that occurred before the tax was enacted. Retroactive leg is inherently offensive to the natural law of decency, to the principles of the social compact set out in the Declaration of Independence, and to the underlying tenets of the Constitution….

Yes, the majority has the law on its side, if following what other courts have said is the law. . . .

Congress is perfectly capable of raising all the revenue it needs without making its tax laws reach backward, taking property from citizens based on events that, at the time they occurred, were not subject to the new law.”

Applying a retroactive tax back to January 1st might not also meet the two-step doctrine of Carlton. First, the issue is whether applying back an estate tax back to January 1st when there is no estate tax code would serve a legislative purpose or be arbitrary. Legislatively would be the easier hurdle given the need of the government to raise revenue. The counter-arguments is that EGTRRA eliminated the stepped-up basis exempt for capital gains made on transfers occurring at death during death specifically to address government’s revenue need.  But that is a relatively weak argument so a retroactive estate tax would likely be okay legislatively.

But, whether retroactive application of an estate tax would not be arbitrary is much different.  Nationsbank would not help much because the court only looked at a 5% rate change applied to everyone.  Everyone in 1993 still had to file federal estate tax returns with the IRS. Here there is no need. In Nationsbank, the issue concerned the amount of the tax paid and not if there was even a tax. The issue, now, is if you can apply a tax that never existed back to the first of the year.  It could certainly be argued that it is arbitrary to allow an estate to pass through October 1st without a specific tax and then apply an entire difference tax scheme to the estate post the filing date. As I said, currently, there are approximately 40 different bills in Congress dealing with the estate tax. Which bill would be applicable to an estate tax return that does not even need to be filed?

Here is where the question of October 1st becomes significant.  Normally, federal estate tax returns are due 9 months from the date of death of the decedent.  But no federal returns are due because there is no estate tax in 2010.  However, a number of states do have state estate tax and, generally, the states conform to the federal time frame.  Thus, personal representatives have been readying to file state estate tax forms for decedents dying on January 1, 2010.

Judge Plager’s dissent comes into play, too.  It could be argued that it is patently unjust to allow the October 1st date to pass freeing personal representative from filing a federal estate tax return but then reach back from the future forcing a personal representative to then file a return months or even a year after the fact.  At some point, an estate needs to be closed for everyone. As Plager notes it seems unfair “to enact a statute that imposes a tax on a citizen based on an event that occurred before the tax was enacted,” particularly where there was no tax.

As for the time period, Carlton allowed for a 14 month retroactive application, so the current 9 month period would likely meet constitutional mustard.

If, a bill had passed earlier this year, I would think retroactive application would be more likely found to be constitutional. But, with most of the year gone, it could be argued the delay is excessive.

Given the passing of October 1st, and, estate tax returns would be due in a normal year, the argument that a retroactive estate tax is constitutional has been weakened based on standing precedent but also based on fairness, as advocated by Judge Plager.


About Chris Guest

I am a trust and estate planning attorney working in the Washington, DC metro area. I offer comprehensive estate planning, trust administration, probate services and general business counseling for accountants, attorneys, business owners, consultants, federal and local government employees, retirees, other business professionals and other individuals.
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