Opinion ID: 1990251
Heading Depth: 2
Heading Rank: 1

Heading: The Retroactive Reach Of H.B. 541 Is Unreasonable And So Violates The Due Process Clause.

Text: The Supreme Court addressed the issue of retroactive tax legislation in United States v. Carlton, 512 U.S. 26, 114 S.Ct. 2018, 129 L.Ed.2d 22 (1994). Carlton involved an estate tax provision originally enacted in October 1986 which provided for a deduction when an estate sold stock to an employee stock-ownership plan (ESOP). In December 1986, Carlton, the executor of an estate, used estate funds to purchase stock which he then resold to an ESOP for the express purpose of claiming the estate tax deduction. A week after Carlton filed the estate tax return, the Internal Revenue Service announced that it would seek clarifying legislation because the deduction had been intended only for estates where the stock in question was owned by the decedent immediately before death. Approximately a year after Carlton's stock transactions, Congress amended 26 U.S.C. § 2057 so that it expressly applied only where the decedent had owned the stock at death. The amendment was made retroactive to the date of the original October 1986 enactment. In upholding the amendment the Supreme Court noted that tax legislation is frequently made to apply retroactively to transactions completed earlier in the year of enactment or even in the year prior to enactment. The Court explained that [t]he due process standard to be applied to tax statutes with retroactive effect, therefore, is the same as that generally applicable to retroactive economic legislation: Provided that the retroactive application of a statute is supported by a legitimate legislative purpose furthered by rational means, judgments about the wisdom of such legislation remain within the exclusive province of the legislative and executive branches.... To be sure,... retroactive legislation does have to meet a burden not faced by legislation that has only future effects.... The retroactive aspects of legislation, as well as the prospective aspects, must meet the test of due process, and the justifications for the latter may not suffice for the former'.... But that burden is met simply by showing that the retroactive application of the legislation is itself justified by rational legislative purpose. Id. at 30-31, 114 S.Ct. 2018, (quoting from Pension Benefit Guaranty Corporation v. R.A. Gray & Co., 467 U.S. 717, 733, 104 S.Ct. 2709, 81 L.Ed.2d 601 (1984)). The 1987 estate tax amendment passed that test, the Carlton Court held, because [f]irst, Congress' purpose in enacting the amendment was neither illegitimate nor arbitrary. Congress acted to correct what it reasonably viewed as a mistake in the original 1986 provision that would have created a significant and unanticipated revenue loss. There is no plausible contention that Congress acted with an improper motive, as by targeting estate representatives such as Carlton after deliberately inducing them to engage in ESOP transactions. Congress, of course, might have chosen to make up the unanticipated revenue loss through general prospective taxation, but that choice would have burdened equally innocent taxpayers. Instead, it decided to prevent the loss by denying the deduction to those who had made purely tax-motivated stock transfers. We cannot say that its decision was unreasonable. Second, Congress acted promptly and established only a modest period of retroactivity. This Court noted in United States v. Darusmont, 449 U.S. at 296 [101 S.Ct. 549], that Congress almost without exception has given general revenue statutes effective dates prior to the dates of actual enactment. This customary congressional practice generally has been confined to short and limited periods required by the practicalities of producing national legislation. Id. at 296-297 [101 S.Ct. 549]. In Welch v. Henry, 305 U.S. 134, 59 S.Ct. 121, 83 L.Ed. 87, [] (1938), the Court upheld a Wisconsin income tax adopted in 1935 on dividends received in 1933. The Court stated that the `recent transactions' to which a tax law may be retroactively applied must be taken to include the receipt of income during the year of the legislative session preceding that of its enactment. Id. at 150 [59 S.Ct. 121]. Here, the actual retroactive effect of the 1987 amendment extended for a period only slightly greater than one year. Moreover, the amendment was proposed by the IRS in January 1987 and by Congress in February 1987, within a few months of § 2057's original enactment. Id. at 32-33, 114 S.Ct. 2018 (emphasis supplied). Recent transactions, then, may be retroactively taxed, provided that the retroactive application of the statute is itself a reasonable means of furthering a legitimate state purpose. Although the Carlton Court refrained from defining recent transactions beyond noting that they would include transactions during the year of the legislative session preceding that of [the retroactive statute's] enactment, the Court's discussion indicates that the length of the retroactivity period is an important factor bearing on the reasonableness of the legislation and that a period much in excess of the one upheld in Welch (two years) would raise serious due process concerns. The Cabinet tries to downplay the prompt legislative response and the limited period of retroactivity in Carlton, insisting that neither of those factors is part of the due process analysis, an analysis which should focus solely on whether there is a legitimate legislative purpose. [8] Given the Commonwealth's delay of over five years in responding to the GTE decision and the long retroactive reach of H.B. 541, it is understandable that the Cabinet would want to minimize these aspects. Unfortunately, a fair reading of Carlton does not bear out that position. Central to the Carlton decision was the recognition that Congress had not disturbed long-standing transactions because, as Justice O'Connor noted in her concurring opinion, [t]he governmental interest in revising the tax laws must at some point give way to the taxpayer's interest in finality and repose. 512 U.S. at 37-38, 114 S.Ct. 2018. Here, KRS 141.200(18) offends Carlton 's timeliness standard in two ways. First, the statute was not passed promptly but rather five and one-half years after GTE . Second, it reaches back from its effective date of July 2000 to income received while RP 41P225 was in effect, from September 1988 until December 1994, a retroactivity period from five-and-a-half years to twelve years. I agree with the Court of Appeals that the state's interest in avoiding the financial consequences of refunds is an inadequate justification for belated legislation with such a long retroactivity period. If the state had carte blanc simply to impose retroactive taxes to avoid costly refund claims, then the refund remedy would be rendered uncertain if not entirely meaningless, a result that is clearly unreasonable, and in violation of Carlton 's due process standard. The Cabinet offers two cases in support of its position that retroactive tax legislation can reach back for an extended period of time, perhaps indefinitely, and still satisfy due process. [9] Neither case supports the unlimited power which the Cabinet attributes to a taxing authority. In Montana Rail Link, Inc. v. United States, 76 F.3d 991 (9th Cir.1996), a railroad had made tax payments based on the less favorable reading of an ambiguous statute, a provision of the Railroad Retirement Tax Act, which is the functional equivalent of the Social Security Act for railroad employers. In short, the railroad had mistakenly overpaid. The railroad later sought refunds for 1987 and 1988 based on a more favorable reading suggested by the Railroad Retirement Board. In 1989, while the refund claims were pending, Congress amended the RRTA to resolve the ambiguity in favor of the higher tax and made the amendment retroactive so as to apply to the entire period of the statute's ambiguity, from 1983 through 1989. The amendment thus nullified any refund claims based on the ambiguity. The Ninth Circuit held that the retroactive aspect of the amendment satisfied Carlton 's rational basis requirement because a shorter retroactive period would have severely decreased the benefits of some retired railroad workers. Significantly, the Montana Rail Court distinguished this situation from cases such as Reich, supra , where refund claims were based on taxes found to be illegal: At no point did MRL [the railroad] pay any tax barred by the Constitution or federal law. The constitutionality and legality of the RRTA is not in dispute, and MRL does not challenge the legitimacy of taxing 401(k) contributions per se. MRL erroneously equates its mistaken overpayment of taxes with the government's unlawful, improper and erroneous collection of taxes. Contrary to MRL's assertion, the IRS did not violate any federal law by accepting MRL's overpayment. Seeking a refund for one's own voluntary overpayment of a lawful tax is not the same as pursuing a remedy for payment of an illegal tax. Id. at 995 (emphasis supplied). Montana Rail thus addressed only the retroactive clarification of a valid tax which the taxpayer had voluntarily overpaid through its own misinterpretation of an ambiguous statute. While the Cabinet may find Montana Rail 's approval of a clarifying amendment stretching back six years appealing, the Ninth Circuit decision makes clear that it is not addressing the due process issues that arise when a tax has been unlawfully exacted and then retroactive tax laws are passed. King v. Campbell County, 217 S.W.3d 862 (Ky.App.2006) involved KRS 68.197, a statute authorizing counties to collect occupational license fees. Although a 1986 amendment to the statute required counties to give taxpayers a credit for city license fees they had paid, Campbell and Kenton Counties maintained that the amendment did not apply to them. Both had adopted occupational license fees in 1978 when the statute required the issue to be placed on the ballot for voter approval and when counties were permitted, but not required, to give taxpayers credit for their city occupational license fees. Only Campbell and Kenton Counties had passed occupational license fees under this older statutory procedure. The Court of Appeals agreed with the counties' interpretation that the amended statute did not require them to give county taxpayers tax credits for city occupational license fees. However, in City of Covington v. Kenton County, 149 S.W.3d 358 (Ky.2004), this Court decided that the amendment did apply to Kenton (and implicitly Campbell too) and thus exposed the county to potentially devastating refund claims for the withheld credits. [10] Almost immediately, in March 2005, the General Assembly amended KRS 68.197 to clarify that Campbell and Kenton Counties were not subject to the city fee credit. The legislation was made retroactive so as to abrogate the City of Covington decision and to nullify refund claims based upon it. In King the Court of Appeals rejected Campbell County taxpayer challenges to the retroactive legislation. The Court found that the General Assembly had acted promptly, consistent with Carlton, to further the legitimate legislative purpose of avoiding severe disruption of county finances and, that the unanticipated City of Covington decision had not interfered with settled expectations on the part of Campbell County taxpayers, who had acquiesced in the counties' interpretation of the ambiguous statute for years. [11] Unlike the amendment in Carlton, however, which withdrew an unambiguous deduction and deliberately undermined reasonable taxpayer reliance, House Bill 400 does not withdraw a provision upon which taxpayers have relied, but seeks to clarify the license fee credit provision in the wake of our Supreme Court's City of Covington decision. The Campbell County taxpayers could have sought refunds in 1986, when Campbell County first raised its license fee rates following the 1986 amendment to KRS 68.197. For all these years, however, the taxpayers acquiesced in the County's interpretation of that statute, an interpretation that this Court found reasonable, but the Supreme Court rejected. If there are settled expectations in this case, they are the County's, not the taxpayers. The taxpayers' expectations arose only with the Supreme Court's City of Covington decision in November 2004, and within a few short months, in March 2005, long before those expectations could be deemed settled or vested, the General Assembly had acted to revise the law and to shield Campbell and Kenton Counties from what it believed could be the devastating consequences of the Supreme Court's decision. In these circumstances-where the General Assembly has not attempted to withdraw legislation upon which taxpayers have relied in structuring their affairs, but has promptly sought to foreclose refunds as the result of an unanticipated judicial interpretation of a constitutionally valid tax provisionthe retroactive provisions of House Bill 400 do not run afoul of the timeliness concerns expressed by the United States Supreme Court in Carlton. 217 S.W.3d at 870. The Cabinet understandably focuses on King as an example of judicial validation of retroactive tax legislation stretching back for a period well in excess of the modest periods addressed in Carlton. King is admittedly more akin to the situation before this Court than the mistaken overpayments in Montana Rail but there are crucial differences in King and this case which bear strongly on the due process analysis. Campbell and Kenton Counties were the taxing authorities in King and City of Covington but their taxing authority was constrained by state statute. The counties construed the rather ambiguous statute (which significantly was not of their own making) as inapplicable to them and this construction, as noted above, was acquiesced in by county taxpayers for many years. The reasonableness and good faith of that particular construction, which relieved Campbell and Kenton of the obligation to credit county taxpayers for city occupational fees, was underscored by the fact that the Court of Appeals upheld it. When City of Covington was decided, as the Court of Appeals noted, it was an unanticipated judicial interpretation of a valid tax. In other words, the counties had interpreted the ambiguous statute passed by the General Assembly in a consistent, plausible way but this Court ultimately found that the taxpayers who eventually had begun to question the interpretation and who had brought suit to obtain the credits were, in fact, correct. Within four months of that decision, the General Assembly passed a statute that clarified its original intention that the tax credit did not apply to those counties where a license fee has been authorized by a public question approved by the voters. In short, the interpretation consistently followed by Campbell and Kenton Counties had been the legislative intent all along. This case presents a decidedly different scenario. Here, the Cabinet, with the General Assembly's acquiescence, had long construed KRS 141.120 and 141.200 as allowing combined reporting. Only in 1988, without any change in a settled law, did the Cabinet purport to adopt a different construction. In GTE this Court held that the Cabinet was not free to say that the statutes meant one thing one day and then the next day to say that they meant something entirely different. Its original reading of those statutes was reasonable, had not been corrected by the General Assembly, and thus was binding. Clearly King did not involve the taxing authority suddenly and unilaterally reinterpreting an unchanged tax law to the taxpayers' detriment. Moreover, while King arose from an unanticipated judicial interpretation, GTE could not possibly have been unanticipated. Taxpayers challenged the Cabinet's about-face in RP 41P225 promptly and GTE was a return to the precise reading of the statute that the Cabinet itself had engaged in for sixteen years. Given the long-standing, consistent interpretation of KRS 141.120 to allow combined reporting, KRS 141.200(18) cannot be deemed merely to abrogate GTE and to clarify what the law had always been. Like the estate tax amendment in Carlton, KRS 141.200(18) is an attempt to alter the tax law retroactively, but unlike the amendment in Carlton it purports to apply the change not just to recent transactions but to transactions (the receipt of income) in tax years from five years to twelve years earlier. Although I recognize the General Assembly's desire to spare the state's budget from the significant refund claims springing from the Cabinet's unauthorized 1988 rereading of KRS 141.120 and 141.200, I agree with the Court of Appeals that this five-year plus backward reach, particularly on these facts, exceeds what the Supreme Court has indicated is reasonable under the Due Process Clause and thus cannot be upheld. Simply put, difficult economic consequences can never justify disregarding citizens' due process rights.