Retroactive Tax Laws – But They Can’t Do That, Can They?

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We all know that change is likely coming to the tax regimes governing individual income and gift and estate taxes – but what if the change is already here? There are a number of potential effective dates floating around for President Biden’s tax bill, with some in the future and some already in the past.

The uncertainty of the substantive changes coupled with potential retroactive effective dates may leave many individuals looking for some form of steady ground, and understandably asking themselves, “but they can’t do that, can they?” After all, the U.S. Constitution says no “ex post facto Law shall be passed.” And understandably, a taxpayer should be able to confidently rely upon the law in place when they enter a transaction without fear that the same, published law might not later govern their transaction.

Surprisingly, the answer doesn’t follow our common intuition; and instead, the United States Supreme Court has repeatedly upheld retroactive tax law changes. As early as the 1930s, the Supreme Court has found retroactive tax laws constitutional and subject to a standard that depends upon whether “retroactive application is so harsh and oppressive as to transgress the constitutional limitation.” Welch v. Henry, 305 U.S. 134, 147 (1938). As the Supreme Court later noted:

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 a rational legislative purpose.

United States v. Carlton, 512 U.S. 26, 30-31 (1994) (quoting Pension Benefit Guar. Corp. v. R.A. Gray & Co., 467 U.S. 717, 729-30 (1984).

The standard established by the Supreme Court is undeniably broad and extremely deferential to the legislature. In fact, it’s hard to imagine a circumstance where a retroactive tax law change (whether an increase or a decrease) would not be supported by some rational legislative purpose. So, don’t expect certainty in either the substantive terms or the effective date of the proposed tax legislation. Rather, it’s best to bet on change – change that may already be here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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