In United States v. Carlton, the Supreme Court rejected a Due Process challenge to the retroactive elimination of an estate tax deduction. In 1986, Congress revised the Internal Revenue Code to allow a deduction under 26 U.S.C. § 2057 for half the proceeds of a sale of employer securities by the executor of an estate to an employee stock ownership plan (ESOP). Jerry W. Carlton was the executor of Willametta K. Day's estate. In December 1986, Carlton used estate funds to purchase MCI stock valued at $11,206,000. Two days later, Carlton sold the stock to the MCI ESOP for $10,575,000, losing $631,000 in the transaction. Carlton filed a timely estate tax return, claiming a deduction under section 2057 for half the proceeds of the sale of stock, which amounted to a tax liability reduction of $2,501,161. In January 1987, the IRS announced it would interpret the deduction to be available only to estates of decedents who owned the securities immediately before death In February 1987, a bill was proposed in the House and Senate to codify the IRS interpretation. On December 22, 1987, the amendment to section 2057 was enacted. It provided that in order to qualify for the deduction, the securities sold to the ESOP must have been "directly owned" by the decedent "immediately before death. The amendment was made effective as if it had been included in the original statute of October 1986. The IRS disallowed Carlton's section 2057 deduction. Carlton paid the asserted tax deficiency, plus interest, filed a claim for a refund, and initiated a refund action in the United States District Court for the Central District of California, claiming that the retroactive application of the statute violated the Due Process Clause of the Fifth Amendment. The parties stipulated that if the statute could not be retroactively applied without violating the Constitution, Carlton would be entitled to a refund; else the Government would prevail. " The court held the tax was not so "unduly harsh and oppressive" as to violate due process and entered summary judgment for the United States." The court focused on: (1) whether the statute was a "wholly new tax" or a rate change in an existing tax; and (2) whether the change (amendment) was reasonably foreseeable. The court found the statute was simply a "rate change" and the change was foreseeable; therefore, the amendment did not violate the Due Process Clause. The Ninth Circuit Court of Appeals reversed the district court in a two-to- one decision, using a different test than the district court. The United States Supreme Court granted certiorari and reversed. The Court held retroactive application of a tax statute does not violate the Due Process Clause if the application of the statute is rationally related to a legitimate legislative purpose.
"Gambling with the IRS: The Enforcement of Retroactive Tax Statutes in United States v. Carlton,"
Mercer Law Review: Vol. 47:
4, Article 8.
Available at: https://digitalcommons.law.mercer.edu/jour_mlr/vol47/iss4/8