Retroactive taxes are rarely unconstitutional, according to a report by the Congressional Research Service in late October.
There is a risk, with corporate tax reform looming, that the US Congress will change tax rates and repeal deductions or credits and that it may do so retroactively.
Often, when Congress takes away tax benefits, it does so effective as of the first vote by one of the tax-writing committees in the House or Senate. Tax rate changes are more likely to apply from the start of the year in which the change is enacted.
There are few examples of retroactive taxes being struck down by the US Supreme Court. The tax changes would have to cross a line in the fifth amendment to the US constitution, which guarantees Americans will not be “deprived of ... property ... without due process of the law.”
According to the Congressional Research Service, a retroactive tax is most likely to run afoul of this guarantee if the tax is applied many years in the past. The Supreme Court found fault with an estate tax change that caught transfers occurring up to 12 years in the past, but it has not had trouble with tax law changes that are applied retroactively to the start of the current year or even the year before.
When Congress takes away tax benefits, it usually provides transition relief to let anyone who signed a binding contract committing to an investment based on the benefits see the investment through. However, it is not required to do so. There are also questions this time whether to offer the standard binding contract relief. Some economists on the Joint Committee on Taxation staff question whether it makes sense to let companies keep tax incentives that are being repealed and also benefit from new lower tax rates.
According to the report, the Supreme Court has said the tax laws are “not a promise, and a taxpayer has no vested right” in the US tax code. Therefore, detrimental reliance by a taxpayer on existing law is not enough to protect him from a retroactive change. Lack of notice is also not a constitutional problem, although retroactive enactment of a gift tax in 1924 was struck down because it was a wholly new tax. Taxpayers who made gifts earlier in the year had no reason to suspect that the gifts might subject them to tax. “It does not appear the Court has found any other situations where lack of notice was an issue,” the Congressional Research Service said.
The report is called “Constitutionality of Retroactive Tax Legislation” and was released on October 25, 2012. CRS is the research arm of the Library of Congress. It writes reports on legal and policy issues at the request of members of Congress.