As lawmakers consider the magnitude of tax increases, taxpayers may wonder whether those increases will be retroactive not only to the date of the bill’s introduction, but to the beginning of 2021. This is an important and interesting question: Can tax legislative increases be retroactive?
Under conventional wisdom, the answer is no. Taxpayers should be able to rely on the existing rules; otherwise, the government’s pursuit of short-term revenue could create a sense of unfairness and animosity toward the system.
In reality, however, the answer is yes. Tax increases can be retroactive, and not just to the current year.
As surprising as this may sound, there are few constitutional constraints on the legislature’s ability to set effective dates of legislation. Congress has wide discretion in its constitutional power to tax. When the question came before the Supreme Court about 250 years ago in Calder v. Bull, the justices held that the ex post facto clause of the Constitution prohibited only retroactive criminal laws. There was no prohibition on retroactive economic laws.
With few constitutional constraints, Congress has used various effective dates for tax legislation. For example, the Tax Reform Act of 1969 had more than 40 effective dates, many of which were retroactive to one of 20 pre-enactment dates. Congress can and has enacted tax legislation that was effective retroactively.
In 1993, retroactive tax legislation was being considered in Congress. The Omnibus Budget Reconciliation Act of 1993 (“OBRA ‘93”) increased the corporate rate from 34 percent to between 35 percent and 38 percent, added newly created 36 percent and 39.6 percent brackets to the top individual rate, and increased the top estate tax rate to 55 percent. The legislation had higher tax rates for tax years after Dec. 31, 1992, even though it was not enacted until August 1993 — meaning tax rates for most of 1993 were increased after the fact, and estate and gift tax rates that had expired were extended.
While Congress was working through that law, United States v. Carlton was winding its way through the courts on retroactive taxation under the Tax Reform Act of 1986. Under that law, Congress added a new estate tax provision granting a deduction for half the proceeds of “any sale of employer securities by the executor of an estate” to “an employee stock ownership plan.” The terms of the statute were clear and the taxpayer, Jerry Carlton, as executor of the estate of Willametta Day, followed them to take advantage of the deduction. In 1987, Congress changed the rules for the deduction, which meant that the estate no longer qualified to take it.
The U.S. Court of Appeals for the 9th Circuit, which decided the underlying case, found in favor of the estate, citing reasonable reliance and lack of notice. But the Supreme Court reversed the 9th Circuit and upheld the retroactive features of gift and estate taxes. Before Carlton, the Supreme Court had deferred to Congress’s legislative function, but did not necessarily bless statutes that negatively affected taxpayers who reasonably relied on preexisting law and had no notice of impending changes. Carlton made clear that Congress could make changes retroactive as long as the statute is “supported by a legitimate legislative purpose furthered by rational means.”
To withstand a constitutional challenge, retroactivity must be for a limited period, according to various court rulings. So for Biden’s purposes, it would seem clear that a statute retroactive to the beginning of the year, Jan. 1, would be fine. But could the retroactive tax increase go back to, say, last year?
Yes, and in fact, it could go back a lot further. For example, the 9th Circuit has upheld a tax statute that reached back seven years, holding that a shorter period of retroactivity, such as one or two years, “would have been arbitrary and irrational.” Although conventions to respect past congressional rules prevent such a clawback most of the time, it is possible.
Congress has used various effective dates in recent tax legislation with no real standard for how to choose a date. In terms of when these proposed increases might apply, taxpayers could expect many provisions to be effective as of the date they were introduced into committee. This prevents taxpayers from planning around the changes, which could happen if the provisions were effective at the beginning of the next year. This allows stakeholders to advocate for their position and the legislative body to address the issue carefully.
If Congress decides not to make the proposed tax increases retroactive, it will be most likely for practical purposes: At this point, it’s unlikely that a tax bill will be finished early enough to incorporate changes into IRS forms and software before large numbers of taxpayers begin filing their 2021 tax returns early next year. But if enough money is at stake, practicality might not stand in the way of retroactivity.