Retroactivity is an endemic problem in the state tax world. In this year alone, we have seen retroactive repeal of the Multistate Tax Compact (MTC) in Michigan, as well as significant retroactivity issues in New York, New Jersey and Virginia. But after decades of states changing the rules on taxpayers after-the-fact, relief may be on the way if the Supreme Court of the United States grants certiorari in a Washington estate tax case, Hambleton v. Washington, with retroactivity that makes you say “What the heck?”.
The taxpayers filed a petition for certiorari on June 5, 2015. The Court requested a response, which is now due by September 9, 2015. The Tax Executives Institute filed an amicus brief on July 6, 2015.
The case involves two widows’ estates. As stated in the petition:
Helen Hambleton died in 2006, and Jessie Macbride died in 2007. Each was the passive lifetime beneficiary of a trust established in her deceased husband’s estate, and neither possessed a power under the trust instrument to dispose of the trust assets. Under the Washington estate tax law at the time of their deaths, the tax did not apply to the value of those trust assets. In 2013, however, the Washington Legislature amended the estate tax statutes retroactively back to 2005, exposing their estates to nearly two million dollars of back taxes.
In 2005, Washington state enacted an estate tax that was intended to operate on a standalone basis, separate from the federal estate tax. In interpreting the new law, the Department of Revenue issued regulations that the transfer of property from the petitioners’ husbands to the petitioners through a Qualified Terminable Interest Property (QTIP) trust was not subject to the Washington estate tax. The Department then reversed its position and assessed tax. Petitioners, along with other estates, challenged the Department’s position and won in Washington Supreme Court (In re Estate of Bracken, 290 P.3d 99 (Wash. 2012)). Then in 2013, the Washington legislature amended the estate tax to retroactively adopt the Department’s position, going back to 2005. The petitioners challenged this law up to the Washington Supreme Court, which held in favor of the Department and concluded that the retroactive change satisfied the due process clause under a rational basis standard.
The petition urges the Supreme Court to take the case to resolve the uncertainty as to “how long is too long” when it comes to retroactive taxes, citing multiple examples of past and ongoing litigation in which lower courts have taken divergent approaches to the length of retroactivity that is permissible. Of particular interest, one of the cases cited is International Business Machines Corp. v. Michigan Department of Treasury, 852 N.W.2d 865 (Mich. 2014). The retroactive repeal of the MTC election in Michigan is a central issue in that ongoing litigation. If the Supreme Court takes Hambleton, its decision would likely impact the Michigan MTC litigation. The recent decision by the New York Court of Appeals, allowing retroactivity that a lower court had voided, Caprio v. New York Department of Taxation and Finance, no. 116 (slip op. Jul. 1, 2015), is another example of a retroactive tax that could be affected if the Supreme Court takes up Hambleton.
It is hard to imagine a more sympathetic situation for a due process retroactivity challenge to a state tax. The taxpayers took a position on their returns consistent with the law and regulations, challenged the Department’s arbitrary re-interpretation of the law and won. The Supreme Court of Washington had made a definitive interpretation as to the application of the law as then in effect. Unfortunately, the legislature then retroactively amended the statute in an effort to raise revenue, subjecting the petitioners to a tax that was not owed under the law at the time. This type of chain of events is inherently unfair, and if allowed, potentially subjects taxpayers to new tax liabilities at any time. For instance, if the imposition of an entirely new tax is allowed, then what could stop a legislature from raising money by retroactively increasing the corporate income tax rate for the previous few years on all taxpayers because the legislature did not budget correctly with the initial passage of the rate?
It will be interesting to see if the Court takes up this case as a vehicle to address the retroactivity question, as the Court has had opportunities in the past to review other retroactive state tax impositions but has declined (e.g., Miller v. Johnson Controls, Inc., 296 S.W.3d 392 (Ky. 2009), cert. denied, 560 U.S. 935 (2010)). There is some hope for certiorari given the Roberts Court’s recent willingness to take state tax cases (e.g. Direct Marketing Association, Wynne, Hyatt); until the decision on certiorari this fall, we won’t know whether both death and taxes are truly certain.