by John Anthony Castro, J.D., LL.M.
It has long been declared that “the power of Congress to enact income tax laws with retroactive effect is clear.” Nothing could be further from the truth. But don’t take our word from it, read below through a consolidated summary of all the U.S. Supreme Court’s rulings on this topic limiting retroactivity of tax laws with regard to time, unfair consequences, and unintended results stemming from arbitrary and harsh application.
Period of Retroactivity
“[R]etroactive imposition [of tax] does not necessarily infringe due process, and to challenge the present tax it is not enough to point out that the taxable event, the receipt of income, antedated the statute.”
In other words, a due process challenge to a retroactive tax law must point out more than the mere retroactive nature of the tax; retroactivity is not an automatic, per se violation of due process.
“The Court consistently has held that the application of an income tax statute to the entire calendar year in which enactment took place does not per se violate the Due Process Clause of the Fifth Amendment.”
In other words, tax laws passed late in the year that relate back to the start of the year are always valid as a matter of law.
“Nobody has a vested right in the rate of taxation, which may be retroactively changed at the will of Congress at least for periods of less than twelve months.”
In other words, a change in a tax rate going back further than 12 months would not benefit from established case law permitting retroactivity.
The retroactive nature is generally limited to “relatively short periods so as to include profits from transactions consummated while the statute was in process of enactment, or within so much of the calendar year as preceded the enactment.”
In other words, although retroactivity is permitted and generally limited to 12 months retroactive, it can only include transactions completed during the year or while the new tax law was being enacted. Beyond that, the retroactive tax would not benefit from established case law permitting retroactivity.
Section 965 applies to accumulated deferred foreign income going back to 1986. It was retroactive by 31 years.
“[T]he questioned provision cannot be declared in conflict with the Federal Constitution merely because it requires gains from prior but recent transactions to be treated as part of the taxpayer's gross income.”
In other words, a tax law can be retroactive to apply to “prior” transactions, but those must still be “recent transactions.” No one can reasonably argue that earnings and profits from 1987 qualify as recent transactions.
Unfair and Unintended Consequences
The U.S. Court of Federal Claims has held that there “is an element of fiction about a retroactive statute which particularly justifies an interpretation which will avoid unfair and unintended consequences.”
Arbitrary, Harsh, and Oppressive
Where the retroactive application of a tax law is “so harsh and oppressive as to transgress the constitutional limitation,” it will be found to violate due process. A tax law will be found unconstitutional if “the retroactive imposition of the tax after the [taxable event] was arbitrary, harsh, and oppressive.”
In other words, if the retroactive application is arbitrary, harsh, or oppressive, as applied to a particular taxpayer, it will be unconstitutional as applied to that taxpayer.
Arbitrary means “not restrained or limited in the exercise” thereof. Section 965 is not restrained in its application. Without limits, it applies to all foreign accumulated earnings and profits in a manner that produces a patently unfair and unintended consequence of punishing Main Street for the sins of Wall Street while those that Section 965 intended to apply against were able to implement defensive structures to prevent its application.
Harsh means “unduly severe” or “excessive” in “making demands.” Section 965 applies to accumulated earnings and profits going back to 1987. It is excessive with regard to retroactivity, unduly severe in applying to 31 years of accumulated earnings and profits, and it made demands in a manner that shocked the conscience of accountants and tax attorneys throughout the United States.
The oppressive nature was mitigated by the option to elect to pay the tax over eight annual installments, but this did not cure its arbitrary and harsh nature.
As you can see for yourself, the power of Congress to enact income tax laws with retroactive effect is not as clear as the legal community currently believes. Real lawyers delve into the details and intricacies of case law to formulate new legal opinions and mold consensus around that new interpretation of the law.
Congress does not have unlimited power to enact retroactive tax legislation. Section 965 went far beyond the period of retroactivity that the U.S. Supreme Court allows. Our firm intends to challenge any and all retroactive tax laws that we determine do not comport with established case law from the United States Supreme Court, which is the final word on what is the supreme law of the land.
In particular, we will be bringing a constitutional challenge to the Section 965 Deemed Repatriation Tax.
Other Cases to Distinguish
It should be noted that there are a number of federal cases that seemingly apply, but are easily distinguishable.
The U.S. Supreme Court has upheld two retroactive tax laws, but both involved tax penalties tied to wrongdoing by the taxpayer; one for intentional fraud and the other for substantial understatement. Lower courts also permitted retroactive tax penalties for abusive tax shelters that were indisputably linked to wrongdoing.
The United States Court of Appeals for the Second Circuit permitted a retroactive tax law going back 4 years but only because it was simply a codification of an existing IRS policy that had been published 15 years prior in a revenue ruling.
The U.S. Supreme Court also clarified in U.S. v. Darusmont that you cannot analogize gift and estate tax cases to income tax cases. This is the case that largely makes U.S. v. Carlton irrelevant in the income tax context since Carlton dealt with the estate tax. 512 U.S. 26 (1994).
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About the Author
John Anthony Castro, J.D., LL.M., is the Managing Partner of Castro & Co., the author of International Taxation in Plain English as well as International Estate Planning in Plain English, an esteemed graduate of Georgetown University Law Center in Washington DC, an OPM Fellow at Harvard Business School, and an internationally recognized tax attorney with offices in New York, Los Angeles, Miami, Chicago, Dallas, and Washington DC.
Bluebook Citation: John Anthony Castro, The Constitutionality of Retroactive Tax Legislation, Int’l Tax Online Law Journal (Feb. 6, 2020) url.
 Mertens Law of Fed. Income Tax’n § 4:15
 Charles B. Hochman, The Supreme Court and the Constitutionality of Retroactive Legislation, 73 Harv. L. Rev. 692, 706 (1960).
 Welch v. Henry, 305 U.S. 134, 146–147 (1938).
 U.S. v. Darusmont, 449 U.S. 292, 297 (1981).
 Cohan v. C.I.R., 39 F.2d 540, 545 (2d Cir. 1930).
 U.S. v. Hudson, 299 U.S. 498, 500 (1937).
 Cooper v. U.S., 280 U.S. 409, 411 (1930).
 Kress v. U.S., 159 F. Supp. 338, 341 (Ct. Cl. 1958).
 Welch v. Henry, 305 U.S. 134 (1938).
 U.S. v. Darusmont, 449 U.S. 292, 299 (1981).
 Helvering v. Mitchell, 303 U.S. 391, 401, 404–05 (1938). The Court upheld a 50% tax penalty where there was evidence of intentional fraud. There is undoubtedly a compelling governmental interest with evidence of wrongdoing by the taxpayer.
 Karpa v. C.I.R., 909 F.2d 784 (4th Cir. 1990).
 DeMartino v. C.I.R., 862 F.2d 400, 409 (2d Cir. 1988).
 Canisius Coll. v. U.S., 799 F.2d 18, 26 (2d Cir. 1986).
 449 U.S. 292, 299 (1981).
 This effectively invalidates any rationale expressed in the following cases: Blodgett v. Holden, 275 U.S. 142 (1927), modified, 276 U.S. 594 (1928); Untermyer v. Anderson, 276 U.S. 440 (1928); Canisius Coll. v. U.S., 799 F.2d 18, 26 (2d Cir. 1986); Fein v. U.S., 730 F.2d 1211, 1211 (8th Cir. 1984).