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Carlton v. United States

filed: August 10, 1992.


Appeal from the United States District Court for the Central District of California. D.C. No. CV-90-0685-AHS. Alicemarie H. Stotler, District Judge, Presiding.

Before: Arthur L. Alarcon, William A. Norris, and Diarmuid F. O'Scannlain, Circuit Judges. Opinion by Judge O'Scannlain; Dissent by Judge Norris.

Author: O'scannlain

O'SCANNLAIN, Circuit Judge:

We consider whether retroactive application of an amendment to the federal estate tax portion of the Internal Revenue Code violates due process.


On October 22, 1986, the Tax Reform Act of 1986 ("TRA") became law. One provision of the TRA allowed an estate to deduct half of the proceeds of a sale of securities to an Employee Stock Ownership Plan ("ESOP") from a decedent's gross estate ("the ESOP proceeds deduction"). See 26 U.S.C. § 2057*fn1 (repealed 1989). The result of the ESOP proceeds deduction was to remove half of the estate from the reach of the federal estate tax, to the extent the estate was comprised of money received from the sale of stock to an ESOP. This deduction, codified at section 2057 of the Internal Revenue Code, was available to any estate that could timely file its return after the enactment date of the TRA, irrespective of the date of death of the decedent. See 26 U.S.C. § 2057(c)(1).

The 99th Congress adjourned on October 18, 1986. Between passage by Congress of the TRA on September 27, 1986 and adjournment, Congress considered hundreds of potential technical and clerical amendments to the TRA, but only one proposed amendment related to section 2057: deletion of an extraneous "is." Furthermore, the parties have stipulated that "no bill or resolution was introduced that would have added any condition to the availability of the new section 2057 deduction other than those contained in the statute itself during the period between passage of the TRA and adjournment on October 18, 1986."

Willametta K. Day died on September 29, 1985. Because of an extension of the filing deadline not at issue here, her estate tax return was not due until December 29, 1986. As a matter of timeliness, the Day estate was potentially eligible for the ESOP proceeds deduction contained in section 2057.

Carlton was executor of the Day estate. He reviewed the TRA and determined that it was in the interest of the estate to utilize the new ESOP proceeds deduction. The parties have stipulated that in specific reliance on the newly enacted section 2057, Carlton purchased 1,500,000 shares of MCI stock on December 10, 1986 at an average price of $7.47 per share, for a total price of $11,206,000. Carlton chose to buy MCI shares because the trustee of the MCI ESOP had expressed an interest in purchasing MCI shares. At the time Carlton bought the shares, however, the MCI ESOP had not entered into any legally binding agreement to buy them from him; hence, the estate bore the risk of loss if the market in MCI stock declined. Two days later, the MCI ESOP agreed to buy the shares from the estate at $7.05 per share, which was about 26 cents below the mean market price that day, as well as below the price at which the shares were purchased. As part of the agreement, the MCI ESOP provided documentation that it was a qualifying ESOP as required under section 2057. See 26 U.S.C. § 2057(e). The total sale price was $10,575,000, or $631,000 below Carlton's purchase price. The government concedes that Carlton would not have sold the shares at a discount - and consequently the MCI ESOP would not have been able to acquire shares at a discount - if not for the section 2057 deduction.

On December 29, 1986, Carlton duly filed the estate tax return, in which he deducted $5,287,500 from the gross estate pursuant to the ESOP proceeds deduction. On behalf of the estate, Carlton paid a net estate tax of $18,752,250.

On January 5, 1987, the Internal Revenue Service ("IRS") issued an advance version of Notice 87-13, which stated, inter alia, that "pending the enactment of clarifying legislation," the IRS would not recognize a deduction pursuant to section 2057 unless the decedent had "directly owned" the securities before death ("the decedent ownership requirement"). Notice 87-13 was formally published on January 26, 1987. The government concedes that the decedent ownership requirement announced in Notice 87-13 was not contained in section 2057 as originally enacted in 1986, was not contained in any amendments to the TRA passed before the 99th Congress adjourned, nor was it in any of the proposed technical and clerical amendments to the TRA considered by the 99th Congress.

On February 26, 1987, a bill was introduced in the new 100th Congress to enact into law the decedent ownership requirement as announced in Notice 87-13 ("the 1987 amendment"). The bill eventually became law on December 22, 1987, and applied the decedent ownership requirement retroactively as if the TRA as originally enacted had contained such a requirement. See Pub. L. No. 100-203 § 10411,*fn2 101 Stat. 1330-432 (1987). The 1987 amendment was labeled a "Congressional Clarification of Estate Tax Deduction for Sales of Employer Securities" and its legislative history included a Committee Report statement:

As drafted, the estate tax deduction was significantly broader than what was originally contemplated by Congress in enacting the provision. The committee believes it is necessary to conform the statute to the original intent of Congress in order to prevent a significant revenue loss under the TRA.

H.R. Rep. No. 100-391(II), 100th Cong., 1st Sess. 1045 (1987), reprinted in 4 U.S.C.C.A.N. 2313-1, 2313-661 (1987).

The Day estate's tax return was audited, and the IRS determined a deficiency of $3,385,333. The net deficiency attributable to the disputed ESOP proceeds deduction was $2,501,161. Carlton does not dispute the remaining deficiency.

Carlton paid the total deficiency plus $996,953.18 in interest. On July 3, 1989, he filed a refund claim for that part of the deficiency attributable to the ESOP proceeds deduction. The IRS denied the refund claim. On October 11, 1990, Carlton filed a refund action in district court for $2,501,161 plus interest, costs, and attorneys' fees.

Carlton moved for summary judgment on stipulated facts, and the government moved to dismiss with prejudice, which the district court construed as a motion for summary judgment. The parties agreed to an order narrowing the potential issues in controversy. The government conceded that the estate was entitled to the ESOP proceeds deduction under section 2057 as passed in 1986, and that if the 1987 amendment could not be retroactively applied consistent with due process, that Carlton was entitled to judgment. Carlton conceded that if the 1987 amendment could be retroactively applied to his transaction, the estate would not be entitled to the ESOP proceeds deduction, that there would be no other basis for claiming the refund, and that the government would be entitled to judgment.

The district court granted the government's motion for summary judgment. The district court determined that the retroactive application of the 1987 amendment to the MCI ESOP transaction did not violate due process because the 1987 amendment did not impose a "wholly new tax." The district court also rejected Carlton's Contract Clause and Takings Clause arguments, and Carlton does not press those points on appeal.


Whether a statute may be applied retroactively consistent with the Due Process Clause is a question of law, and thus we review the district court's determination on this issue de novo. Licari v. Commissioner, 946 F.2d 690, 692 (9th Cir. 1991).



Over the past half-century the Supreme Court has consistently stated a single standard to determine if a tax statute may be applied retroactively consistent with the Due Process Clause.*fn3 Courts "must 'consider the nature of the tax and the circumstances in which it is laid before it can be said that its retroactive application is so harsh and oppressive as to transgress the constitutional limitation.' " United States v. Hemme, 476 U.S. 558, 568-69, 90 L. Ed. 2d 538, 106 S. Ct. 2071 (1986) (quoting Welch v. Henry, 305 U.S. 134, 147, 83 L. Ed. 87, 59 S. Ct. 121 (1938)); accord United States v. Darusmont, 449 U.S. 292, 299, 66 L. Ed. 2d 513, 101 S. Ct. 549 (1981) (per curiam) (court's inquiry is "whether a particular tax is so harsh and oppressive as to be a denial of due process").*fn4 Outside of the tax context, the constitutional standard is often stated differently: a retroactive application of a statute must be "arbitrary and irrational" to violate due process. See Usery v. Turner Elkhorn Mining Co., 428 U.S. 1, 15, 49 L. Ed. 2d 752, 96 S. Ct. 2882 (1976). The Supreme Court has made clear, however, that the "harsh and oppressive" standard used in the tax context "does not differ from the prohibition against arbitrary and irrational legislation that we clearly enunciated in Turner Elkhorn." Pension Benefit Guaranty Corp. v. R.A. Gray & Co., 467 U.S. 717, 733, 81 L. Ed. 2d 601, 104 S. Ct. 2709 (1984).

We are instructed to "consider the nature of the tax and the circumstances in which it is laid." We "perceive no . . . rigid standard of constitutionality in the decided cases. . . . We are guided, rather, by the more flexible criteria delineated by the Supreme Court in Welch v. Henry. . . ." Purvis v. United States, 501 F.2d 311, 313 (9th Cir. 1974) (quotations omitted), cert. denied, 420 U.S. 947 (1975). Accordingly, we reject the notion of a per se rule that tax statutes can never be retroactively applied. The Supreme Court has "made clear that some retrospective ...

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