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Supreme Court Refuses to Hear Retroactivity Cases — What Does It Mean?

Tax Law Alert Dawn R. Gabel, David Brunori

On May 22, the United States Supreme Court denied several petitions for certiorari all seeking review of state court decisions that upheld retroactive tax legislation concerning the Multistate Tax Compact. The petitioners challenged state supreme court decisions in Michigan and Washington that found retroactive legislative changes did not violate the US Constitution.

The decisions stem from a multiyear debacle over the Multistate Tax Compact. The compact, signed by Washington and Michigan, provided taxpayers an election to use the traditional three factor formula to calculate corporate income tax liability. Later, the states in question adopted different formulas that would apply if taxpayers did not elect the three factor compact formula. Because some corporate taxpayers could significantly lower their tax burdens by electing the compact three-factor formula, the legislatures in Washington and Michigan repealed, retroactively, the compact and thereby precluded electing the three-factor formula. As a result, corporations that had made the election were then faced with retroactive tax liability years later.

The decision to deny the petitions was not surprising. It is very difficult to prevail in a claim that retroactive tax legislation violates the Due Process Clause of the US Constitution. The vast majority of challenges to retroactive tax laws have been unsuccessful. The courts have long held that the retroactive changes to tax statutes are valid as long as there is a "legitimate legislative purpose that is furthered by a rational means." In these cases, the state courts held that the Compact elections were unintended and that the government would lose substantial revenue.  Both of these reasons were deemed to be legitimate by the state courts.

We believe that retroactive tax legislation should be viewed warily from both a policy and legal perspective. Most taxpayers order their affairs to comply with the law. Changing the law after a company has taken action is, frankly, unfair. People who follow the rules should not be penalized later. As importantly, changing the law retroactively creates uncertainty in the business community. And this undermines confidence in government in general and the tax system in particular.

The Supreme Court's decision to deny review has implications beyond the Multistate Compact. It is likely that states will be encouraged by the Michigan and Washington victories. States may pursue more retroactive legislation particularly during times of budget problems as a result. We certainly think that it may be appropriate to challenge retroactive tax legislation at times. But many companies are likely to seek legislative or constitutional remedies. Currently about a half dozen states have constitutional limitations on retroactive legislation. Given the perceived unfairness of retroactive tax legislation, there are likely to be more.

If you have questions about retroactive tax legislation, or any other tax issue, please contact Dawn Gabel at [email protected]/(602) 230-4630, David Brunori at [email protected]/(202) 780-2634 or your Quarles & Brady attorney.