On June 26, 2013, by its decision in Windsor v. United States,1 the U.S. Supreme Court determined that Section 3 of 1996’s Defense of Marriage Act (DOMA), which defined marriage for federal law purposes as between one man and one woman, was unconstitutional.2 In the area of trusts and estates, the post-Windsor focus has been primarily on the allowance of the federal transfer tax marital deduction and whether a taxpayer can retroactively claim the marital deduction and collect a refund of prior transfer taxes paid. To a much lesser extent, additional focus has been placed on certain prior transactions in which the application of Windsor could potentially generate additional transfer taxes. Here’s an in-depth analysis of these two issues.3
Ability to Claim Refunds
The first issue is whether a taxpayer is permitted to seek a refund for prior transfer taxes paid due to the non-recognition for federal law purposes of the taxpayer’s same-sex spouse.4 The question is whether a subsequent change in the law is applied retroactively, so that a taxpayer may claim a refund based on a different tax position.
To answer this question, a technical distinction must be made with respect to changes in the law. A legislative change in a statute is prospective, unless specifically stated to be retroactive. Unconstitutionality, however, renders the statute wholly void and ineffective from the time of its enactment. Thus, the statute is inoperative, as if it had never been passed and never existed, so as to be void ab initio.5 If the statute is void ab initio, it follows that since a particular tax return filed in a prior year was based on a non-existent law, the return should be permitted to be amended in accordance with the laws deemed to be in effect for said year.
Based on the constitutional analysis described above, if a tax year isn’t closed by a statute of limitations, a taxpayer should have the ability to file an amended tax return for such year and claim any refund that’s due. For example, suppose that Ann, a Massachusetts taxpayer who’s a party to a legal same-sex marriage, purchased a mansion in 2011 for $16 million and titled the property as tenants-by-the-entirety with her spouse, Bea. Because pre-Windsor law didn’t recognize Bea as Ann’s “spouse” for federal transfer tax purposes, Ann’s transfer to Bea of one-half of the value of the mansion, or $8 million, didn’t qualify for the federal gift tax marital deduction under Internal Revenue Code Section 2523.6 Assuming that Ann hadn’t made any prior taxable gifts, Ann was responsible for the payment of $1.050 million in federal gift taxes, which were timely paid with her 2011 federal gift tax return on
April 17, 2012.
As a result of the void ab initio effect of DOMA’s unconstitutionality, Bea should now retroactively be treated as Ann’s spouse. Since tax year 2011 is within the applicable refund limitations period under IRC Section 6511(a), Ann should be able to claim a refund for her gift taxes paid by declaring Bea as her spouse for federal transfer tax purposes and applying the federal gift tax marital deduction.
The result isn’t as clear if the facts are changed so that Ann’s purchase occurred in 2008. Applying the 2008 transfer tax rate schedule and gift tax applicable exclusion amount of $1 million, Ann’s gift tax liability is $3.135 million. For refund purposes, pursuant to Section 6511(a), 2008 isn’t a year subject to a refund claim in 2013, because the claim wouldn’t have been made within the later of three years from the filing date of the return or two years from the payment of the tax. However, in 2013, DOMA, which caused Ann not to claim the federal estate tax marital deduction, is deemed to have never existed. The issue becomes whether the unconstitutionality supersedes the statute of limitations.
There’s no statute or Internal Revenue Service ruling on point; therefore, the answer must be derived from judicial precedent.7 While there are no Supreme Court decisions on this topic, the Supreme Court has discussed the issue of unconstitutionality as to state tax statutes.
The leading case is McKesson Corp. v. Division of Alcoholic Beverages and Tobacco, Dept. of Business.8 In McKesson, wholesale liquor distributors in Florida filed suit, challenging the Florida excise tax that gave preferential treatment to beverages that were manufactured from Florida-grown citrus and other agricultural crops and then bottled in state. The Florida lower courts invalidated the tax scheme under the commerce clause of the U.S. Constitution. On appeal to the Florida Supreme Court, the lower court decisions were upheld, but the Florida Supreme Court didn’t provide for any post-tax payment refunds, so the liquor distributors appealed to the U.S. Supreme Court.9
In its decision, the Supreme Court concluded that if a state penalizes taxpayers for failure to remit their taxes in a timely fashion, thus requiring them to pay first and obtain review later, the due process clause of the 14th Amendment requires that the state afford a meaningful post-payment remedy for taxes paid pursuant to an unconstitutional tax scheme. The Supreme Court also stated that:
. . . in the future, States may avail themselves of a variety of procedural protections against any disruptive effects of a tax scheme’s invalidation, such as providing by statute that refunds will be available to only those taxpayers paying under protest, or enforcing relatively short statutes of limitation applicable to refund actions … Such procedural measures would sufficiently protect States’ fiscal security when weighed against their obligation to provide meaningful relief for their unconstitutional taxation.10
By the emphasized statement (procedural statement), the Supreme Court is seemingly stating that for “closed” tax years, so long as the taxpayer had some form of “post-deprivation remedy,” a refund is allowable. The parameters of the remedy may, however, be established solely by the state; all that matters is that the state must provide a remedy. The question, though, is whether the procedural statement is a conclusion as part of the Supreme Court’s holding or dicta used to illustrate a point. In other words, does a statute of limitations applicable to the tax matter remedy, however short, automatically satisfy the Supreme Court’s test for a post-deprivation remedy, or is this is a subjective test to be applied on a case-by-case basis, thus allowing for extrinsic evidence to determine whether the length of the statute of limitations is sufficient?
Several subsequent Supreme Court opinions, including Davis v. Michigan Dept. of Treasury,11 Harper v. Virginia Dept. of Taxation12 and Reich v. Collins,13 adopted the principles of McKesson and held that retroactivity applied to the unconstitutionality of state taxes, provided that an adequate, post-deprivation remedy was available. These cases didn’t, however, interpret the meaning of the procedural statement as part of their respective holdings.
The next question is whether McKesson’s 14th Amendment analysis can be applied to a federal tax statute by applying the same reasoning to the 5th Amendment.
The leading federal decision to apply this logic is Stone Container Corp. v. United States.14 In Stone Container, Stone Container Corp. (Stone), along with other corporations, brought an action to recover harbor maintenance taxes that they had paid to the federal government and which were deemed to be unconstitutional.
In its analysis, the Federal Circuit Court of Appeals cited McKesson’s 14th Amendment analysis and stated that, although McKesson is based on the due process clause of the 14th Amendment, its principles are equally applicable to the federal government through the due process clause of the 5th Amendment. Thus, Stone was entitled to pursue a refund as a result of the tax’s unconstitutionality. However, the applicable statute of limitations was closed, so Stone argued that the unconstitutionality should prevail over the statute of limitations. The Federal Circuit rejected this argument, again citing McKesson; specifically, the procedural statement. The Federal Circuit stated that under McKesson, it’s important that the taxing authority offers a post-deprivation remedy, and this is satisfied by the ability to file for a refund. Thus, the relatively short period of time for a refund claim under Section 6511(a) satisfied the procedural statement requirements. Responding to Stone’s argument that the procedural statement was dicta, the Federal Circuit acknowledged the argument but failed to engage in the discussion, instead stating that as “a subordinate Federal court, we do not share the Supreme Court’s latitude in disregarding the language in its own prior opinions.”15
Application to DOMA
Applying this logic to DOMA, a taxpayer must seemingly apply McKesson and argue that DOMA’s unconstitutionality deprived him (or his spouse’s estate) of property (that is, tax dollars paid as a result of a void ab initio statute) without due process to obtain a refund. McKesson required an unconstitutionality determination; this has already been granted, courtesy of Windsor. McKesson also required that a post-deprivation remedy be available. As with Stone Container, the post-deprivation remedy is found in the taxpayer’s ability to claim a refund. If the limitations period is closed, the taxpayer must find a way to convince a court that the procedural statement is subjective.
The IRS could argue in this instance that, even if the applicable statute of limitations under Section 6511(a) is deemed to be insufficient, taxpayers have another post-deprivation remedy to extend the statute—the “protective claim” for refund. While taxpayers have had the authority for protective claims for refund, procedurally it remained unclear exactly what was required to ensure acceptance of the claim. The IRS issued formal guidance under Revenue Procedure 2011-48 (Oct. 14, 2011) with respect to the filing of a protective claim for refund regarding additional administrative expenses and debts pursuant to IRC Section 2053. Although Rev. Proc. 2011-48 only applies to Section 2053 deductions, the procedures could be applied to the formal filing of a protective claim for refund for IRC Sections 2056 (as to the estate tax) or 2523 (as to the gift tax) deductions. Therefore, it follows that for a closed tax year, a donor same-sex spouse or the executor of a deceased same-sex spouse could file for a protective marital deduction election to stay the statute of limitations for filing for refunds in accordance with Section 6511(a). If this filing doesn’t occur prior to the tolling of the statute, the refund claim is barred.
The taxpayer’s counterargument would be that, during the limitations period, it was completely unreasonable to assume that DOMA would be judicially determined to be unconstitutional; therefore, there was no reasonable basis for the taxpayer to file a protective claim for refund. In other words, some form of remoteness test must be applied to the procedural statement.
Considering that judicial challenges have only recently been successful,16 in 2009, the likelihood of the repeal of DOMA or a Supreme Court unconstitutionality ruling was infinitesimal. In 2005, the Middle District of Florida in Wilson v. Ake17 upheld the constitutionality of Florida’s DOMA-type statute, namely, Fla. Stat. Sec-tion 741.212(2). For those taxpayers who filed returns in now-closed years, the question is whether it would be reasonable to bar taxpayers from challenging closed tax years because they failed to file a protective claim for refund. The basis for the reasonableness is the remoteness (at the time) of ever collecting the sought after refund amount.
Not all federal transfer tax matters involving DOMA involve a refund claim—if refunds are authorized, then retroactive assessments should also be authorized. In the transfer tax realm, the assessment applicability concerns those same-sex married couples who engaged in the common law
grantor retained income trust (GRIT) technique.
Until Windsor, it was possible for same-sex married couples to engage in a common law GRIT. Until 1990, common law GRITs were a popular estate-planning technique used to transfer trust property to the next generation at a reduced transfer tax value. A common law GRIT involved the retention by the grantor of income interest in a trust for a fixed number of years. On the termination of the income interest, the property passed to other family members. Assuming that the grantor survived the retained term, for transfer tax purposes, only the actuarial value of the remainder interest was a taxable gift by the grantor.
With the application of IRC Section 2702, common law GRITs were rendered ineffective; because the remainder interest passed to a family member, the transfer tax value of the grantor’s retained income interest is determined to be $0. However, because a same-sex spouse wasn’t considered to be a “spouse” for purposes of federal law, a common law GRIT with a remainder interest that passed to the surviving same-sex spouse didn’t violate Section 2702.
Thus, suppose that in September 2008, Al, a 50-year-old male married to a same-sex spouse in Massachusetts, transferred $10 million to a common law GRIT, retaining a 29-year income interest. On the conclusion of the retained interest, the remainder passes to Ben, his spouse, who’s 35 years old. Assuming that Al hadn’t used any of his gift tax applicable exclusion amount, the value of the taxable gift of the remainder interest is $997,900, or slightly less than the amount of Al’s gift tax applicable exclusion amount.
As a result of the Windsor opinion, Ben is now Al’s spouse for federal transfer tax purposes; therefore, he’s a “family member” for the purposes of Sec-
tion 2702. Although the 3-year statute of limitations for assessments under IRC Section 6501(a) expired on April 15, 2012, because Ben is now a spouse, the provisions of Section 2702 would value Al’s retained interest at $0, resulting in a taxable transfer of $10 million, or $9,002,100 more than what was reported by Al as a taxable gift. Because the new taxable transfer amount overwhelmingly exceeds 25 percent of the originally reported taxable transfer, the provisions of IRC Section 6501(e)(2) extend the statute of limitations for assessment of gift taxes to six years, which means that the IRS can technically assess a tax deficiency against Al for the additional value of the taxable transfer (although it’s unlikely that the IRS would so assess).
1. United States v. Windsor, 570 U.S. ___, 2013 LEXIS 4935 (2013).
2. For purposes of this article, Section 3 shall be referred to, generally, as the Defense of Marriage Act (DOMA).
3. Certain portions of this article are derived from George D. Karibjanian, “DOMA: What If Unconstitutionality Becomes a Reality?” LISI Estate Planning Email Newsletter #1986 (July 16, 2012); George D. Karibjanian, “Windsor and Perry: A Supreme Split Decision,” LISI Estate Planning Email Newsletter #2110 (June 26, 2013); and George D. Karibjanian, “Guidance on Effect of the United States Supreme Court’s Decision in Windsor v. United States,” as filed with Department of Treasury on July 18, 2013 (GDK Treasury Comments).
4. The issue of whether the state of residence of the couple recognizes the marriage and the effect that a non-recognition of the marriage may have on the application of federal benefits isn’t discussed in this article; for this purpose, it’s assumed that the marital deduction applies, regardless of the state of residence. For more information on this issue, see George D. Karibjanian, “Federal Law for Same-Sex Married Couples After Windsor: Equality for All or Only for Some?,” LISI Estate Planning Email Newsletter #2118 (July 23, 2013) and the GDK Treasury Comments.
5. 16A Am. Jur.2d Constitutional Law Section 195 (updated May 2012).
6. Unless otherwise indicated, all section references shall be to sections of the Internal Revenue Code of 1986, as amended.
7. A portion of this analysis is derived from Roger C. Siske, Michael R. Maryn and Barbara Smith, “What’s New In Employee Benefits: A Summary Of Current Case And Other Developments,” American Law Institute—American Bar Association Continuing Legal Education, ALI-ABA Course Of Study—Pension, Profit-Sharing, Welfare, And Other Compensation Plans (Oct. 12, 1995).
8. McKesson Corp. v. Division of Alcoholic Beverages and Tobacco, Dept. of Business, 496 U.S. 18 (June 4, 1990).
9. McKesson Corp. v. Division of Alcoholic Beverages and Tobacco, Dept. of Business, 524 So.2d 1000 (1988).
10. McKesson, supra note 8 at 50 (emphasis added).
11. Davis v. Michigan Dept. of Treasury, 489 U.S. 803 (1989).
12. Harper v. Virginia Dept. of Taxation, 509 U.S. 86 (1993).
13. Reich v. Collins, 513 U.S. 106 (Dec. 6, 1994).
14. Stone Container Corp. v. United States, 229 F.3d 1345 (Fed. Cir. 2000).
15. Ibid. at 1349-50.
16. Cases challenging DOMA have only been successful since 2010 and mostly in 2012. See, for example, Golinski v. Office of Personnel Management,
824 F. Supp.2d 968 (N.D. Cal., Feb. 22, 2012); Dragovich v. U.S. Department of Treasury, 872 F. Supp.2d 944A (N.D.Cal. May 24, 2012); Massachusetts v. U.S. Department of Health and Human Services, 682 F.3d 1 (1st Cir. Mass. May 31, 2012), aff’g Gill v. Office of Personnel Management, 99 F. Supp.2d 374
(D.Mass. July 8, 2010) (No. CIV. A. 09-10309-JLT); Pedersen v. Office of Personnel Management, 881 F. Supp.2d 294 (D.Conn. 2012).
17. Wilson v. Ake, 354 F. Supp. 1298 (M.D. Fla. 2005).