The Role of Federalism in Administering a National System of Taxation
Robert T. Danforth
Washington and Lee University - School of Law
Tax Lawyer, Vol. 57, No. 3, Spring 2004
There is no federal general common law.
State law creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed.
By erasing the careful line between state laws that purport to disclaim or exempt property interests after the fact, which the federal tax lien does not respect, and state laws' definition of property and property rights, which the federal tax lien does respect, the Court creates a new federal common law of property. This contravenes the previously settled rule that the definition and scope of property is left to the States.
This Article addresses the intersection between the federal tax laws and the state laws on which administration of the tax laws depend. Under our federal system of government, state laws generally prescribe the rights and duties arising from a transaction, while federal law determines the tax consequences that attend the state law rights and duties. The interplay of these two bodies of law generates multiple tensions. For example, to what extent must a federal court defer to the judgment of a state court concerning a state law matter with federal tax implications? To what extent are state-to-state variations in law respected by those charged with administering federal tax laws, given the countervailing desire for national uniformity in tax law application? To what extent should federal law discourage state legislative "gaming" of the tax system - i.e., state legislative efforts designed specifically to achieve federal tax advantages for its residents (or others availing themselves of favorable state law)? This Article considers these tensions by examining two contrasting legal developments. The first is the gaming phenomenon, which the Article examines specifically in the context of the federal tax laws concerning gratuitous transfers. The second is an apparent judicial trend toward a federal common law of property rights, with a focus on how that trend may affect the traditional primacy of state law concerning such matters.
The Article begins with an overview of the traditional rules governing the interplay of state law and federal tax law. It then examines several recent state legislative efforts to craft laws producing favorable federal transfer tax and related income tax consequences. Next, the Article critically examines a trend in the federal courts away from the primacy of state law concerning property rights having federal tax implications. That is followed by a consideration of the extent to which the latter trend may undermine the tax advantages intended to accompany the recent state legislative developments. The Article observes that some of these developments may not withstand federal judicial scrutiny but criticizes this likely result as raising federalism concerns. Finally, the analysis concludes by asserting that public policy concerns about the gaming phenomenon should be addressed by Congress, not the federal courts.
Accepted Paper Series
Date posted: July 25, 2004
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