Making an Offer in Compromise Does not Stop Seizure and Sale of Home

In United States v. Brabant-Scribner, No. 17-2825 (8th Cir. Aug. 17, 2018) the Eighth Circuit affirmed the decision of the district court allowing the sale of taxpayer’s home and affirmatively determining that an offer in compromise request filed by the taxpayer has no impact on the ability of the court to grant the request by the IRS to sell the home or on the IRS’ ability to sell the home once the court granted its approval. In reaching this conclusion the Eighth Circuit analyzes the exemptions to levy in IRC 6334 and the relief those provisions do and do not provide.

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Taxpayer owes the IRS over $500,000. The opinion does not discuss the actions by the taxpayer to pay or resolve her liability prior to the action by the IRS to sell her house. I imagine that the IRS considered her a “won’t pay” taxpayer. Before seeking to sell her home, the IRS had seized and sold her boat and levied on her bank accounts.

The 1998 Restructuring and Reform Act added IRC 6334(e)(1)(A) to require that prior to seizing a taxpayer’s principal residence the IRS must obtain the approval of a federal district court judge or magistrate in writing. Before the passage of this provision, the IRS could seize a taxpayer’s home with the same amount of prior approval needed to seize any other asset owned by the taxpayer. No approval was necessary to seize any asset of the taxpayer. Prior to 1998 collection due process did not exist. Prior to 1998 the 10 deadly sins did not exist one of which calls for the dismissal of an IRS employee who makes an inappropriate seizure. So, the landscape regarding seizures, and especially personal residence seizures, changed dramatically after 1998; however, the amount of litigation regarding seizure of personal residences is low and the Brabant-Scribner case offers a window on one aspect of this process.

As the IRS initiated the process of seizing her personal residence by obtaining the appropriate court approval, the taxpayer filed an offer in compromise. She filed an effective tax administration offer of $1.00, but the amount and sincerity of her offer do not really matter to the legal outcome of this case. The timing and the amount of the offer may have influenced the thinking of the judges and made them more inclined to dismiss her argument but her possibly bad faith effort to stop the approval and execution of the sale should not have affected the outcome here.

To convince the court to allow the sale of a personal residence, the IRS must show compliance with all legal and procedural requirements, show the debt remains unpaid and show that “no reasonable alternative” for collection of the debt exists. Taxpayer argued that her offer was a reasonable alternative; however, the court spends three paragraphs explaining that an offer does not matter in this situation. The relevant language in the applicable regulation is “reasonable alternative for collection of the taxpayer’s debt.” The court explains that the word “for” holds the key to the outcome.

“For” refers to an alternative to the sale of the personal residence such as an installment agreement or the offer of funds from another source to satisfy the debt. An offer in compromise is not an alternative for collection but an alternative “to” collection.

Having determined that the words of the regulation point toward a resolution other than an offer as providing the necessary alternative, the court looks at the remainder of the regulation for further support of its conclusion. It points to the provision in Treasury Regulation 301.6334-1(d)(2) which provides that the taxpayer has a right to object after the IRS makes its initial showing and “will be granted a hearing to rebut the Government’s prima facie case if the taxpayer … rais[es] a genuine issue of material fact demonstrating … other assets from which the liability can be satisfied.” This regulation, like the one providing an alternative “for” collection, looks not to relief from payment of the liability but a source for making payment. It does not provide the offer in compromise as a basis for relief. Based on this the court concludes that “nothing requires the district court to ensure that the IRS has fully considered a taxpayer’s compromise offer before approving a levy on a taxpayer’s home.”

Since the IRS properly made its case for seizing and selling the home and the taxpayer did not rebut that case, the Eighth Circuit affirms the decision of the district court to approve the sale. The decision provides clear guidance for district courts faced with the request by the IRS to seize and sell a personal residence. Personal residence seizures by the IRS remain rare at this point. Taxpayers faced with such a seizure, almost always taxpayers the IRS characterizes as “won’t pay” taxpayers, will find it difficult to stop the seizure and sale based on this decision. I do not think this decision will motivate the IRS to increase the number of personal residence seizures but it will make it a little easier to accomplish when it decides to go this route.

 

District Court Blesses Sale of Marital House to Satisfy Other Spouse’s Tax Liability

What happens when a spouse or other third party co-owns a house with someone who has a sizable federal tax liability? IRS seizures to satisfy an assessment are relatively rare. IRS attempts to enforce a lien and foreclose on a home are even rarer. And forced sales of homes when one of the co-owners of the house owes none of the taxes probably occurs only a handful of times a year.

We are in the process of reviewing cases and other developments that we have read over the past few months as we gear up to complete the last of the three updates we do annually for the Thomson Reuters treatise IRS Practice and Procedure. Earlier this year I read US v Tannenbaum, a case out of the Eastern District in New York where the IRS sought to enforce its lien and foreclose and sell upon a marital home in Brooklyn that was shared by the Tannenbaums, Sarah and Gershon. I flagged Tannenbaum for inclusion in our discussion of the government’s authority to force the sale of co-owned property under Section 7403.

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Including interest and penalties Gershon unfortunately had run up a couple of million dollars in income tax liabilities. I am not sure if he filed MFS or if Sarah were relieved of the liabilities via Section 6015; the opinion is silent but Sarah was not on the hook for those assessments. Since 1977, the Tannenbaums jointly owned a house in Brooklyn that had an appraised value of over $1.2 million (a far cry from the Brooklyn home values when I was born and lived there in the days of Mayor Lindsay).

While the tax assessment only related to Gershon, both had some history with the government. In the mid 90’s both Sarah and Gershon had been indicted for conspiracy to defraud or commit an offense against the US and for false statements made to the IRS. Gershon pleaded guilty to the conspiracy charges and Sarah entered into a deferred prosecution agreement and all charges were dropped against her. Gershon had been sentenced to a year and a day and supervised release.

That background takes us to the case at hand and likely matters in terms of how the government approached this case. IRS sought to enforce the assessment against Gershon by foreclosing on and forcing the sale of their Brooklyn house. Both lived in the house, where they raised their children and also now lived with Sarah’s disabled mom. The house was specially set up to accommodate Sarah’s mom, who was in her 80’s and bound to a wheelchair.

This takes us to an issue that we discuss heavily in the Saltz/Book treatise, courtesy of Keith who has taken the lead oar as primary author on the revised collection chapters. Under Section 7403, a federal district court can “determine the merits of all claims to and liens upon the property, and, in all cases where a claim or interest of the United States therein is established, may decree a sale of such property,…, and a distribution of the proceeds of such sale according to the findings of the court.

Yet that power to force a sale and distribution of the proceeds is limited. In the 1983 case US v Rodgers the Supreme Court said that while the government has broad discretion to force a sale, “Section 7403 does not require a district court to authorize a forced sale under absolutely all circumstances, and that some limited room is left in the statute for the exercise of reasoned discretion.” Keith has discussed the application of Rodgers in prior posts here and here

To assist courts in exercising that discretion, Rodgers identifies factors:

1) “the extent to which the Government’s financial interests would be prejudiced if it were relegated to a forced sale of the partial interest actually liable for the delinquent taxes[;]”

(2) “whether the third party with a nonliable separate interest in the property would, in the normal course of events (leaving aside § 7403 and eminent domain proceedings, of course), have a legally recognized expectation that that separate property would not be subject to forced sale by the delinquent taxpayer or his or her creditors[;]”

(3) “the likely prejudice to the third party, both in personal dislocation costs and … practical undercompensation [;]” and

(4) “the relative character and value of the nonliable and liable interests held in the property ….”

The Tannebaum opinion applies these factors to the case at hand. While I will not discuss all the factors here, usually the most interesting part of these cases considers the prejudice to the non liable party if there is a forced sale. Of course, when the government comes in and kicks you out of your marital residence (and one that here was the marital home for close to 40 years) there is going to be prejudice.

What is too much in terms of prejudice? Sarah starts off at an atmospheric disadvantage because of her (and Gershon’s) prior history with the government. It did not help that Gershon’s mother had bequeathed a condo to Sarah and Gershon’s sister in what looks like an attempt to transfer assets outside the reach of creditors, including Uncle Sam. In addition, the opinion suggests that Sarah had other assets at her disposal and upon sale of the Brooklyn house, she would be entitled to about $600,000, as the government offered to split the sale proceeds of the Brooklyn house equally.

Those facts led the court to conclude that there was little prejudice to Sarah if the government would go ahead with the sale, as Sarah could find somewhere else to live.

Despite those facts that were stacked up against Sarah I did find one aspect of her prejudice argument to be interesting. She emphasized that in thinking about prejudice the court should “consider intangible factors” and “other common sense special circumstances.” In particular, Sarah noted that the forced sale would also impact her elderly and disabled mom, who lived with Gershon and Sarah in Brooklyn. She also pointed to the unique character of the neighborhood, which was predominantly Orthodox Jewish, as were the Tannenbaums. To top it off, she included in her papers an affidavit from a local real estate broker who noted that there was little market turnover in the neighborhood and that the house had additional value to elderly residents due to its proximity to a hospital.

The court agreed with Sarah on the principle that intangible factors matter but in the end concluded that the mom’s presence and the neighborhood’s character did not tip the scales on prejudice. First, on the mom:

The Court sympathizes with Sarah Tannenbaum concerning the care of her mother. But the evidence does not support Sarah Tannenbaum’s argument that she is short on resources. First, her financial resources are not limited to her salary, an amount that she has not disclosed.

The opinion then discussed that she and her sister in law sold the condo they inherited from Gershon’s mom and that all things considered Sarah (and her mom) would be ok if the IRS sold the marital home given the assets she had at her disposal:

Nonetheless, her share of the Condo sales proceeds, $350,000, plus the approximately $600,000 that she is anticipated to receive from the sale of the Home, mean that Sarah Tannenbaum will have $950,000 to lease or buy another home that can accommodate the Tannenbaums and Sarah Tannenbaum’s mother. Although neither side presented any evidence of the cost of leasing or buying an apartment or house in this neighborhood, the Court finds that $950,000 should suffice where the Tannenbaums can look for a smaller home, and the amount is not far off from the $1.2 million estimated market value of the Home. The Court is not aware of any controlling law, nor does Sarah Tannenbaum bring any to the Court’s attention, holding that a non-liable party is prejudiced if that party has to lease rather than buy a home.

The opinion noted that there were other Orthodox communities even if there were few alternates in the specific neighborhood. At the end of the day, however, while the court acknowledged the relevance of Sarah’s special circumstances, her resources were enough to tip that factor in favor of the government.

Conclusion

After applying all the Rodgers factors, the district court held that IRS had the right to force the sale of the Brooklyn house. Interestingly, the government argued that one of the factors in its favor was the prejudice to the government if it did not permit the forced sale. It is hard to force a sale of half a house, so there is always some prejudice if a court does not permit the sale of the entire property.

But there is more. Here the government pointed out that under NY law if Gershon were to die the US would not have the right to collect because its lien would be extinguished. Earlier this year and in fact prior to the court order setting the sale Gershon in fact did pass away (See Brooklyn, NY – Jewish Community Mourns The Sudden Loss Of Rabbi Gershon Tannenbaum ). The court was not aware of his passing when it wrote the opinion as the opinion noted Gershon failed to file any responsive papers. I suspect that the rabbi’s passing may then have extinguished the government’s interest in the residence, which would allow Sarah to remain in the house and give her the relief she sought. After the court issued its opinion, Sarah in fact filed a motion effectively asking the court seeking relief from a final judgment; the government has yet to respond and last week filed a motion seeking additional time to respond.

 

 

 

 

Revoking the Release of the Federal Tax Lien and Appointing a Receiver

In United States v. Evseroff the Eastern District of New York rendered an opinion which seems to have brought a case with procedural history spanning almost 15 years and six prior decisions to conclusion. After appointing a receiver to sell Mr. Evseroff’s residence, the property at the heart of this case, the court gave him 35 days to vacate and declined his invitation to exercise equitable powers to stay the appointment of the receiver and the sale of the property.

Since both the revocation of the release of federal tax lien and the appointment of a receiver are unusual procedural actions, with the appointment of a receiver the much more unusual of the two, a discussion of the Evseroff case provides an opportunity to examine two little used procedures and to look at another situation in which the Court declines to exercise its equitable powers to stop a sale.

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Mr. Evseroff, a retired attorney, owns a valuable house in Brooklyn. After, or in conjunction with, incurring substantial tax liabilities, he transferred the house to a trust. In an earlier proceeding the Second Circuit, overturning the district court, determined that the transfer of the house to the trust was fraudulent.

Because the property at issue in this case serves as the taxpayer’s personal residence, the IRS has two primary choices as it seeks to get the unpaid taxes out of the taxpayer’s equity in the property. Ignoring for a moment the appointment of a receiver in this case which represents a very rarely used third choice, the normal choices available to the IRS involve seeking to administratively sell the house after an ex parte hearing before a District Court judge or Federal Magistrate as provided in IRC 6334(e)(1) or bringing a suit in federal district court to foreclose the federal tax lien pursuant to IRC 7403. On April 18, 2014, the IRS issued guidance on how to proceed in these cases. The guidance makes clear that the IRS prefers the administrative course and seeks to use foreclosure proceedings (or the appointment of a receiver) only in the more difficult cases.

While this case journeyed through the courts for many years, the IRS improvidently released the notice of federal tax lien filed against Mr. Evseroff. Section 6325(a) provides for lien release where the tax is satisfied or no longer enforceable. Occasionally, the IRS will issue a release when it should not. The opinion contains a suggestion that Mr. Evseroff’s representative may have played an inappropriate role in the release; however, that issue went unresolved and did not impact the outcome of the case.

When the IRS releases a lien improvidently, it has the ability to reverse the release. It must follow the procedures of IRC 6325(f)(2) which involves filing a release revocation form in the same place(s) where it recorded the release. Revoking the release requires little effort; however, the process of releasing the federal tax lien and then revoking the release can have very negative consequences on the priority of the federal tax lien vis a vis other competing creditors.

During the period between the release and its revocation, other creditors, or a purchaser, can intervene to defeat the federal tax lien. Here, that did not appear to happen. The IRS discovered its mistake relatively quickly. No one purchased the property during the period after the release or recorded a mortgage or judgment. So, the improvident release did not harm the IRS. A taxpayer who thinks the federal tax lien has been improvidently released may want to act quickly if they want to get the value of the property without the burden of the lien. Considering the earlier transfer to a trust in this case in an apparent attempt to defeat the federal tax lien, Mr. Evseroff’s failure to sell or encumber the property during the period when the federal tax lien did not attach to the property suggests his earlier action did not evince an effort to defeat the federal tax lien or, if it did, he no longer sought to do so or did not appreciate the window of opportunity.

The federal tax lien release can occur either with the filing of a release with the court(s) where the notice was recorded or it can occur with the passage of time. The more frequent cause of inadvertent releases, which themselves are rare, results from a combination of the failure of the IRS to refile the notice within the appropriate period coupled with the self releasing feature of the notice of federal tax lien. The IRS incorporated the self releasing feature into the notice in the early 1980s because it could not keep up with all of the releases it needed to file in order to meet its statutory obligation to release a lien once the liability was satisfied or became unenforceable. The IRS monitors its liens to determine when they will self release and refiles them when appropriate – usually when something has extended the statute of limitations on collection. It occasionally fails to properly monitor a lien resulting in an unintended release. As mentioned above, fixing the improvident release requires little effort but the release itself can have dire consequences for the priority of the federal tax lien in its competition with other creditors or purchasers of any encumbered property.

Aside from the lien release issue, Mr. Evseroff’s case contains another interesting issue because of the appointment of a receiver. The appointment of a receiver got scant attention in the opinion yet this action by the IRS rarely occurs. Usually, the IRS simply forecloses its lien on the property subject to a lien and sells the property itself. It does not see the appointment of a receiver because of the expense of paying the receiver and, quite often, the difficulty in finding a receiver willing to accept the task and acceptable to the IRS. Getting a receiver appointed also requires a demonstration to the court of the necessity of a receiver. The opinion contained little or no information guiding a reader to an understanding of why it chose to appoint a receiver here. The motion seeking the appointment of a receiver makes it clear that the receiver here is a real estate agent experienced in the Brooklyn. The motion also includes information that the IRS expects to recover more for the property by selling it through a local real estate agent than a typical IRS sale. This approach makes a great deal of sense but is not one I routinely encountered when I worked at Chief Counsel’s office.

I can offer some speculation based on other situations in which I have seen a receiver appointed. Usually, the property needs to have characteristics that will make sale of the property by the IRS difficult or one in which the IRS will obtain a depressed price. About 15 years ago the IRS split the function for sale of property off from an occasional duty of a revenue officer handling the account into a special unit, the Property Appraisal and Liquidation Specialists (PALS) unit. The individuals assigned to the PALS unit do nothing but sell property. As a consequence, they know the complicated rules under the Internal Revenue Code for selling property and the market for such sales better than revenue officers did. Because of the low number of seizures and sales of property following the Revenue Reform Act of 1998, a typical revenue officer might sell property only a handful of times through a career. This specialization brings many benefits while losing very little except for the local market contacts some of the senior revenue officers had developed.

Some types of property exceeds even the capacity of the PALS unit to property market and sometimes even the clear title following a judgment and foreclosure of the lien will still not make it beneficial for the government to conduct a sale. In those circumstances, the IRS should consider the appointment of a receiver by the court because a knowledgeable receiver will better market the property. If done correctly the increased price will benefit the IRS (and the taxpayer) because it will more than pay for the extra expense of the receiver. Typical IRS sales bring in a depressed sales price because of the nature of the sale. A receiver has the opportunity to market the property in a manner much more likely to achieve a fair market value for the property.

Aside from the legal issues presented here involving lien release and the appointment of a receiver, the case also presents another view at the factors a court considers when asked to exercise its equitable powers to postpone foreclosure, or in this case the appointment of a receiver. Mr. Evseroff made the request and the Court relatively easily said no. He argued that his “age, physical condition, history as an attorney, veteran and law-abiding taxpayer, as well as the age of this case” should factor into the Court’s decision to grant a stay. The Court found that unlike the Rodgers case Mr. Evseroff’s wife did not have an interest in the property. It also found that appointing a receiver rather than simply allowing the IRS to foreclose was itself an equitable result. His tax liabilities were over 10 years old (not an unusual age in these types of cases) and they were so old because of his actions to hinder and delay the IRS from collecting. When someone has been found to have made a fraudulent transfer of property, they need to have significant equity on their side in order to persuade a court to exercise its discretion using the Rodgers factors. Mr. Evseroff did not have enough equity to overcome his earlier actions.

 

“Crafting” an Appropriate Value for Your Tenancy by the Entireties Interest When Your Spouse Owes the IRS

Tenancy by the entireties serves as a common means for married couples to hold property in the Eastern half of the United States, as well as some states further West. This form of property ownership derives from a fiction developed in English common law that the marital unit holds property separate and apart from the individuals in the marriage. Many states permitting this form of property ownership combine it with the fiction that the marital unit holding the property causes the property to remain free from attachment by creditors of only one spouse. So, for example, if the husband has a small business that runs into financial difficulty and he becomes personally liable to a number of creditors for the debts of the business, those creditors cannot look to the marital home or to any other asset held as tenants by the entirety in states that protect that property interest from the debts of one spouse.

After many years of trying, the IRS broke the protection provided by tenancy by the entireties status with a victory in the Supreme Court in 2002 in Craft v. United States. After Craft, Chief Counsel Notice 2003-60 set out the government’s view of the decision and the intentions of the IRS regarding property held as a tenancy by the entireties where only one spouse owed federal taxes. The Supreme Court’s decision turned on the power and special status of the federal tax lien. Now that the issue of whether the federal tax lien can attach to tenancy by the entireties property has been answered, the past twelve years have provided incomplete instruction on what happens when the IRS takes action against the property.

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Imagine tenancy by the entireties property owned by the late Anna Nicole Smith and her late husband during the period of their marraige. What is the value of her interest in any jointly held property versus his? Given their significant age difference, her interest in such property seems more valuable than his since her life expectancy extends many decades beyond his. Suppose he owed a significant trust fund recovery liability for which she did not share the liability. If the IRS had brought a foreclosure action and sold the property, how much of the proceeds of the sale should go to her and how much to the IRS in recognition of her husband’s interest?

Six circuit courts have now faced this question in some fashion and their answers have differed but so far the Supreme Court has declined to take a case on this issue. The basic split stands at four to two with four circuits (Second, Fifth, Ninth, and Tenth) deciding that the property interest of each spouse includes the actuarial interests of the spouses and two (Sixth and Third) deciding that a 50/50 split appropriately values the interests of the spouses. The IRS position favors the 50/50 split. I imagine that taxpayers whose actuarial interest would give the indebted spouse the bigger share have not engaged in this litigation.

The Ninth Circuit supported their position on using actuarial tables for the interests of both spouses by asserting that a different method would result in the property being valued at something different than 100% of the property value. The Fifth Circuit echoed this outlook by stating the actuarial tables, “properly reflect the fact that the aggregate value of all the interests in a piece of property equals 100 percent the value of the property.”

On the other hand, the Sixth Circuit has held that actuarial valuation should only be used out of necessity. The Third Circuit has also rejected the actuarial approach and determined the interests held by tenants by entirety is equal. The Third Circuit cited to precedent indicating Pennsylvania has a long history of tenants by entirety equally possessing the estate.

An article written for The Florida Bar Association in 2005 noted that none of the courts addressing the issue of the value of the separate interest of one owner of jointly held property utilized marketability discounts.  The reason that marketability discounts may not apply is that the property is usually being sold in its entirety and the issue is how to divide up the proceeds which have not been diminished by a marketability discount because a court has generally allowed the sale of the whole property.

One reason the IRS favors the 50/50 split is the administrative convenience of such a split. The IRS does not need to engage in age verification, in calculations, in fending off arguments that the younger spouse is the sicker spouse. Having a simple 50/50 test to apply will sometimes favor the IRS (and perhaps more than a random amount but I know of no studies on this) and sometimes not. Keeping it simple almost always serves the administrator. I wrote about a similar phenomenon when one spouse goes into bankruptcy and the other spouse (sometimes called the injured spouse) competes with the bankruptcy trustee over the proper split of a tax refund.

At some point, I anticipate that this issue will make it to the Supreme Court. In the meantime, if you live in one of the circuits that has not opined on this issue do your research and first decide if it best serves your interest to accept the IRS payment of a straight 50% of the proceeds. If that result provides the best actuarial result, stop there and take the money. If you represent the non-liable spouse who has more projected years to live and therefore an argument for a higher percentage of the proceeds, get the briefs from the cases in the winning circuits and make your arguments. The government’s brief at this point is pretty well fixed. You should have no trouble knowing what the government plans to argue and how it plans to do so.

One problem that you may face is that the cases holding for the split of the proceeds based on actuarial value pre-date the Craft decision. Since that decision on the 3rd and 6th Circuits have spoken on the issue and they have gone with the 50/50 split. You may have to overcome the age factor on the actuarial cases in trying to convince the next circuit that such a result best serves the intent of a statute that never intended a creditor reach this property.

 

 

Effect of Lis Pendens on Federal Tax Lien

Recently, I wrote about the nominee lien calling it the lis pendens of federal tax liens.  A recent case gives me the chance to write about the competition between a third party who has filed an actual lis pendens and the federal tax lien.  The case also provides an example of the type of lien I suggested that the IRS file when it has not yet filed the notice of federal tax lien at the time property transfers from the taxpayer to a third party through some mechanism other than purchase.

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Dyane Smith v. United States involves a fight between the ex-wife of someone who, appears to be, both a bad husband and a bad taxpayer leaving two relatively innocent parties to fight over the mess created by him.  The ex-wife has plenty of equity on her side but little law.  The unfolding of the case shows again the power of the federal tax lien but also some compassionate actions that can save the ex-wife from complete defeat.

Mr. Smith moved out of the marital home to other property (referred to here as the Redding property) owned by the couple.  While living separate from his wife but prior to the dissolution of the marriage, he failed to file returns for 2000 and 2001.  Dyane Smith sued him for divorce on January 12, 2001.  She recorded a lis pendens in early August, 2001.  He filed his returns for 2000 and 2001 on February 2, 2003 by signing a Form 4340 – probably during a substitute for return examination.   Assessments were made against him on March 3, 2003, and March 10, 2003.  Apparently, the IRS timely and properly sent out notice and demand approximately at the same time as the assessments.  The final decree of divorce was entered on July 15, 2003.  The decree required him to make certain payments to her and to transfer the Redding property to her.

He transferred the property to Dyane Smith as a part of the property settlement in the divorce.  Naturally, he did not warn her of his tax issues.  The deed transferring the property was properly recorded.  At the time of the transfer, she had no notice of the assessments against him for 2000 and 2001 and, consequently, no notice that a federal tax lien attached to the property at the time of transfer.  On September 15, 2003, approximately one month after transfer of the property to Dyane Smith, the IRS recorded a notice of federal tax lien against Mr. Smith for the unpaid 2000 and 2001 federal income taxes in the jurisdiction of the Redding property.

She obtained a mortgage on the property in 2005 and a title company issued a letter evidencing clear title to the property.  In 2009 she became aware of the notice of federal tax lien recorded against Mr. Smith and the potential complications that created with respect to her interest in the property.  Meanwhile, an attorney in the IRS Counsel Office in Connecticut responded to questions from a revenue officer trying to collect the unpaid tax from Mr. Smith.  The attorney discussed the problem someone like Dyane Smith or subsequent parties would have in identifying the existence of the federal tax lien on the property.  He recommended the filing of a transferee lien (the very document I suggested the IRS should file in these situations.)  He mistakenly, in my view, also recommended that the filed lien identify Dyane Smith as a nominee.  The IRS did record the transferee/nominee lien in 2001.

Dyane Smith brought a quiet title action seeking a determination that her interest in the property defeated the federal tax lien.  In her action she made several losing arguments.  First, she made a due process argument which the court dismissed rather easily.  I will not address the details of this argument as they provide little interest.  Second, she argued that because she had recorded a lis pendens prior to the existence of the federal tax lien, her interest in the property came ahead of the federal tax lien.  The court properly rejected this argument.  The lis pendens argument runs into an issue of the application of federal or state law.  The court determined that even if Connecticut law would give the party filing a lis pendens priority over a subsequent lien creditor, Connecticut law did not control the situation.  State law creates property interests but does not control priority status.  The lis pendens creates a property interest that remains inchoate until the final judgment establishing the interest of the party who filed the lis pendens.  Here, the federal tax lien came into existence after the filing of the lis pendens but before the final judgment.  In competition against the federal tax lien it must lose because it lace finality or choateness at the time the federal tax lien attached to the property.  The issue has controlling, if old, Supreme Court precedence.  United States v. Sec. Trust & Sav. Bank and United States v. Vermont.

Dyane Smith runs into this problem because she did not take the property in a way that defeats the unfiled federal tax lien.  A purchaser or the holder of a security taking before the filing of the notice of federal tax lien could defeat the federal tax lien under IRC 6323(a).  She did not qualify as a purchaser because she took the property through the divorce proceeding. 

Even though her interest in the property does not defeat the federal tax lien, an issue still exists concerning what the court will do about it.  The IRS sought to foreclose its lien interest in the property and have the property sold to satisfy the unpaid taxes of Mr. Smith.  By the time of this action, Mr. Smith’s liability had dropped to about $37,000.  The value of the property exceeded $700,000.  The court looked at the appropriateness of allowing the IRS to foreclose its lien and sell the property.  To make this determination the court looked to the decision of the Supreme Court in United States v. Rodgers.

The court looked first to the financial prejudice to the IRS.  The court found that the sale of the property could satisfy the outstanding liability but that the IRS had been dilatory in collecting.  On balance it found this factor neutral or only slightly in favor of allowing the sale.  Next, it looked at Dyane Smith’s expectation of foreclosure.  It determined that this factor weighed against forced sale of the property because she had no actual or constructive knowledge of the federal tax lien which gave her a reasonable expectation that the property would not be subject to foreclosure.  Continuing to follow the Rodgers decision, the court next looked to the prejudice to Dyane Smith that would result from the foreclosure of the property by the IRS in terms of personal dislocation costs and under-compensation of interest.  The relative value of the lien and the house coupled with the dilatory collection actions of the IRS led the court to conclude that this factor weighs against forced sale of the property.  The final factor derived from Rodgers is the “relative character and value of the non-liable and liable interests held in the property….”  Because Dyane Smith has a 100% ownership interest in the property at the time of the proposed foreclosure, this factor weighs heavily against foreclosure of the property. 

So, the court refused to allow the IRS to foreclose its lien while simultaneously upholding the existence and priority of the lien.  The court also encouraged the parties to come to a settlement that would allow the removal of the lien.  This outcome seems most appropriate given the law and the circumstances of this case.  Situations in which the federal tax lien attaches  and property transfers prior to a recordation of the notice of federal tax lien will frequently create patterns of prejudice to both the IRS and the non-liable new owner of the property.  Denying foreclosure and nudging the parties toward a settlement seems the best result.  Dyane Smith still has the possibility that the title company that gave the erroneous clear title opinion could come into the picture to rescue her.  In some ways this case reminded me of a penalty case in which the real thrust of the penalty litigation concerns the malpractice policy of the person who gave the advice that got the taxpayer into the penalty position.  Here the title company did not give advice that got her into this position but it did give her a clear title report after she got there.  It should bear some of the cost of fixing the problem caused by Mr. Smith.

In an early part of the opinion that I did not highlight, the IRS apparently failed to fix an order that would have allowed it to obtain a judgment against Mr. Smith.  This could turn out to be an important misstep from a couple of angles although it is a correctable problem if timely addressed.  The possibility still exists, at least until the statute expires, that Mr. Smith could pay his taxes which would remove the lien from Dyane Smith’s property.  Getting the judgment gives the IRS much more time to seek to collect from Mr. Smith’s assets.  The judgment also gives the IRS and Dyane Smith more time to work out a payment plan for the property assuming Mr. Smith cannot or will not pay off his debt.  It also, however, makes it clear to her that she must deal with the debt underlying the lien since she will not have the ability to dispose of the property for a very long time without addressing the federal tax lien if the underlying tax assessment converts to a judgment.