Thanks to celebrity shills such as Alan Thicke even non-tax experts know the reach of IRS’ collection powers. That power extends to allow it to levy on a taxpayer’s property unless that property is subject to a specific exemption in Section 6334(a). Included in that exemption list are things like workers’ compensation and unemployment benefits. Veterans’ disability payments are also on that list.
Last week’s 10th Circuit’s Maehr v Koskinen involved an IRS levy on a bank account that had received the taxpayer’s VA disability deposits. Maehr had challenged the IRS assessment and intention to levy on some of his assets. Maehr appears to be a serial tax protestor, and the order dispenses with the frivolous arguments quickly though not the issue of the levy on the bank account that held his VA payments.
That issue requires a bit more context and analysis. Maehr had an account at Wells Fargo that received his VA disability payments. Under Section 6334(a)(10), IRS is precluded from directly levying on certain armed force connected disability benefits. Maehr argued that Section 6334(a)(10) should protect the assets in the bank account since the funds were comprised of VA disability benefits that are exempt from levy.read more...
The government raised two arguments against Maehr’s challenge to that levy:
(1) the IRS did not place a direct levy on any exempt VA disability payments; and (2) even if the IRS is improperly levying exempt disability payments, the only remedy available to the taxpayer would be full payment of the assessment of his tax liability followed by a suit for refund in district court.
The arguments are closely related. The second of the arguments relates to the Anti-Injunction Act (AIA), which, is codified at Section 7421 and provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed.” In other words, taxpayers unhappy with IRS enforced collection actions are generally unable to get a court to enjoin the IRS from going forward with its collection powers, including levy. We have discussed the AIA on numerous occasions, as courts in the past few years have been poking holes in that restriction. Even before some of the recent exceptions, then Chief Justice Warren in the Williams Packing case crafted a two-pronged common law exception to the AIA: 1) that under no circumstances could the Government ultimately prevail and 2) that equity jurisdiction otherwise exists. Courts have generally looked at that last part of Williams Packing as requiring the taxpayer to prove irreparable injury stemming from the IRS’s proposed collection action.
Taxpayers subject to collection action for excise and employment taxes that were outside the deficiency procedures have often faced the AIA’s reach when IRS sought to collect even while a refund proceeding was in the works. In a 1977 case called Marvel v US the 10th Circuit used the AIA to dispense with a taxpayer trying to challenge the IRS’s levying of business’s assets during a district court refund suit following a partial payment of employment taxes. In Maehr, the 10th Circuit distinguished Marvel on the facts, noting that Maehr also had a cause of action in addition to injunction (I assume a wrongful collection claim as well).
Despite the distinction, the 10th Circuit addressed the broader AIA issue and found that Maehr satisfied the Williams Packing narrow exception allowing the suit to continue:
If the IRS had placed a direct levy on Appellant’s VA disability benefits, we have little doubt that Appellant would have been able to satisfy the Williams Packing test and obtain injunctive relief. We see no possibility of the government prevailing on the merits in such a case, and a disabled veteran will likely be able to show that he will suffer irreparable injury if the government is not enjoined from illegally levying the VA benefits on which he relies for his maintenance and survival. See Comm’r v. Shapiro, 424 U.S. 614, 627 (1976)…
What about the government’s argument that the IRS was not directly going after the VA disability benefits, since the funds were sitting in a bank account? The Tenth Circuit briefly addressed that:
However, here the government has not directly levied Appellant’s VA benefits, and it suggests that it may do indirectly what it may not do directly—that it may wait until exempt VA disability benefits have been directly deposited into Appellant’s bank account and then promptly obtain them through a levy on all funds in the bank account, despite their previously exempt status. The government cites no authority to support this argument, and the few cases we have found adopting such a rule, see, e.g., Calhoun v. United States, 61 F.3d 918 (Fed. Cir. 1995) (unpublished table decision); United States v. Coker, 9 F. Supp. 3d 1300, 1301–02 (S.D. Ala. 2014); Hughes v. IRS, 62 F. Supp. 2d 796, 800–01 (E.D.N.Y. 1999), have not considered whether this result is consistent with the Supreme Court’s opinion in Porter Aetna Casualty & Surety Co., 370 U.S. 159 (1962), or with 38 U.S.C. § 5301’s prohibition against the levy of veterans’ benefit payments either before or after receipt by a beneficiary.
I was not familiar with either the Porter case or 38 U.S.C. § 5301, and this opinion nudged me to look at both. Porter v Aetna Casualty involves a private creditor and not the IRS but it held that VA disability benefits paid to an incompetent veteran and deposited in a federal savings and loan association were exempted from attachment by 38 U.S.C. § 3101(a) [now codified at 38 USC 5301(a)(1)]. That statute provides that payments administered by the VA “shall be exempt from taxation, shall be exempt from the claim of creditors, and shall not be liable to attachment, levy, or seizure by or under any legal or equitable process whatever, either before or after receipt by the beneficiary. The preceding sentence shall not apply to claims of the United States arising under such laws nor shall the exemption therein contained as to taxation extend to any property purchased in part or wholly out of such payments.” (emphasis added).
So Title 38 has its own protection of VA disability benefits that goes beyond the Internal Revenue Code. As I said, Porter did not involve an IRS levy (instead it involved a private creditor) but it did directly consider the reach of the Title 38 protection when the disability benefits were held after payment. The savings and loan rules at issue in Porter treated the depositor as a shareholder, requiring a 30-day demand before the S&L shareholder could reach the proceeds. Porter considered whether the deposit of the VA disability payments in a savings and loan essentially constituted after-acquired property that was no longer protected by Title 38. Porter discusses the earlier case of Lawrence v. Shaw, 300 U. S. 245 (1937), where the Court held that “bank credits derived from veterans’ benefits were within the exemption, the test being whether, as so deposited, the benefits remained subject to demand and use as the needs of the veteran for support and maintenance required.” On the other hand, the Court had held in a prior case that a veteran’s purchase of bonds with the VA proceeds removed the protection of the statute and those bonds constituted an after-acquired investment.
Porter resolved the issue as to whether the S&L account was more like the bank deposit case or the after-acquired investment:
Since legislation of this type should be liberally construed… to protect funds granted by the Congress for the maintenance and support of the beneficiaries thereof… we feel that deposits such as are involved here should remain inviolate. The Congress, we believe, intended that veterans in the safekeeping of their benefits should be able to utilize those normal modes adopted by the community for that purpose — provided the benefit funds, regardless of the technicalities of title and other formalities, are readily available as needed for support and maintenance, actually retain the qualities of moneys, and have not been converted into permanent investments.
Back to Maehr and the IRS’s Collection Powers
The Tenth Circuit remanded the case back to the District Court to consider whether the reach of Porter and whether the “IRS has improperly levied exempt VA disability benefits by placing a levy on all funds in the bank account where Appellant’s disability benefits are deposited.” It left open the question of remedy, expressing “no opinion on the ultimate resolution of this claim or on the unresolved questions regarding the availability of the types of relief Appellant has sought or may seek in an amended Complaint.”
This is an interesting opinion and raises a possible defense to collection on a certain kind of asset, i.e., a bank account that holds veteran’s disability payments. It seems that IRS at the district court should emphasize Section 6334(c), which provides that “[n]otwithstanding any other law of the United States (including section 207 of the Social Security Act), no property or rights to property shall be exempt from levy other than the property specifically made exempt by subsection (a).” Likewise the regulations under Section 6334 provide that “no other property or rights to property are exempt from levy except the property specifically exempted by section 6334(a).”
IRS has a longstanding position that once the funds move from the excepted payor to the taxpayer, the funds lose their exemption. The Porter case and Maehr’s unearthing it suggest a possible barrier to the vast collection powers that IRS generally has when there is a bank account that has solely as the source of its deposits disability payments the IRS would be unable to reach directly. Given the explicit language in Section 6334(c) and IRS’s longstanding view that the exempted property loses its character when the funds reach the taxpayer I would expect a vigorous challenge to extending Porter to include protection from the reach of an IRS levy. In addition, even if that protection were extended, there could be some interesting second order questions. Query for example the tracing problems if the account has other funds beyond the disability payments or if the IRS were to show that the taxpayer had other funds that he used to meet his necessities beyond the disability payments.