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

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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.

 

 

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