Seeking a Federal Tax Refund via Habeas Corpus – Reminder of the Injured Spouse Remedy

In the recent case of Turner v. United States, (N.D. Cal. 2019) a prisoner sought to obtain a refund of money for his wife using the remedy of habeas corpus. Mr. Turner’s effort to obtain the refund through this process failed but in his predictable failure a few points can be made about the process. The main point that jumped out from the case concerns the issue of injured spouse relief. In reading the case I did not get the impression that the judge was aware of injured spouse relief. This makes sense because the judge is a district court judge. It also did not appear that the DOJ Tax Division attorney mentioned it though any mention may have been made informally. In case we have any readers who are unaware of injured spouse relief, I thought I would briefly review the grounds for this relief since this is the time of year when such relief is most important. We have written about it before here and here.

read more...

Mr. Turner was sent to prison almost two decades ago as a result of a conviction for first degree murder. While in prison he apparently met and married Regina in 2017. She filed a return for that year claiming him as a dependent. The facts as presented in the opinion state that she did not file a joint return although on the facts that would have been the correct filing status and that would have made what happened next easier to understand.

When Mrs. Turner filed her 2017 return, she apparently claimed a large refund which Mr. Turner alleges that the IRS took to satisfy Mr. Turner’s outstanding federal tax liability. I would not expect someone in prison for murder for 20 years to have an outstanding federal tax liability. It is possible that he had another type of liability that comes within the offset provisions and it is also possible that he totally misconstrued the reason the IRS hung onto her refund. Aside from the puzzling aspect of someone in prison so long having a liability, there is the issue that this was not a joint return raising the question of what would have triggered the offset to his outstanding debt.

The court took very little time disposing of the case because habeas corpus relief does not extend to tax refunds. Because it’s so clear that relief could not be granted on the basis requested, I think the court did very little to flush out the correct facts and perhaps untangle the situation for a confused petitioner.

Still, the case can provide a basis for discussing the injured spouse provisions which often confuse taxpayers and occasionally confuse practitioners. Perhaps the best way to avoid injured spouse issues is to carefully vet any prospective marital partner to ascertain what debts the partner brings into the marriage. A partner coming into the marriage with tax debts, student loan debts, outstanding child support or any of the types of debts that trigger offset is a partner for whom the taxpayer must be very careful when filing the tax return. Filing a joint return with someone who owes a type of debt subject to offset means that any refund on the return will be taken and applied to the outstanding debt unless the parties affirmatively alert the IRS that it should not.

The injured spouse provisions often get confused with the innocent spouse provisions of IRC 6015. In an innocent spouse case a married couple has filed a joint return on which they owe more money either as a result of an additional assessment or an underpayment. One of the spouses (sometimes both) seek to limit their exposure to the liability for the reasons provided in IRC 6015. In contrast the injured spouse provisions arise when a married couple files a joint return on which they report a refund due to them. The IRS takes all or part of the refund to satisfy the outstanding debt of one of the spouses, the liable spouse. The non-liable spouse is injured because all or part of the refund results from their payment and the non-liable spouse seeks a return of the portion of the refund attributable to him or her. Unlike the innocent spouse provisions, the injured spouse provisions are a creature of administrative practice and not the statute.

If the refund on the joint return results wholly or partially because of the spouse who does not owe a debt to the government, the spouse who does not owe the debt should file a Form 8379 with the tax return. This means filing the return by paper and waiting a long period for the refund. The extra delay will be worth it if the form prevents the IRS from offsetting the refund of the non-liable spouse. Some taxpayers will not know about the Form 8379 or will not know that they spouse has an outstanding liability. So, the IRS will make the offset and send them a notice of what was done. For the non-liable spouse in this situation whose refund has been partially or wholly taken to satisfy the separate liability of their spouse, the possibility of the return of the money still exists. In this situation the injured spouse should file the Form 8379 after learning of the taking of the refund. The IRS will require the injured spouse to provide the portion of the refund attributable to that spouse. Assuming that the injured spouse can successfully prove to the IRS that all or part of the offset refund was generated by the party with no liability, the IRS will release the appropriate refund to the injured spouse and increase the debt owed by other spouse.

Because the process of requesting injured spouse relief is a bit cumbersome, some spouses take the tack that the safest path with a spouse who owes outstanding debts is a married filing separate return. Using the injured spouse provision, the non-liable spouse can obtain the benefit of the joint return rates while still getting back the refund resulting from their efforts. Of course, if the existence of the other spouse’s debt has caused them to lose confidence in their spouse, opting for a married filing separate return may be best for other reasons.

It’s not clear to me if Ms. Turner has the ability to seek a return of her refund based on the injured spouse provisions but based on the arguments made by her husband she should at least look into the injured spouse provisions to determine if they would form the basis for relief.

 

Reflections on Nina Olson as the National Taxpayer Advocate

Les, Christine and I are each writing to share our reflections on Nina as the National Taxpayer Advocate (NTA).  We each know her well and each from a slightly different perspective.  We all agree that she has provided a tremendous voice for taxpayers during her tenure as our advocate and that finding someone to pick up that voice with the same level of passion and knowledge she has brought to the position will be quite a challenge.

Keith

Nina called me out of the blue one day in 1992 and that’s how we met.  She had an idea to start a freestanding tax clinic in Richmond, Virginia.  Someone at Georgetown Law School where she was pursuing her LLM and where I taught as an adjunct professor suggested that she call because I was the District Counsel for the IRS in Richmond.  We talked for about an hour and her passion came through the phone with no trouble.  I thought she had a great idea and offered her some suggestions of people to contact not knowing if anything would come of this conversation.  I soon found out.

Nina did start a low-income taxpayer clinic (LITC) in Richmond.  It was not the first LITC but it was the first one that was not based at an academic institution.  As she had explained to me on the phone, she was appalled that tax lawyers would be called upon to work on landlord tenant cases or criminal cases in order to perform pro bono work.  She wanted a clinic that marshalled the tax bar into a force to fight for low income taxpayers.  I got to watch her do this with a front row seat.  As she built her clinic, she was regularly the representative of taxpayers whose cases were being handled by my office.  Today, we think of Nina as an advocate for all taxpayers but I experienced her as the advocate for individual taxpayers that her clinic represented.  As you can imagine she provides knowledgeable and passionate representation for her clients.  Not everyone at the IRS in Richmond hailed the coming of the new tax clinic.

Starting from scratch she built the Community Tax Law Project into a statewide clinic seeking to assist taxpayers who would otherwise go unrepresented.  She not only chased down tax lawyers to join her pro bono panel but she chased down donors from many different sources.  Even though she received enough donations and pro bono volunteers to keep the doors open, she hardly had enough to pay herself.  She lived a Spartan existence.  I have joked with her that I invited her regularly to come and speak to the students who volunteered at my office because that way we could feed her.  When IRC 7526 providing funding for LITCs came into existence, thanks in no small part to her efforts, she finally had a stable financial base for her clinic.  I remember her telling me of the shopping spree she was going to have to finally buy furniture for her office.  Even then her discussion was of funds for the clinic and not a decent salary for herself.

Eighteen years ago I attended her investiture at the IRS building in the theater on the 7th floor.  By that point she had made a name for herself testifying before Congress in the run up to the Restructuring and Reform Act of 1998 but few people in the tax world knew what they were in for when she became the second NTA.  The first NTA served only for a short time and operated pretty much under the radar of the tax world.  Nina was able to take the structure he had begun to build and turn it into a powerful voice for taxpayers that Congress could only have imagined when writing the statute creating the position.

When I began teaching at Villanova in 2007, my role vis a vis Nina had come full circle.  Now she was the IRS and I was the clinician.  One of her many jobs as NTA is to oversee the administration of the grant funds created by IRC 7526.  Just as she worked hard to create the grant funds, she has worked hard to maintain and increase those funds.  She was not my adversary the way I had been hers when she was a clinician but she was my grant funder.  Never having taken a clinic in law school, I took from Nina’s model in developing my role as a clinician.  She has done a great job of nurturing clinicians and clinics around the country.  While she has many responsibilities as the NTA, I suspect that few of her responsibilities hold the same place in her heart as clinics and the low income taxpayers they serve.

Nina’s achievements as the NTA are many.  Her annual reports provide an amazing resource to Congress, the IRS, academics and anyone interested in taxes.  The Taxpayer Bill of Rights which she promoted and sheparded into adoption by the IRS and then by Congress creates aspirational goals for the relationship between taxpayers and the IRS and will continue to evolve as a resource for taxpayers with conflicts with the IRS.  Her many, many times testifying before Congress to explain the importance of some act or some omission has helped to guide legislation in ways that we can only guess.  Of course, her work inside 1111 Constitution Avenue is probably the most important but the most difficult for outsiders to assess.

Hat’s off, Nina.  You have had a great run.

The Supreme Court Clears the Way for a State Tax Refund to a Class of Federal Employees

Thanks to Carl Smith for bringing the case of Dawson v. Steager to my attention.  This case was decided by the Supreme Court on February 20 in a unanimous victory for a federal marshal who retired to West Virginia.  Even though the issue in the case concerns a refund of state taxes, it has a procedural aspect and deserves some attention.  I do not know if the decision has implications beyond West Virginia but knowing about the decision will allow you to check to see if any problems continue to exist with the laws in your state. 

read more...

Mr. Dawson spent the bulk of his career as a federal marshal.  After retiring to West Virginia, he noticed that the state had a law that exempted from taxation the pensions of certain law enforcement officials who retired after working for the state of West Virginia.  It’s not clear how he knew about the Supreme Court precedent in this area or maybe he just felt the law was unfair and happened to bring the issue up across the dinner table from a tax lawyer with knowledge of the precedent but his case follows closely behind a Supreme Court case decided three decades ago, Davis v. Michigan Department of Treasury, 489 U.S. 803 (1989). 

 Justice Gorsuch, rendering the opinion for a unanimous court, framed the issue as follows: 

If you spent your career as a state law enforcement officer in West Virginia, you’re likely to be eligible for a generous tax exemption when you retire. But if you served in federal law enforcement, West Virginia will deny you the same benefit. The question we face is whether a State may discriminate against federal retirees in that way. 

The problem for West Virginia is that 30 years ago the Supreme Court faced a very similar issue concerning state employees in Michigan whose pensions were exempted by state statue there and retired federal employees living in Michigan whose pensions were not exempted.  In the Davis case the Supreme Court decided that the state could not exempt the pensions of its employees while taxing the pensions of federal employees because of 4 USC 111.  Describing that statute Justice Gorsuch stated:  

In that statute, the United States has consented to state taxation of the “pay or compensation” of “officer[s] or employee[s] of the United States,” but only if the “taxation does not discriminate against the officer or employee because of the source of the pay or compensation.” §111(a). 

He provided background for the adoption of section 111: 

Section 111 codifies a legal doctrine almost as old as the Nation. In McCulloch v. Maryland, 4 Wheat. 316 (1819), this Court invoked the Constitution’s Supremacy Clause to invalidate Maryland’s effort to levy a tax on the Bank of the United States. Chief Justice Marshall explained that “the power to tax involves the power to destroy,” and he reasoned that if States could tax the Bank they could “defeat” the federal legislative policy establishing it. Id., at 431–432. For the next few decades, this Court interpreted McCulloch “to bar most taxation by one sovereign of the employees of another.” Davis v. Michigan Dept. of Treasury, 489 U. S. 803, 810 (1989). In time, though, the Court softened its stance and upheld neutral income taxes—those that treated federal and state employees with an even hand. See Helvering v. Gerhardt, 304 U. S. 405 (1938); Graves v. New York ex rel. O’Keefe, 306 U. S. 466 (1939). So eventually the intergovernmental tax immunity doctrine came to be understood to bar only discriminatory taxes. It was this understanding that Congress “consciously . . . drew upon” when adopting §111 in 1939. Davis, 489 U. S., at 813. 

In Mr. Dawson’s case the trial court in West Virginia determined that his duties were essentially similar to the duties of the state law enforcement officers whose pensions were exempted.  Based on that determination the trial court held for Mr. Dawson applying the Davis precedent; however, the Supreme Court of West Virginia reversed finding that the state did not intend to discriminate against this class of retired federal employees but only intended to benefit certain state law enforcement retirees.  The Supreme Court was not buying what West Virginia was selling and reversed the decision of the state supreme court.  Read the opinion to see the other arguments made by the state but the Supreme Court rightly dismissed them with little effort.   

I have to think that this decision did not come as a big surprise in West Virginia.  It’s possible that other federal law enforcement officers who have retired to West Virginia will seek to show that their duties paralleled the duties of the individuals exempted by the state.  I do not know if the fight will now morph to see how close others may be to federal marshals or if the state will amend its statute to eliminate the exemption altogether.  Given the small number of individuals covered here and the types of work performed by those individuals, I doubt that the state will eliminate the exemption just because of this opinion. 

So, Mr. Dawson is going to get a refund of taxes he has paid; however, the procedural issue facing him and others who are similarly situated is how far back can he go?  In the Davis case federal retirees could not obtain the state taxes they had paid for every year but were limited to the years for which the refund statute remained open.  So, retired federal law enforcement officials in West Virginia who were not already clued into this case need to file their refund claims ASAP in order to preserve the right to obtain as many years of refunds as possible. 

After the Davis case came out, and not before it because his son was not paying attention to the issue, my father, a retired federal employee living in Virginia filed claims for all open years and eventually received a nice refund.  It took several years before he received his refund because of the high number of federal employees in Virginia and the strong efforts by Virginia to obtain a ruling from the Supreme Court that the Davis case did not apply in Virginia for a variety of reasons similar in spirit to the arguments made by West Virginia in the Dawson case. 

Restitution Order, IRA Account, Community Property = Unfortunate Result for Non-Liable Spouse

It’s never a good thing for your spouse to be the subject of a $2,165,126 restitution order. You know when that comes out in the first few sentences of an opinion that things do not look good for the non-liable spouse. That proves true in United States v. Berry, No. 4:17-cr-00385 (S.D. Tex. 2018).

From the perspective of the IRS, this case presents the not always available situation of a wayward party who still has assets after a criminal prosecution. Here, the asset takes the form of an IRA. An IRA generally does not provide the best place to hold assets if you seek to protect them from creditors. Here, the court mentions the general rule that ERISA does not govern IRAs as a shorthand way to state that the substantial protections from creditors afforded to individuals holding assets in an account covered by ERISA do not apply when the retirement account instead exists in an IRA. The court does not make mention of the fact that ERISA’s protections do not insulate a taxpayer from the collection tools available to the IRS. Because of the way this case arises, I am unsure if the IRS tools are available here. So, the fact the account existed in an IRA could make a crucial difference not always present in federal tax collection cases.

read more...

The Berrys live in Texas although I am unsure where Mrs. Berry is serving her 51 month sentence for wire fraud, mail fraud and filing a false tax return in violation of IRC 7206. In this case the government seeks to obtain 100% of Mrs. Berry’s retirement account and 50% of Mr. Berry’s account. The Berrys make four legal arguments and one equitable argument in an effort to protect their accounts. I will go through the arguments in the order presented by the court. Spoiler alert – none of the arguments work for the Berrys.

Federal Pre-emption

They argue that retirement funds are not community property. The retirement accounts are IRAs. The court finds that because the funds are held in IRAs and not ERISA protected retirement accounts, no pre-emption of state community property laws exists.

State Law

They argue that the retirement accounts are governed by Pennsylvania law because the custodial agreement says that the funds are governed by the law of that state which happens to be the state where Vanguard is located. Mrs. Berry argues that Pennsylvania law (and Texas law if PA law does not apply) waives her rights in the accounts and removes them from community property. She did not sign a specific waiver of her community interest in the property. Because she did not waive her interest in community property, the court finds that the retirement accounts are community property allowing the restitution liens to attach. The court cites United States v. Elashi, 789 F.3d 537, 551 (5th Cir. 2015) in support of its position. Since Mrs. Berry had a ½ interest in Mr. Berry’s solely managed community property, the government can seek to obtain her half interest in that account.

Consumer Credit Protection Act

The Berrys argue that even if the government can reach half of Mr. Berry’s retirement account despite the previous two arguments, its ability to reach Mrs. Berry’s community property interest in Mr. Berry’s property is limited to no more than 25% pursuant to section 30 of the Consumer Credit Protection Act. This Act limits the maximum garnishment to 25% of the earnings for that week. The court finds that the weekly limitation imposed by this act depends on whether Mr. Berry is limited to receiving periodic payments or has the ability to cash out. Because he has the ability to take out the entire amount at any time, the government is not limited in the amount of Mrs. Berry’s interest that it can obtain.

Facially Invalid

The Berrys argue that the writ of garnishment issued in this case overstates the amount due because it includes a future debt to the IRS not currently due. The court finds that the amount listed does not invalidate the writ of garnishment.

Equity for Mr. Berry

The Berrys argue that even if their legal arguments do not prevail it would be a significant strain on Mr. Berry to allow the government to take half of his retirement account. The case does not make clear how his finances would be impacted by the taking of half of this account. Certainly taking half of funds in his IRA limits his future ability to take distributions but what that does to his finances is unclear. Perhaps the court does not go into this type of detail because the court finds this type of equitable argument to be unavailing where the government has the legal right to take the property. It seems that the Berrys were essentially asking for the court to create something akin to the Rodgers factors and apply them to this situation.

I think that something could be made of the Rodgers factors in a case like this if the facts support Mr. Berry’s need for the funds in order to avoid seeking benefits from the state. The equitable portion of the opinion is too short to provide an adequate description of the arguments made by the Berrys or the thought process of the court.

Conclusion

Similar to the result in bankruptcy, holding funds in an IRA provides little more protection from creditors than holding funds in an ordinary bank account. Because the government is collecting pursuant to a restitution order rather than a tax assessment, its ability to use the powerful collection tools of the IRC may be limited but that does not matter here. The court does not discuss whether the restitution order would allow the IRS to assess all of part of the amount in the order. If some or all of the restitution order covered taxes, then it could have gone about collection by first assessing the taxes and then pursuing normal federal tax collection alternatives as discussed here.

 

Commenting on Regulations

A recent paper shines a light on the fascinating process of commenting on regulations. This year Tax Notes recognized the regulation writers at the IRS Office of Chief Counsel and the Treasury Department as the most significant tax players. Because of the 2017 legislation and the downsizing of Chief Counsel’s office due to the budget reductions over the past eight year, the attorneys there did a tremendous job under very difficult circumstances. They are very deserving of the recognition given by Tax Notes.

The recent paper, entitled “Beyond Notice-and-Comment: The Making of the § 199A Regulations” was written by Shu-Yi Oei of Boston College Law School and Leigh Osofsky of the University of North Carolina at Chapel Hill. The authors focus on the comments made to Treasury and the IRS regarding just one provision of the 2017 legislation. This provision resulted in a high volume of comments because of its nature. The paper not only looks at the volume and the substance of the comments but takes a hard look at the timing and how the timing of comments plays into the final product.

read more...

Although I have limited experience in writing regulations and in commenting on regulations, the article was eye opening in its detail of the process of submissions. In addition to formal submission, the article also comments on the informal ways that parties can influence regulations through the scholarly and popular press, including blogs.

The authors spent a fair segment of the article chronicling the comments on section 199A made prior to the call for formal comments. They detail their effort to find the early comments. These comments do not have the same type of recordkeeping that attaches to formal comments made during the notice and comment period. Their efforts to find these comments is interesting in itself. Also interesting is the impact the early comments had on the proposed regulation. The authors note the number of times the proposed regulations refer to the comments receiving during the period prior to the call for notice and comments. This section had the greatest impact on me because it told me that players with early access have influence at the most critical time. Certainly, parties making comments on the proposed regulation have an influence but having an influence in the formation of the regulation seems even more meaningful.

Because low income taxpayers have no ability to hire lobbyists or attorneys to make their case during the process of creation of a regulation, the Pro Bono and Tax Clinic Committee of the ABA Tax Section tries to comment on legislation and other notices when the IRS puts out a call for comments. At some low income taxpayer clinics around the country, there is also an effort to comment. The article makes me wonder if we are missing an opportunity to more proactively provide our voice on the formation of rules because we generally wait for the IRS to make a request.

If you have ever participated in making comments or wondered about the process, this article will open your eyes. Thanks to the authors for great work.

Bankruptcy Decisions Impacting Taxes in 2018

We provided a year in review look at the Collection Due Process cases decided in 2018 on which we wrote. Here is a similar year in review for bankruptcy cases involving tax issues. We wrote 18 posts on bankruptcy issues involving a wide range of issues. For the most part 2018 was not a year of groundbreaking jurisprudence in the intersection of bankruptcy and taxes but cases continue to clarify certain areas not previously addressed or to supplement prior decisional law. Because it is possible to litigate the merits of a tax liability in bankruptcy as well as to eliminate the liability completely under the right circumstances, it is not possible to fully discuss tax procedure without examining the law and the case in the bankruptcy area.

read more...
  • What is the effect of BC 523(a)(7) on the fraud penalty and how does bankruptcy impact the statute of limitations on collection?

In the case of United States v. Joel No. 3:13-cv-01102 (W.D. Ky. Oct. 18, 2018) the taxpayer committed fraud on the bankruptcy court. His bankruptcy case was reopened once the fraud was uncovered. At issue in this case is the impact of his bankruptcy case on the statute of limitations for collection.

https://procedurallytaxing.com/effect-of-a-revoked-discharge-on-the-suspension-of-the-collection-statute-of-limitations/

  • Interplay between the Federal Tax Lien and the Homestead exemption.

The bankruptcy trustee tries to use the federal tax lien to his advantage to bring property into the estate. The bankruptcy court holds that the trustee cannot step into the shoes of the IRS for the purpose of reaching property that he could not otherwise reach.

https://procedurallytaxing.com/the-federal-tax-lien-and-the-homestead-exemption/

  • Excluding pension plan from property of the estate.

Even though the Supreme Court ruled a couple of decades ago that pension plans are not included in property of the estate under BC 541, the issue of what is a pension plan remains and was addressed in this case. Here, the court holds that the taxpayers retirement plan did not qualify under ERISA and therefore the assets in the retirement account came into the bankruptcy estate for the creditors to use to satisfy their claims.

https://procedurallytaxing.com/bankruptcy-court-declines-to-exclude-retirement-plan-from-estate/

  • Tolling the Period for the IRS to obtain priority status for its claim

If the taxpayer files a prior bankruptcy case or submits an offer in compromise, the act can extend the period in which the IRS can file its claim as a priority claim. A pair of cases discuss how actions taken prior to bankruptcy can extend the statute. In the Clothier case the Assistant United States Attorney arguing the case initially, failed to fully apprise the bankruptcy court of the scope of the statute extension available which caused a motion for reconsideration and a revised opinion from the court once it understood the reach of the statute.

https://procedurallytaxing.com/suspending-the-priority-claim-period-and-an-update-on-clothier-v-irs/

https://procedurallytaxing.com/bankruptcy-court-limits-prior-supreme-court-decision-on-equitable-tolling/

  • Proper treatment of the EITC as source of funds for trustee vs taxpayer

Bankruptcy trustees regularly seek a chapter 13 debtors tax refund during the time the case is pending. The Seventh Circuit holds that the trustee does not have a right to a refund caused by the EITC if the taxpayer can show that the amount received by the taxpayer is needed for necessary expenses. Here there was evidence that the money the debtor received through the EITC tax refund allowed her to pay necessary expenses. Under these circumstances, the court did not order the debtor to pay over to the trustee the amount of the refund related to the EITC.

https://procedurallytaxing.com/proper-treatment-of-earned-income-tax-credit-in-calculating-disposable-income/

  • Who owns the refund in consolidated return cases

When some but not all members of a consolidated group go into bankruptcy the issue arises of who is entitled to refunds of the consolidated group and whether the refunds become property of the estate.

https://procedurallytaxing.com/who-owns-a-refund-consolidated-returns-and-bankruptcy-add-wrinkles-to-refund-dispute/

  • When can the bankruptcy court clawback money paid to the IRS by a fraudster

Cases regularly arise in which a party perpetrating a fraud pays taxes on the money gained by the fraud with the money fraudulent acquired. A circuit split exists on whether the bankruptcy court can clawback the money paid for the taxes in order to use it to repay the parties who lost it due to the fraudulent scheme.

https://procedurallytaxing.com/another-clawback-of-money-paid-to-the-irs/

  • The application of the voluntary payment rule in bankruptcy cases

The IRS allows taxpayers to designate the liability to which their payment will be posted if they make a voluntary payment. If the IRS levies to obtain money or otherwise obtains it involuntarily, it does not allow the taxpayer to designate how the payment will be applied. How does a bankruptcy payment fit into this scheme?

https://procedurallytaxing.com/bankruptcy-and-the-voluntary-payment-rule/

  • What happens when the IRS wrongly tells the taxpayer a debt was discharged by a bankruptcy case

Following bankruptcy many taxpayers have not spoken to their bankruptcy lawyer in a long time and rely upon the IRS determination regarding discharge. Sometimes the IRS person to whom they speak may give them wrong advice. What then?

https://procedurallytaxing.com/detrimental-reliance-on-the-irs/

  • Filing the notice of federal tax lien during the automatic stay

The stay prohibits collection action including filing the NFTL. In this case the IRS asked the bankruptcy court to lift the stay to allow it to file the NFTL and the bankruptcy court agreed to do so.

https://procedurallytaxing.com/filing-the-notice-of-federal-tax-lien-during-the-automatic-stay/

  • Must the IRS affirmatively obtain permission of the bankruptcy court before pursing post discharge collection from a taxpayer.

The IRS makes a discharge determination in each bankruptcy case in which it is listed as a creditor. When it makes the decision that a debt is excepted from discharge, it sends the case back into the collection stream. It does not seek a ruling from the bankruptcy court before doing so. One bankruptcy court challenged this practice. If the IRS must seek a ruling from the bankruptcy court in every case in which it makes a discharge determination and determines that the bankruptcy case did not discharge the taxes, the bankruptcy courts will see a definite rise in the cases on their dockets since it is common for some taxes to pass through bankruptcy without being discharged.

https://procedurallytaxing.com/does-irs-bear-the-responsibility-to-affirmatively-obtain-a-ruling-from-the-bankruptcy-court-before-pursuing-collection-after-discharge/

  • Can a taxpayer obtain a discharge on a late filed tax return

There is a serious circuit split on the meaning on the language at the end of BC 523(a) regarding late filed tax returns. These cases continue to bubble up although the pace has slowed and the tide has turned against the per se one day late rule adopted by three circuits. 2018 did not produce any groundbreaking decisional law in this area but an opinion from the 9th Circuit continued to provide a basis for court opinions on the subject of late returns.

https://procedurallytaxing.com/mr-smith-continues-to-suffer-from-his-failure-to-file-and-other-updates-on-late-filed-returns/

  • Validity of IRS claims in bankruptcy

A pair of cases examines how and when to attack IRS claims in bankruptcy. One deals with who is authorized to file the claim while the other deals with the amount of the claim.

https://procedurallytaxing.com/irs-claims-in-bankruptcy/

  • Priority claim status of unpaid individual mandate tax (penalty)

Several liabilities imposed by the IRC carry the label tax but walk like a penalty and talk like a penalty. Bankruptcy courts have determined that several such liabilities cannot result in priority status claims. It recently applied the same logic to the liability imposed by the individual mandate of the ACA.

https://procedurallytaxing.com/priority-status-of-individual-mandate-tax-obligation/

  • Dischargeability of the first time homebuyer credit

In an issue similar to the priority provision for the individual mandate, a bankruptcy court addresses the dischargeability of the credit. The similarity between to two situations is the need for the bankruptcy court to examine what type of debt is really present and whether the debt created when someone does not fulfill their obligation under the homebuyer credit provisions is tax debt or some other type of debt.

https://procedurallytaxing.com/dischargeability-of-the-first-time-homebuyer-recapture-liability/

  • Cases raising the issue of excepting a liability from discharge due to the fraud exception

Taxpayers who fraudulently evade their liability cannot obtain a discharge. A pair of cases are discussed.

https://procedurallytaxing.com/bankruptcy-cases-involving-evasion-of-payment-and-classification-of-the-failure-to-file-penalty/

  • Who can avoid the federal tax lien in a bankruptcy case

A debtor tries to avoid the federal tax lien and fails in a situation in which the trustee would have succeeded.

https://procedurallytaxing.com/avoiding-the-federal-tax-lien-securing-penalties-in-a-bankruptcy-case/

 

Ponzi Scheme Victims Seek to Defeat the Federal Tax Lien with Constructive Trust Argument

All too often a person cheating others ends up pitting the defrauded individuals against the IRS in a battle over the remaining assets of the cheater. The most recent version of this longstanding problem exists now in the Ninth Circuit case of Wadsworth v. Talmage, 123 AFTR 2d 2019-305 (911 F.3d 994), (9th Cir. 2018) (order certifying question to the Supreme Court of Oregon). On December 27, 2018, the Ninth Circuit declined to sustain the dismissal of the action by the district court and certified the issue of the meaning of a constructive trust in Oregon to the Oregon Supreme Court. Presumably, the Oregon Supreme Court’s decision on the application of constructive trusts in that state will allow the Ninth Circuit to reach a decision on whether property existed to which the federal tax lien could attach.

These types of cases put the IRS in the awkward position of taking the assets of the thief to satisfy outstanding tax debts resulting from the theft. By taking those assets, the IRS prevents the actual victims of the theft from receiving restitution. I am always pulling for the victims in these cases because it does not seem right to me that the tax authority should take the money instead of the actual victims of the theft. I have written about these types of situations previously in the bankruptcy context, here and here, in circumstances in which the issue was whether the court could order a clawback of the money from the IRS.

read more...

The Ninth Circuit describes the basic facts regarding the use of the money fraudulently obtained from investors:

John Wadsworth and other members of the RBT Victim Recovery Trust (collectively, “the Trust”) allege that Ronald Talmage, an investment manager, began fraudulently diverting his clients’ funds in the 1990s as part of a Ponzi scheme. Members of the Trust entrusted Talmage with “over $55 million” between 2002 and 2015.

In 1997, Talmage and his first wife purchased RiverCliff for almost $1 million. The property was purchased with the proceeds of Talmage’s Ponzi scheme. From 1998 to 2008, Talmage spent over $12.5 million of entirely stolen funds to improve the property. Talmage paid his first wife $1.5 million dollars in 2005 using money “stolen . . . from . . . Trust beneficiaries” to purchase her half-interest in RiverCliff after the couple divorced. Throughout this time, Talmage resided at RiverCliff.

Unlike the debtors in the bankruptcy cases linked above in which the issue was a clawback of money paid to the IRS, here the perpetrator of the scheme also failed to pay his taxes. Because he failed to pay his federal taxes, the IRS filed a notice of federal tax lien. The lien attached to RiverCliff and all of the property owned by Mr. Talmage. The IRS brought suit to foreclose its lien on the property. The Recovery Trust sought to intervene in that action and was denied. The Recovery Trust then brought this action seeking to quiet title to the property. At the district court level the IRS succeeded in having the suit dismissed. The referral to the Oregon Supreme Court comes because the Ninth Circuit sees the possibility that under Oregon law the Recovery Trust may have a superior property interest to the lien of the IRS.

Although the priority of the federal tax lien is determined under federal law, whether the taxpayer has a property interest to which the lien can attach is a question of state law. Looking at Oregon law, the Ninth Circuit found that opinions existed supporting both the majority and minority views of constructive trust:

The rights of the legal title-holder, and of lienors such as the Government, depend on when the constructive trust arises. Under the laws of the several states, a constructive trust can arise either at the moment a purchase is made with the fraudulently-obtained funds, or at the moment a court imposes the trust as an equitable remedy. Under the majority rule, a trust arises automatically at the moment of purchase. See In re Leitner, 236 B.R. 420, 424 (Bankr. D. Kan. 1999) (“[U]nder the majority state law rule, a constructive trust arises at the time of the occurrence of the events giving rise to the duty to reconvey the property, not at the date of final judgment declaring the trust . . .”); see also RESTATEMENT (THIRD) OF RESTITUTION AND UNJUST ENRICHMENT § 55 cmt. e (2011). In states following this rule, the legal title-holder is a constructive trustee who holds no rights beyond bare legal title. For purposes of the federal tax lien statute, 26 U.S.C. §6321, property held in a constructive trustee-taxpayer’s name therefore does not “belong” to the taxpayer, and tax liens cannot attach. See, e.g., FTC v. Crittenden, 823 F. Supp. 699, 704 (C.D. Cal. 1993) (finding that an “IRS lien does not attach” to business funds that are subject to a constructive trust under California law); Mervis Indus., Inc. v. Sams, 866 F. Supp. 1143, 1147 (S.D. Ind. 1994) (finding tax liens could not attach to property whose title is held by an embezzler because Indiana law “is clear” that “an embezzler, from the beginning, acquires no beneficial ownership in property purchased with stolen funds”).

Under the minority rule, a constructive trust arises only once it is imposed as a judicial remedy. In that case, the legal title-holder retains all the rights of a property owner until such a remedy is imposed by a court. Until that time, the property “belongs” to the title-holder for purposes of 26 U.S.C. § 6321 and federal tax liens against the title-holder can attach. If no court has imposed a trust when the tax liens attach, the beneficiaries of a potential constructive trust hold at most an inchoate claim to the property. For example, in Blachy v. Butcher, 221 F.3d 896, 905 (6th Cir. 2000) (quoting Soo Sand & Gravel Co. v. M. Sullivan Dredging Co., 244 N.W. 138, 140 (Mich. 1932)), the Sixth Circuit found that “[u]nder Michigan law, a ‘constructive trust is strictly not a trust at all, but merely a remedy administered in certain fraudulent breaches of trusts.’” Because “a constructive trust does not arise until a judicial decision imposes such a trust under Michigan law,” beneficiaries of the trust alleged in that case held only an inchoate state-created lien, over which an attached federal tax lien takes priority. Id.

Because state law controls a critical question concerning the competition between the parties due to the issue of what property interest in the taxpayer held, the Ninth Circuit correctly certified the question to the Oregon Supreme Court. The specifics of Oregon law may impact few readers but the issue of constructive trust and the ways that states have construed ownership in these situations has broad application. The lawyers for the trust have done a great job of keeping the case going in the face of significant adversity after being rebuffed in their effort to intervene and being dismissed in the quiet title action. They have one more hurdle to leap before the defrauded investors (and probably the lawyers themselves) have a chance at using the value of the property purchased by Talmage to satisfy their claims.

Ninth Circuit Affirms Earlier Decisions Denying Debtor Right to Alter IRS Lien after Bankruptcy

On November 7, 2017, I posted on the case of In re Nomillini in which the debtor sought to limit the secured claim of the IRS based on the confirmation of his chapter 13 plan. The Ninth Circuit, in an unpublished opinion dated December 18, 2018, denied the debtor’s motion to cut off the rights of the IRS lien in debtor’s property. Here, the debtor’s plan did not seek to limit the rights of the IRS as a secured creditor. The court relied on the normal rule that a lien against a debtor passes through the bankruptcy unaltered absent a specific attack on the lien as a part of the bankruptcy proceeding.

read more...

The Ninth Circuit stated the general rule as follows:

For a debtor to avoid a creditor’s lien or otherwise modify the creditor’s in rem rights, the debtor’s confirmed plan must do so explicitly and provide the creditor with adequate notice that its interests may be impacted. Id. at 873. Any ambiguity in the plan will be interpreted against the debtor. Id. at 867.

Mr. Nomillini did not mention the IRS lien in his chapter 13 plan. He gave no notice to the IRS during his bankruptcy proceeding that he sought to reduce or eliminate its lien on his property. He sold his home. He entered into an agreement with the IRS that its lien would attach to the proceeds. The sale of the home brought a greater price than anticipated by the IRS when it filed its original lien. Based on the sale price, the IRS amended its claim to increase the amount of its lien claim to match the proceeds. Mr. Nomillini sought to limit the IRS lien claim to the amount of the original claim. He then brought an action seeking to avoid the IRS lien to the extent that it exceeded the original claim. The lower courts dismissed the case and the 9th Circuit affirmed.

Lien claims not only pass through bankruptcy unimpacted (absent a specific challenge) but the amount of a lien claim can change during or after a bankruptcy as the value of the property increases or decreases. When the IRS filed its original claim in this case, it had to value its lien claim and claim any portion not covered by equity in Mr. Nomillini’s property as an unsecured claim. Here, the value of the secured property turned out to be low either because the IRS made a wrong determination at the outset or because the property continued to increase in value. In either event the debtor does not receive a windfall because of the low value in the initial claim.

Once the property was sold, the value of the property was set and the IRS amended its claim up to the amount of the sales proceeds. The Ninth Circuit joins the lower courts in determining that the IRS has the right to do this. Had the property sold for less than the amount of the lien claim that the IRS made, the value of the lien claim would have decreased rather than increased. For this reason creditors often seek to protect themselves from a downward movement of value in secured property by seeking adequate protection. The IRS does not do this often because of the time involved to seek adequate protection and, in cases in which its lien is secured by real property, because of the difficulty in proving that the property will decrease in value.

The case resolves the issue in a manner consistent with existing law. The lesson here is that the value of a lien claim is not fixed at the time of filing bankruptcy.