Filing a Notice of Federal Tax Lien For Personal Property

Today PT contributor Bob Probasco brings us a recent case that demonstrates the value of verifying that the IRS followed proper procedures in filing a Notice of Federal Tax Lien.

A recent decision by a bankruptcy court, In re: Vanessa Catherine Stephenson, (docket no. 21-22684 in the Western District of Tennessee), is a reminder of potential pitfalls for the IRS when filing a notice of federal tax lien (NFTL).  The IRS identified part of its claim as secured by the debtor’s personal property, based on an NFTL filed on August 21, 2018.  The debtor/taxpayer objected, arguing that the entire claim was unsecured because the NFTL was not filed properly and did not attach.  The court identified this as issue of first impression.  After two hearings and additional briefing, the court agreed with the debtor.  The NFTL was filed in the wrong county and therefore not effective/invalid.  The entire IRS claim was unsecured.

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Background

Ms. Stephenson moved around the country a lot during 2016 – 2018: Longmont, Colorado; Fort Mills, South Carolina; Keeling, Virginia; Semora, North Carolina; and finally Shelby County, Tennessee, where she resided when the NFTL was filed.  However, she filed her 2017 tax return using her mother’s address, in Benton County, Tennessee.  She also used that address for employment purposes and as a result received W-2s showing that address.  The IRS, using the information it had, filed the NFTL in Benton County rather than Shelby County.

Where to file an NFTL

Section 6323(f)(1) specifies that an NFTL is to be filed in the appropriate office of the state (or county or other subdivision), as designated by the state, where the property is situated.  Where is the property situated?  Section 6323(f)(2) specifies that as the physical location (for real property) or the taxpayer’s residence at the time the lien is filed (for personal property). 

Corwin Consultants, Inc. v. Interpublic Group of Cos., 512 F.2d 605 (2d Cir. 1975) pointed out that prior to the Federal Tax Lien Act of 1966, there was “some dispute as to where personal property, both tangible and intangible, was situated” but in most cases intangibles were located at the taxpayer’s domicile.  For section 6232(f)(2), the drafters deliberately chose residence instead of domicile “because of the difficulty in determining a person’s domicile, based as it is on (among other things) his state of mind” (quoting the legislative history).  The district court in Corwin decided that the debtor/taxpayer’s residence could not be determined but treated the NFTL as valid because of due diligence and substantial compliance by the IRS. 

The Second Circuit rejected that decision as premature and remanded for the district court to try again to determine the facts.  It acknowledged that might not be obvious, because residence “when used in a sense other than domicile, is one of the most nebulous terms in the legal dictionary.”  It also noted the importance of other creditors receiving notice as to possible claims by the IRS.

In light of this purpose, the residence of a delinquent taxpayer is a question of fact to be determined by various criteria: Among them are the taxpayer’s physical presence as an inhabitant and not a mere transient; the permanence of that presence; the reason for his presence; and the existence of other residences.  In general, for this statute, where a taxpayer resides is where he dwells for a significant amount of time and where creditors would be most likely to look for him.  What proportion of time is “significant” is not capable of exact definition and must be determined on a case by case basis, at all times keeping the purpose of the filing requirement in mind.

One of the judges on the Corwin panel concurred with remanding to the district court but disagreed with the burden of proof (or reasonable effort/due diligence) that should be placed on the government.  He would have construed section 6323(f)(2)(B)

to mean that, where the government cannot through reasonable inquiry ascertain a taxpayer’s actual residence, it may satisfy the statute’s requirement by filing notice of its judgment lien with the state-designated office within the jurisdiction of the taxpayer’s last known or verifiable abode.  This practical construction seems to me to be in accord with the purpose of the statute, which is to put other creditors on notice, since they too would be most likely to inquire about liens in the county of the last residence of the taxpayer that could be ascertained by reasonable effort.

It would not be enough, though, to rely on the last address shown on IRS tax records, which can’t readily be determined by other creditors.  Additional effort would be required to determine the “last publicly known address of a taxpayer.”  The concurring opinion did not go into further detail.

Compare to notices of deficiency

Even the standard set forth in the Corwin concurring opinion is more challenging that the IRS requirement for mailing a notice of deficiency.  Section 6212(b)(1) specifies that the notice of deficiency for income taxes, with limited exceptions, be sent to the “last known address.”  Absent clear and concise notification by the taxpayer, courts allow the IRS to use the address on the taxpayer’s most recently filed tax return.  (For the definition of “last known address” and how taxpayers can provide the clear and concise notification, refer to Regulation § 301.6212-2 and Rev. Proc. 2010-16.  It’s also worth revisiting Audrey Patten’s PT post on the Gregory case.)

Courts generally impose an obligation to do more only if the IRS becomes aware of an address change prior to mailing the notice.  For example, if the notice itself is returned by the Post Office, the IRS may try to find a different address – but the Tax Court will not require the IRS to do that.  Tucker v. Commissioner, T.C. Memo 1989-408 has a good summary of caselaw on this.  It also describes a few practices the IRS may use to find a different address: rechecking IRS records, checking with credit rating agencies, and checking with the Post Office for a forwarding address.

It is reasonable to treat notices of deficiency and NFTLs differently in terms of how much effort is required from the IRS.  The “last known address” rule for notices of deficiency protects only the taxpayer.  If the taxpayer has not notified the IRS of a new address, or taken steps to have mail forwarded, it’s only the taxpayer injured by that inaction.  The “residence” rule for NFTLs is primarily aimed at protecting other creditors.  They don’t have access to IRS records, to know where the IRS might have filed an NFTL and would be disadvantaged if they don’t realize the IRS is likely to, and can, file elsewhere.

Back to the Stephenson case

The IRS argued that it should be entitled to use the mother’s address for the NFTL because Ms. Stephenson had “held out” that as her home address on tax returns and W-2.  The court rejected that argument because it  found “no binding legal support that the IRS was entitled to use the address Ms. Stephenson held out as her home address as the place Ms. Stephenson resided when it was not in fact the address where she physically resided.”  It cited another bankruptcy case, affirmed by the Eleventh Circuit, that rejected the “last known address” interpretation because it would “read . . . additional language into the statute.”  (It also referred to the concurring opinion in Corwin.)  Based on the testimony at trial, Ms. Stephenson did not reside in Benton County when the NFTL was filed there.  The NFTL was invalid and the entire IRS claim was unsecured. 

Even if this was a “case of first impression,” I think the opinion is consistent with most practitioners’ understanding or interpretation of the statute.  It creates problems for the IRS, for example, when the taxpayer has moved but not yet filed a tax return.  This case points out another example, when the taxpayer doesn’t use her actual residence for her tax returns.  That may not be common, but it certainly happens.  Whether it’s worth additional IRS effort to identify the taxpayer’s actual residence before filing the NFTL, or it’s better to just lose occasional bankruptcy disputes over priority, is another question.

The process is intended to provide notice to parties who subsequently provide the taxpayer credit (or purchase real property).  If such parties wouldn’t be able to find the NFTL through a lien search, the IRS should not be given a place in the line ahead of those parties.  Courts generally won’t apply a strict compliance standard.  They focus on whether a purchaser or subsequent creditor could have found the lien, even with some errors in the lien filing, through reasonable care and diligence during a search.  Here’s an example: U.S. v. Z Investment Properties, LLC, 921 F.3d 696 (7th Cir. 2019).

The “residence” rule generally does a good job of protecting other creditors; at least the lien will be reported in the proper county.  However, it’s not perfect.  Even if the IRS has the right address initially, that won’t help later creditors after the taxpayer has moved.  Filing the NFTL in the county where the taxpayer resides at the time means it will attach to the personal property even after she moves.  But other creditors in the new location would have no warning that they needed to check lien registries in previous places the taxpayer lives.  That’s not the only problem with notice of a lien, but it’s a significant one.  Keith’s proposal of a national tax lien registry seems a much better solution for both the IRS and other creditors.

Power of Federal Tax Lien

Before discussing today’s case, I want to provide some information on a fellowship opportunity that Tax Analysts (the publisher of Tax Notes) is generously sponsoring in partnership with the ABA Tax Section.  This new two-year Fellowship will fund an attorney to work at a non-profit agency. Unlike other fellowships, this one is geared towards seasoned attorneys including those seeking to move into the public interest sector. In future years, the Fellow will select the public interest sponsoring organization. For this inaugural year, Tax Analysts selected the organization, The La Posada Tax Clinic in Twin Falls, Idaho. Run by Bob Wunderle, the clinic – and Bob — do amazing tax controversy work with the farm worker community in that area. Bob is a national leader in this practice.  You can learn more about Bob’s cutting edge work by listening to the podcast which is part of the Tax Notes Talk series. This is a unique opportunity in a beautiful part of the country. Application materials are available here.  Keith

The recent case of United States v. Sadig, Dk. No. ___ (N.D. Ill. 2022) demonstrates the power of the tax lien and tells a sad tale regarding a home that once was.  The district court provides a thorough explanation of the lien interest of the IRS in reaching the conclusion that the property to which the lien attaches may be sold.

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Before moving to a discussion of the lien interest, I want to mention the local rule regarding summary judgment that exists in the Northern District of Illinois.  The IRS moved for summary judgement here.  Because Mr. Sadig was pro se, the local rule required the IRS to explain to him what he must do to respond to the motion:

Local Rule 56.1 governs the procedures for filing a motion for summary judgment. The moving party must file a “statement of material facts that complies with LR 56.1(d) and that attaches the cited evidentiary material.” See L.R. 56.1(a)(2). “Each asserted fact must be supported by citation to the specific evidentiary material, including the specific page number, that supports it.” See L.R. 56.1(d)(2).

Local Rule 56.1 also explains how to respond to a motion for summary judgment. The non-moving party must file a “response to the LR 56.1(a)(2) statement of material facts that complies with LR 56.1(e).” See L.R. 56.1(b)(2). That response “must consist of numbered paragraphs corresponding to the numbered paragraphs” of the movant’s statement of facts. See L.R. 56.1(e)(1). So, by way of illustration, imagine if the movant filed a statement of material facts with 15 paragraphs. The non-movant must file a response that addresses each of those 15 paragraphs, and must do so paragraph by paragraph, one at a time.

To help pro se litigants, the Local Rules require parties to serve a notice that explains the procedure, so that they are not lost at sea. See L.R. 56.2. That way, unrepresented parties will receive clear instructions about what they need to file, and how they need to do it.

Mr. Sadig did not properly respond to the motion for summary judgment despite the government’s compliance with the local rule providing him with clear instructions on what to do.  I doubt that it mattered in this case whether he responded appropriately given the facts, but the local rule does provide a model that other courts might adopt in summary judgment settings to give pro se litigants a better chance to provide the court with appropriate information.  Of course not every pro se litigant will follow the instructions but having the moving party give them instructions directly tailored to the response they need to provide seems like a great idea.

Mr. Sadig’s problems begin sometime before the years at issue in this case because the court makes passing reference to the expiration of the collection statute of limitations on a 2004 liability of over $90,000.  The years in this case begin with his failure to file returns for 2005 and 2006.  Although not directly stated in the opinion, I suspect that the IRS made assessments against him based on the substitute for return procedures.  The assessments occurred in 2010 and totaled about $40,000.  He then had problems with paying taxes again in 2012 and 2013.  By the time of the case he owed about $100,000.

Mr. Sadig and his wife bought a home in a Chicago suburb in 2002 for almost $300,000.  He made substantial renovations to the home; however, the renovations failed spectacularly creating not only structural problems with the house but, I suspect, severe structural problems with the marriage:

Sadig’s renovations failed, catastrophically. His project compromised the structural integrity of the house. In December 2013, the City of Park Ridge sent him a notice that the residence was “not in compliance with the health and safety code due to structural issues.” The letter explained that, given its current state, the property may need to be demolished.

In fact the house was demolished in June, 2014 and divorce ensued in October, 2016.  In the meantime, Mr. Sadig transferred his interest to his wife in May, 2014 for no consideration.  At that time, the assessments for 2005, 2006 and 2012 existed and the IRS had filed a notice of federal tax lien in February 2014.  In September, 2018, his ex-wife transferred the property to a trust for no consideration.

The foreclosure case is a slam dunk for the years assessed before the transfer to his wife.  Even without the filing of the notice of federal tax lien, the lien continued to attach to property transferred for no consideration.  Because of the existence of the notice, the government’s case was lock tight.  The discussion of the lien issue for those years took the court little effort.

The assessment for 2013 occurred shortly after the transfer.  The court walked through the Illinois Uniform Fraudulent Transfer Act to show that the transfer of the property met the definition of constructive fraud with respect to the 2013 liability, which existed at the time of the transfer.  The existence of the unassessed liability coupled with the transfer for no consideration and his insolvency at the time of transfer met the statutory requirements.

The court then turned to the effect of the ex-wife’s transfer of the property to the trust.  It finds the trust serves as her nominee after walking through the nominee provisions.  She maintained the sole power to possess, manage and physically control the property.

Finally, the court examined the factors set out in United States v. Rodgers, 461 U.S. 677, 703-05 (1983) which it must do whenever the IRS seeks to foreclose property of one owner of property in a forced sale that will impact non-liable owners.  Because the property is now a vacant lot, it is very hard for her to stop the sale in the application of these factors:

In accounting for innocent third-party interests during forced property sales, courts look to four non-exhaustive factors: “(1) the prejudice to the government’s interest as the result of a partial, rather than a total, sale; (2) whether the third party with a non-liable separate interest in the property would, in the normal course of events 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 prejudice to the third party as the result of a total sale; and (4) the relative character and value of the non-liable and liable interests held in the property.”

Conclusion

The case does not present new law.  The existence of the local rule seeking to protect pro se litigants facing a motion for summary judgment is interesting and instructive.  While I do not believe that a different outcome would have resulted had Mr. Sadig properly responded, such a rule does provide pro se litigants with a better chance of making a winning argument than having to do so without good instructions on how to respond.