Tax Judgments and Quiet Titles

I have written before about the effect of the IRS obtaining a judgment with respect to a tax assessment.  In Boykin v. United States, No. 5:21-cv-00103 (W.D.N.C. 2022), the fact that the IRS had a judgment carries the day in a contest with a taxpayer involving a quiet title action.  The case provides no great revelations but shows how obtaining a judgment can benefit the IRS many years past the normal 10-year statute of limitations.

Between this case and the Tilley case I recently blogged from the Middle District of North Carolina, it appears that the Chief Counsel office in North Carolina has been busy in pursuing collection against taxpayers using real property held by nominal owners, with both opinions coming out on January 4, 2022.

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Mr. Balvich owed the IRS for 1999 through 2006.  The IRS filed an action to reduce the assessments to judgment in 2019 and obtained a judgment on August 6, 2020.  In bringing an action of this type, the IRS must sue before the collection statute expires.  The opinion in the current case doesn’t spell out the status of the statute of limitations on collection of the assessments for the years at issue, but something must have caused the statute to be open for each of the years at the time the IRS brought the suit.  It could have been that the assessments for those years occurred many years after the close of the tax year, or that Mr. Balvich filed bankruptcy or made a CDP request.  Many possibilities exist for the statute on collection to still remain open 20 years after the end of the tax year.

The plaintiff in the quiet title action, Rebecca Boykin, began a relationship with Mr. Balvich in 2010 and eventually married him in 2015.  She worked as an administrative assistant at a company owned by Mr. Balvich.  When they got married, he gifted to her a 50% interest in his medical services business.  He and the business also, according to the IRS, put up the money to buy real property in Boone, North Carolina in which Ms. Boykin is the record owner.  On March 20, 2019, the IRS filed nominee liens encumbering the Boone property.  I have discussed nominee liens previously here

After Ms. Boykin brought suit to quiet title seeking a declaration that the nominee liens were invalid, the IRS filed a counterclaim arguing that the money used to purchase the property was fraudulently transferred from the taxpayer who sought to place his property out of the reach of the IRS.

She argued that the North Carolina Uniform Voidable Transaction Act barred the IRS argument regarding the fraudulent transfer claims because it placed a four-year statute of limitations on such claims.  The district court graciously described her argument as misguided.  It pointed to the Supreme Court case of United States v. Summerlin, 310 U.S. 414, 416 (1940), where the court held:

It is well settled that the United States is not bound by state statutes of limitation or subject to the defense of laches in enforcing its rights.

The court followed the Supreme Court cite with a string cite of federal circuit court cases following the Summerlin case and swatting back arguments similar to Ms. Boykin’s that have been made in the eight decades following the Supreme Court’s pronunciation.

Piling on to Ms. Boykin’s legal woes, the court explained further that the judgment obtained by the IRS took its time period for seeking a remedy against this property outside of the mere 10-year period into the much longer period provided to the holder of a judgment:

Additionally, when the United States has obtained a timely judgment, its “subsequent efforts to enforce the liability or judgment against a third party will be considered timely.” United States v. Anderson, 2013 WL 3816733, at *2 (M.D. Fla. July 22, 2013) (holding that civil action to collect federal income taxes of an Estate from the Estate’s beneficiaries as a result of transferee liability under the Uniform Fraudulent Transfer Act was not time barred by the ten-year statute of limitations found in 26 U.S.C. § 6502(a)); see also United States v. Worldwide Lab. Support of Illinois, Inc., 2011 WL 148196, at *2 (S.D. Miss. Jan. 18, 2011) (holding that the ten-year statute of limitation period of “Section 6502 is inapplicable” to an action “against an alleged transferee in aid of collecting a judgment already obtained against the taxpayer”)

The decision here does not mean that the IRS has proven there was a fraudulent transfer, but only that she cannot dismiss the counterclaim based on the statute of limitations.  Perhaps she will concede, knowing that the IRS can prove a fraudulent transfer or fight the next battle in the effort to retain ownership of the property.  I hope that she does not choose to appeal this decision and add to the long string of cases holding that the Supreme Court meant what it said in holding that state statutes of limitations do not override the controlling federal statute here.

Local Taxes and the Federal Tax Lien

Cases involving lien priority fights between the IRS and local taxing authorities became quite rare after the Tax Lien Act of 1966.  That act has stood the test of time and brought federal lien law into the “modern” age.  With almost no changes to the statute since its enactment, it still operates with great efficiency.

The case of United States v. Tilley, No. 1:19-cv-00626 (M.D.N.C. 2022) purports to resolve a case or controversy between the IRS and a group of counties with local real estate taxes but is really just the court memorializing an assertion of lien priority by the counties and an acknowledgement by the IRS of their priority.  It wasn’t always this way.  Prior to 1966 and the enactment of 26 U.S.C. § 6323(b)(6), lien priority questions between the IRS and local taxing authorities too often ended up with a circular priority problem.  That provided one of the big reasons for passage of the Tax Lien Act.  The love fest exhibited in this case shows how the Tax Lien Act fixed the problem.

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Mr. Tilley got in a heap of trouble.  For readers old enough to have watched the TV series the Andy Griffith Show, I picture Mr. Tilley providing material for one of the episodes of that show, based in rural North Carolina in the central part of the state, as one of the occasional scallywags that Sheriff Griffith had to navigate.  While Sheriff Griffith did not deal with too many “elaborate scheme[s] of sham trusts, fake corporations, and other nominee entities,” perhaps the character on the episode Bailey’s Bad Boy grew up to bigger problems.

Mr. Tilley defrauded the IRS through his schemes and ultimately pled guilty to a crime under IRC 7212(a) which is not one of the tax crimes you see prosecuted very often.  To be convicted of this crime you need to forcibly interfere with tax administration.  He interfered enough to draw a restitution order as part of his sentence of $7,676,757.00.  Not bad for a country boy.  At the time the IRS brought suit to foreclose on 35 properties he was holding through nominees, he still owed over $6 million.

Most of the people and entities involved in the holding of these properties did not respond to the suit that the IRS brought to foreclose, but a passel of counties and townships in central North Carolina raised their hands and said, “We want ours.”  Not surprisingly in a scheme of this type, lots of real estate taxes remained unpaid and that’s where the lien priority issue between the IRS and the counties comes into play.

The general rule of lien priority is first in time, first in right and that rule is reflected in IRC 6323(a) as well as in the Supreme Court’s decision in United States v. City of New Britain, 347 U.S. 81 (1954).  This is where the circular priority problem comes into play.  In real property the first lien is usually the mortgage.  If the IRS then files a lien it comes behind the mortgage.  If the owner doesn’t pay his real estate taxes after the IRS has filed its lien, the real estate taxes come after the federal tax lien in a first in time situation but come ahead of the mortgage under local law.  That’s why mortgage companies often require borrowers to escrow their local real estate taxes so that no local tax lien comes ahead of them.  The mortgage beats the IRS because it was first in time, the IRS beats the local taxes because it was filed first, and the local taxes beat the mortgage because of local law, but the local law cannot trump the federal law, thus creating the circle and the problem.

To fix the problem, Congress passed 6323(b)(6).  While 6323(a) sets up the first in time rule of law, 6323(b) provides 10 exceptions which allow a party to defeat the filed federal tax lien even if they come later in time.  Number 6 in that list is local property taxes.  Here, the liens of the counties and the townships clearly fit within the statutory language and the IRS acknowledged that fact in its concession.  The court states:

Although only one taxing authority, the City of Durham, has moved for summary judgment, this court finds judgment may be entered in favor of all taxing authorities similar to the relief requested by the City of Durham. The Government concedes that its interests are not superior to local property tax authorities. … Pursuant to 26 U.S.C. § 6323(b)(6) and 18 U.S.C. § 3613(c), property tax liens held by local property tax authorities have priority over the liens the Government seeks to enforce here. (See Doc. 175.) The City of Lenoir, (Doc. 176), County of Chatham, (Doc. 178), City of Durham, (Doc. 179), County of Harnett, (Doc. 180), County of Wake, (Doc. 181), County of Ashe, (Doc. 182), County of Orange, (Doc. 183), County of Granville, (Doc. 184), County of Durham, (Doc. 185), and County of Alamance, (Doc. 186), all agree with the Government’s position and consent to entry of an order resolving this case as to all property tax authorities which have filed answers.

This doesn’t stop the IRS from foreclosing on the property.  It just means that the proceeds from the sale will go first to satisfy the local taxes, then to satisfy any mortgage or other creditor, if they exist, listed in IRC 6323(a) who filed before the IRS perfected its lien interest and then, after those parties are satisfied, the IRS will take the rest up to the amount of the outstanding liability. It was not clear from the opinion whether the sale of all of the properties Mr. Tilley held through his nominees would satisfy his large liability to the IRS.  If not, there could be more cases involving Mr. Tilley in the future.  What would Andy Griffith say?

Subordination of Tax Lien Denied

In the bankruptcy case of In re Baldwin, 128 AFTR 2d 5762 (Bankr. N.D. Ohio 2021) the trustee’s attempt to use the subordination provisions of BC 724(b) fail because the bankruptcy court determines that selling the debtor’s house would not benefit the unsecured creditors of the estate and would harm the debtor’s wife who did not join in the bankruptcy petition.  Selling the house would have benefited the trustee and it would have benefited the IRS and a couple other secured creditors, but the job of the trustee is not to assist secured creditors but unsecured creditors.  The court provides an excellent analysis of the reason for its denial and a good worksheet showing where the dollars will go if the trustee prevailed. 

The presence of a non-debtor, Mrs. Baldwin, who would lose her home in exchange for a relatively small amount of equity remaining after payment of the secured creditors, plays into the court’s decision as well, giving the opinion somewhat of the feel of a Rodgers’ analysis in addition to the 724(b) analysis.  In the 1983 case U.S. 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 it concluded that “some limited room is left in the statute for the exercise of reasoned discretion.” I have discussed the application of Rodgers in prior posts here and here.

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Ohio has a pretty generous property exemption and Mr. Baldwin claimed an exemption of $220,000 in the property of the estate; most of that was in the jointly owned home.  We have discussed B.C. 522 and exemptions that debtors can claim in a bankruptcy case here and here.  Mr. Baldwin hopes in claiming this exemption that he would get to keep basically all of his property leaving his unsecured creditors empty handed while he received the benefit of a discharge.  I don’t say that because that’s a bad result but because it’s the common result of a no-asset chapter 7 case.  Because of the proposed outcome for unsecured creditors, the initial classification of this case was as a no-asset case since there were no assets available to pay claims of unsecured creditors.  The exemption claim does not impact the position of secured creditors.  It’s not clear that Mr. Baldwin understood that.

Mr. and Mrs. Baldwin had established the Baldwin Revocable Trust not too long before filing bankruptcy and transferred ownership of their home to this trust.  The trustee in the bankruptcy argued that debtor didn’t have an ownership interest in the house where he lived because it was owned by the trust.  Since he did not have an ownership interest, the trustee argued he could not exempt the property.  The court sustained the trustee’s objection after which the trustee revoked the trust. The court notes that the bankruptcy trustee, standing in the shoes of the debtor, was entitled to revoke the trust in accordance with the trust agreement. I have trouble feeling sorry for Mr. Baldwin at this point because putting the property nominally in the name of the trust smacks of an effort to defraud creditors.

The trustee’s revocation vested a half interest in the property to the debtor and the trustee argued that the revocation made the property subject to the control of the bankruptcy estate, potentially turning the case into an asset case with funds available to at least partially satisfy unsecured creditors.  The trustee then sought permission to sell the entire property.  The debtor objected, arguing that the revocation vested 100% of the property in the hands of Mrs. Baldwin, who he argued was the sole grantor of the property to the trust.  This reflects, in my view, another effort by Mr. Baldwin to defraud creditors.  Despite the debtor’s attempted shenanigans, the court marches forward with a determination of the true property interest of the parties holding that trust.  The court finds that H & W each own a half interest.

As mentioned above, this case was initially filed as a no-asset case.  In no-asset cases, creditors are instructed not to bother filing a proof of claim since the claim will not matter.  When the trustee revoked the trust and brought property into the estate, a notice went out to the creditors as happens when a case converts from no-asset to an asset case.  The notice gave creditors six months to file a claim.  Both the IRS and the Ohio taxing authority missed that deadline, which has negative consequences for general unsecured claims, but the court finds it has no negative consequences for secured creditors which both the IRS and Ohio were in this case.

As discussed in the earlier posts discussing the exemption provision in BC 522, the exemption does not exempt property where the taxing authority has perfected its interest by filing a notice of lien prior to the bankruptcy petition.  Both the IRS and Ohio had perfected their lien interest prior to Mr. Baldwin’s bankruptcy petition, which meant he could not exempt the value of the property covered by these liens.

The trustee wants to use the bankruptcy not only to provide some payment to the unsecured creditors but also to the trustee.  When the trustee finds assets, the trustee receives a percentage of those assets for their effort.  This system incentivizes the trustee to look for assets and also benefits the unsecured creditors, who might receive nothing if the trustee did not pursue potential assets of the bankruptcy estate.

The court wants to assist the unsecured creditors but also has a broader responsibility.  The court begins the discussion by signaling the trustee’s responsibilities to the estate as a whole:

“As a general rule, the bankruptcy court should not order property sold `free and clear of’ liens unless the court is satisfied that the sale proceeds will fully compensate secured lienholders and produce some equity for the benefit of the bankrupt’s estate.” In re Riverside Inv. P’ship, 674 F.2d 634, 640 (7th Cir. 1982) (emphasis added) (citing Hoehn v. McIntosh, 110 F.2d 199, 202 (6th Cir. 1940)).

A Chapter 7 trustee is responsible for liquidating the estate and using the proceeds to satisfy the debtor’s unsecured creditors. See generally 11 U.S.C. §§ 704 & 726. This power to liquidate property of the estate, however, “will not be exercised unless it is made to appear that there is a fair prospect of the property being sold for substantially more than enough to discharge the lien or liens upon it.” Hoehn v. McIntosh, 110 F.2d at 202. The Chapter 7 trustee, in other words, must generally abandon property that does not possess substantial equity. See In re Feinstein Family P’ship, 247 B.R. 502, 507 (Bankr. M.D. Fla. 2000).

The court does an excellent job of explaining why the sale here does not make sense, even going to the trouble of providing a detailed analysis of how the money will be divided between the bankrupt husband and his non-petitioning wife.  The outcome of not allowing the trustee to sell the property is arguably a windfall for the debtor but it is the right result.  Some of the secured creditors will undoubtedly get paid in the end.  This is a case where you might see the IRS bring a foreclosure suit to collect its taxes since the property has equity, and the taxpayers don’t seem inclined to pay otherwise.  Such a suit would, however, squarely mire the district court in the Rodgers factors since it would involve selling the house.

Taxpayer Fails in Effort to Dismiss Erroneous Refund Suit

In United States v. Sharpe, No. 2:20-cv-02490 (E.D. Pa. 2021) the court denied the taxpayer’s motion to dismiss an erroneous refund suit filed against her by the IRS.  The denial of the motion still leaves her with the opportunity to argue against the imposition of the erroneous refund provision on its merits.  It also provides an opportunity to look at the impact of prior litigation on the debt at issue in the erroneous refund action.

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In September of 2017 the IRS filed a notice of federal tax lien (NFTL) against Ms. Sharpe for unpaid taxes.  In response to the filing of the notice, she filed suit against the IRS in the Court of Common Pleas of Philadelphia County seeking to have the debt marked as satisfied and have the NFTL released.  The docket sheet in that case is available here. As it will almost always do and as it has the right to do, the IRS removed the case to the federal district court.  Only in very rare cases will the IRS leave a case in which it is a party in a local court.  The motion to remove is almost automatic.  While the IRS wants to litigate in federal rather than state court, depending on the cost of filing such a suit in state court, taxpayers suing the IRS might find a cheaper entrée to the court system by filing with the state court and letting the IRS remove the case to federal court.  This also slows the case down a bit.  I expect that most taxpayers suing the IRS in state court don’t really think too much about the filing fee or the speed but both could be factors in the choice of initial forum.

Another thing taxpayers may not think about, particularly pro se taxpayers such as Ms. Sharpe, is that if you sue the IRS in a matter like this, you also inevitably invite the counterclaim to reduce the liability to judgment.  While the IRS may not have otherwise brought a suit to reduce the liability to judgment, bringing an action such as this will trigger this response, potentially causing the taxpayer to leave the litigation worse off than before they brought it.  I have previously discussed the impact of the judgment here.

In Ms. Sharpe’s case against the IRS, in which the IRS did counterclaim for a judgment, the federal district court dismissed the case for lack of jurisdiction.  The IRS filed a motion for reconsideration, something it does not do lightly, and the court denied that as well.  I discuss motions for reconsideration here telling my own tale of woe on the subject.  I do note that this motion for reconsideration was filed by the Tax Division of the Department of Justice, which does not have the same internal rules for such motions that govern the IRS attorneys in Tax Court cases.  I suspect at the Tax Division the decision is left to the chief of the trial section, creating a lower bar for the filing of the motion than exists in a Tax Court case in which a Chief Counsel IRS attorney must go hat in hand to the National Office.  The district court denied the motion for reconsideration.

The government did not take the dismissal of its motion for reconsideration lying down.  It initiated an erroneous refund suit against Ms. Sharpe for the years 2014 and 2015.  She really had their attention now.  In the same suit it also sought to collect civil penalties against her for filing frivolous returns for five years and, in the alternative, to collect the tax and additions to tax assessed against her for 2014 and 2015.

The IRS alleged that Ms. Sharpe falsely overstated the amounts withheld on her 2014 and 2015 returns and received $452,803.89 in erroneous refunds.  First, this points out with a bigger exclamation mark why she should not have filed her original suit and stirred the hornet’s nest.  Second, this seems like a head scratching indictment of the IRS refund filters.  How could it let that much money out the door based on erroneous claims of withholding credits?

The dollar amounts in the balance of the case are equally eye popping:

The Government submits Defendant owes this entire amount, with accrued interest. (Id. at 8 ¶¶ 45-46.) Moreover, the Government asserts that Defendant remains indebted to the United States for civil penalties for the years 2012 to 2016 in the amount of $32,010.16, plus statutory additions and interest. (Id. at 9 ¶ 51.) Further, the Government avers that Defendant owes $54,479.08 in income tax for the year 2013. (Id. at 11 ¶ 57.) Finally, the Government pleads in the alternative to the claims set forward in Count I, that Defendant owes $72,427.33 for the year 2014 and $2,320,544.55 for the year 2015 for a total of $2,392,971.88, plus statutory additions and interest.

Ms. Sharpe argues that the court should dismiss the suit against her based on res judicata and collateral estoppel.  The court finds that it cannot because the first case did not result in a final judgment on the merits.  It states:

Issue preclusion is appropriate when:

1) The issue sought to be precluded is the same as that involved in the prior action;

2) The issue was actually litigated;

3) The issue was actually determined in a valid and final judgment; and

4) The determination was essential to the prior judgment….

Here, Defendant’s assertions do not meet the elements of either issue preclusion or claim preclusion. Defendant’s prior suit was dismissed for lack of jurisdiction. (Doc. No. 12 at 3.) The dismissal also set aside the Government’s counterclaim. (Id.) Thus, there was no adjudication on the merits of the counterclaim and the case did not end in a final judgment on the merits.

She also raised the issue of the improper service of the complaint; however, she failed to raise this issue in her answer and only raised it later.  On this issue it noted:

Federal Rule of Civil Procedure 12(b)(5) lists as a defense insufficient service of process. If a defense under Rule 12 (except for lack of subject matter jurisdiction) is not raised in an initial responsive pleading, the defense is deemed waived. Fed. R. Civ. P. 12(h)(1)(B)(ii). See also McCurdy v. Am. Bd. of Plastic Surgery, 157 F.3d 191, 193-196 (3d Cir. 1998) (holding that defense of insufficient service of process is waived if objections are not raised in the answer or pre-answer motion).

The court looked at its obligation to give pro se litigants a liberal construction of the rules.  So, it looked closely at her answer to see if anything there could support an argument that she did raise this issue initially.  It finds that nothing in the answer mentions or alludes to improper service.  It then goes on to look at the service and determines that the IRS made proper service.  One argument involved leaving the complaint with her 17-year-old son and the other involved the location of the service.  In both instances, the court found the IRS action proper.

Ms. Sharpe must now defend her erroneous refund case.  Based on the information in the denial of her motion to dismiss, it looks like she will struggle to successfully defend against the IRS.  I do not know what she might have done with the alleged erroneous payment of over $450,000 but my guess would be that unless she has saved this money in a bank account, a result I see as unlikely, or used these funds to buy property that has held or increased in value, a result I also see as unlikely but within the realm of possibility, the IRS may win the erroneous refund case but struggle to actually recover the money.  Ms. Sharpe provides a textbook example of why bringing a case against the IRS should be done only after careful consideration since it can result in significant negative consequences once the attorneys at the IRS and DOJ take a close look at the facts.  Better to stay much lower on the radar if you have this type of possible exposure.

Nominees

Several years ago I wrote a post providing a general explanation of nominee liens in discussing two decisions.  Christine wrote an excellent post on a case that had an income tax twist to the nominee situation, but she also expanded my discussion of the nominee lien doctrine.  The case of United States v. Simones, No. 1:20-cv-0079 (D. N.M. 2021) provides a look at nominee lien cases from the perspective of the nominee rather than the person creating the purported nominee situation.  The Simones case is short, yet it still provides an important point for those the IRS tags as nominees.

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Nominee liens occur when the IRS believes that a taxpayer has transferred property to a third person(s) in an effort to prevent the IRS from collecting the tax from the transferred property.  The person allegedly holding the property for the taxpayer is the nominee.  A nominee case will exist because a revenue officer assigned to the taxpayer’s account believes the taxpayer has transferred the property but retained an ownership interest.  The revenue officer will prepare a case and send it to Chief Counsel for approval before being allowed to file the nominee lien.  Some cases provide a clear picture of nominee status, such as when a taxpayer transfers property but continues to reside there, pay the mortgage, utilities, etc., and some will be much less clear.

The opinion is quite brief and does not provide background information concerning the tax debt or the creation of the nominee situation.  The information presented does not allow a reader to draw conclusions regarding the likely or appropriate final outcome here.  It explains that the taxpayer owes $276,283.56 and that the IRS asserts that the taxpayer fraudulently transferred property to the Ancient of Days Trust.  The case involves an effort by the nominees to extract themselves from a suit brought by the IRS.  The IRS sued to reduce the liability to judgment against the taxpayer and the trust; to obtain a judgment that the trust holds title to property as a nominee of the taxpayer which property is encumbered by the federal tax lien; and to set aside the conveyances of property from the taxpayer to the defendants as a fraudulent conveyance.

When the IRS brings a suit of this type it almost always has a count seeking to reduce the liability to judgment.  Doing so takes little additional effort and provides the IRS with much more time to collect the tax liabilities.  See the discussion of the benefits to the IRS of obtaining a judgment here.  This part of the case does not involve the nominees except to the extent that the IRS seeks a judgment against the trust.

The second reason the IRS brings this suit is to set aside the record title of the property showing that the trust is the record owner.  This is a natural part of any nominee suit.

The third part of the suit seeks to set aside the conveyance of property to the nominees and to the trust.  Two of the three nominees challenge the suit against them, arguing that the court lacks subject matter jurisdiction and that the IRS lacks authority to assert claims against them.  The court disposes of their argument in two sentences:

[F]ederal district courts have original jurisdiction over “any civil action arising under any Act of Congress providing for internal revenue,” 28 U.S.C. § 1340, as well as “all civil actions, suits or proceedings commenced by the United States,” 28 U.S.C. § 1345. Moreover, this court has jurisdiction to issue orders and render judgments “as may be necessary or appropriate for the enforcement of the internal revenue laws.” 26 U.S.C. § 7402(a).

It does not take the court much effort to let the nominees know that the IRS does indeed have a right to bring an action against them.  That does not mean that it will win and prove that they are nominees of the taxpayer, but that on the basic issue of the authority of the IRS to initiate the action there is little to discuss or debate.

The opinion does not discuss it, but prior to the filing of this suit, the IRS almost certainly filed nominee liens against the individuals it has named as nominees in the suit.  It did this to tie up the property while it works to clean up the title so it can be sold for the highest price.  The nominee lien, unlike the regular federal tax lien, will list the specific property covered by the nominee lien and will not attach to all of the property owned by the nominees.  Nonetheless, it will cause the nominees to have to explain the lien to anyone from whom they seek to borrow.  They will also need to explain the existence of the suit itself.  Serving as a nominee for someone seeking to make a fraudulent transfer does not come without downsides.  Frequently, the friends or relatives who agree to serve as a nominee fail to appreciate the potential costs of that action.

Lavar Taylor has discussed in prior posts, two of which are found here and here, the inability of nominees to avail themselves of collection due process.  This means that unless an individual targeted by the IRS as a nominee can convince the IRS informally that they are not nominees, they face the likelihood of being named in a suit such as this and forced to litigate in order to prove they are not serving as nominees.  They have no formal path to an administrative decision.  Because all nominee liens require approval by Chief Counsel, alleged nominees with a good legal argument seeking to avoid getting caught up in litigation might seek a conference with the attorney in Chief Counsel’s office who approved the nominee lien in an effort to convince that person that nominee status does not exist and to provide information that the revenue officer making the nominee referral to Chief Counsel may have failed to provide.

IRS Wins Lien Priority Fight with Bank

In Citizens Bank, N.A. v. Nash, No. 2:20-cv-00351 (E.D. Pa. 2021) a lien priority fight occurred between the IRS and the bank holding the taxpayer’s mortgage.  In many ways the bank’s problem reminded me of problems that routinely plague the IRS in lien priority fights.  The bank erroneously recorded a release and that causes it to lose the lien priority fight. 

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Mr. and Mrs. Nash borrowed money to buy property in Warrington, PA.  The bank recorded a mortgage to secure the loan in 2006.  After buying the home, the Nash’s ran up a fair amount of federal tax debt causing four notices of federal tax lien to be recorded against them.  On March 19, 2019 the bank executed a satisfaction of mortgage and had it recorded.  Not too long thereafter the bank realized its mistake and brought an action for erroneous satisfaction. 

Because they had filed liens, the IRS and the state of PA were named as defendants.  The IRS removed the case to federal district court which it has the right to do and which it will do in almost every case in which it is named.  In their answer the Nashes conceded the mortgage had not been paid in full and consented to the relief sought by the bank.  The IRS meanwhile moved for judgment on the pleadings. 

The bank asks the court to strike the erroneous recording of the release nunc pro tunc and declare it void ab initio to restore it to its place before the filing of the erroneous release.  The court cited state precedent which had held “a satisfaction “entered by accident or inadvertence . . . may be set aside and the mortgage reinstated, except as the rights of third persons may prevent.”  Because the Nashes admitted the recordation was a mistake, the court set aside the release and reinstated the mortgage.  The court, however, refused to declare that the release was void ab initio. 

The court then addressed the priorities between the lienholders.  The court noted the state law which returned the bank to its former position with the proviso for the rights of third parties.  It then briefly discussed federal lien law citing to the seminal cases of Aquilino v. United States, 363 U.S. 509, 514 (1960) which holds that federal law governs priority after state law establishes property rights and then United States v. New Britain, 347 U.S. 81, 85-86 (1954)) and United States v. McDermott, 507 U.S. 447, 449 (1993) which hold that the lien arising first will take priority.

Here, the federal tax liens were filed between 2012 and 2016.  The IRS argued that although the bank’s 2006 mortgage had priority over the federal tax liens prior to its release, the release of the bank’s mortgage made its lien interest inchoate and only the decision to reinstate the mortgage rendered the mortgage lien choate again.  Since the reinstatement occurred in 2021 after the filing of the notices of federal tax lien, the IRS argued that its lien had priority over the mortgage at this point.  The court agreed.  As a result, the mistake in releasing the mortgage causes the bank to lose priority. 

Depending on the value of the house, the action the IRS takes to enforce its lien and the remaining balance on the mortgage, the bank may or may not lose actual dollars from the loss of its priority status.  The IRS does not foreclose on many homes.  If it does not take action against this home, and assuming the Nashes do not otherwise pay the tax liability, it’s possible that their tax liability could fall off of the books due to the statute of limitations. 

In addition to the bank losing, it’s also possible that the Nashes are losers here if the mortgage is a recourse mortgage.  Should the IRS get paid out of the equity in the house, the bank could obtain a personal judgement against the Nashes.  It is much more likely to do so than the IRS would have been had the IRS remained in the second position.  While it’s easy to think of the bank as the loser here, the Nashes might be the real losers.  You see this type of loss sometimes in bankruptcy cases where the IRS fails to properly file a claim but has a nondischargeable debt.  In those cases it might have been paid out of estate assets but instead the estate assets go to pay creditors who might have been discharged.

The lien issue that causes the bank to lose here regularly causes the IRS to lose.  If the IRS fails to refile its lien as the time for refiling expires, the IRS loses its priority and other creditors move up in priority in the same fashion that the IRS has done here.  The case shows the importance of preserving a lien once it exists.  The court does not discuss how the bank came to make the erroneous release, but I expect that a thorough scrub of its procedures has resulted because of this case.  

Stop in the Name of Love and other Legal Arguments Regarding Unpaid Taxes

When one of the top songwriters of the Motown era, Edward J. Holland, Jr., has tax problems that generate a case involving lien priorities the temptation to write a post highlighting some of those song titles becomes too great for a mere mortal blogger to resist.  I realize that most readers will not appreciate the greatness of a song writer whose peak years of productivity were 1963-1967, but I Can’t Help Myself from highlighting some of these great songs.  For those few readers old enough to have grown up with the amazing Motown songs of the 1960s, the case provides a trip through memory lane.  In United States v. Holland, No. 2:13-cv-10082 (E.D. Mich. 2020) the court decides that the federal tax lien has priority of the claim by attorneys for their fees from certain funds interpleaded from the sale of royalties on the songs written by Mr. Holland.  Guest blogger Matthew Hutchens  wrote about an earlier phase of this case which has been You Keep Me Hangin On for quite some time.  At this point the attorneys have Nowhere to Run except maybe back to the 6th Circuit.

About five years ago I wrote another blog post featuring the songs of a singer/songwriter, James Taylor, when someone with the same name had tax penalty issues.  I cannot say that my prior post was a huge hit, perhaps because my musical taste runs a little to the geriatric side, but undeterred, I launch into post with musical Reflections.

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When we last wrote about Mr. Holland, he had run up a small tab to the U.S. Treasury of about $19 million.  A liability of this size will cause even a wounded IRS to Run, Run, Run to try to collect that money.  Fortunately for the IRS the royalties for Mr. Holland’s songs were sold for $21 million and placed into the court’s registry as interpleaded funds.  With a fund of that size, the IRS was not the only party thinking How Sweet It Is.  This case involves the effort by attorneys who performed work for Mr. Holland to recover fees from the interpleaded funds.  For reasons discussed below, the IRS argued that the attorneys could only seek their fees from Mr. Holland personally and not from these interpleaded funds. 

The issue turns on whose funds were interpled.  The IRS argues that the funds came from an entity while the attorneys argue it really came from Holland himself.  The attorneys argue that Holland defrauded them.  They argue:

that Holland fraudulently disguised the settlement proceeds as a “surreptitious loan” in order to avoid paying his attorneys. PY Resp. at 5-6, 14. Without further elaboration or citation to legal authority, Patmon and Young conclude that Holland’s alleged scheme to evade his creditors somehow entitles them to a constructive trust and attorney liens that would attach to the interpleaded funds — which are EHLP’s assets. Id. These theories lack merit.

Essentially, the attorneys argue that EHLP is the alter ego, nominee or fraudulent transferee of Holland hoping to obtain a Band of Gold.  Those theories were at the center of the previous case on which we posted.  In order to succeed the attorneys need to show that they have a lien for their fees that attaches to the funds.  The court describes the types of attorney’s liens available in Michigan:

Michigan law recognizes two types of attorney liens: “(1) a general, retaining, or possessory lien, or (2) a special, particular, or charging lien.” A retaining lien is an attorney’s “right to retain possession of all documents, money, or other property of the client until the fee for services is paid,” and depends upon the attorney’s actual possession of such property. Patmon and Young are plainly not entitled to a retaining lien, as they cannot claim possession of the interpleaded funds held in the Court’s registry.

A charging lien, by contrast, is “a lien placed on a client’s judgment by an attorney who worked on the matter resulting in the judgment.” A charging lien attaches only to the judgment or recovery proceeds from the particular suit on which the attorney worked. The Court previously held that the interpleaded funds would not be subject to any charging liens Patmon and Young may obtain, as those funds “cannot reasonably be considered a ‘judgment or recovery’” stemming from Patmon’s and Young’s representation of Holland in the 1988 or 1992 litigation. (citations omitted)

Based on the absence of a valid attorney’s lien, the attorneys here cannot take from the interpled funds and must look only to Holland himself in order to obtain a recovery.

Next, the court looks at the source of the interpled funds in order to determine if Holland has an interest in those funds that would allow the attorneys to pursue a claim.  It determines that EHLP, the partnership that placed the funds with the court, is a separate legal entity and that placing the funds with the court did not convert the funds from partnership assets to an individual asset of Holland.  Following on that determination it concludes that creditors of the partnership have first right to the funds.  This gives the attorneys almost Nowhere to Run.

After the partnership debts stands the IRS with its lien.  The attorneys try to argue that the IRS lien had lapsed, but the court finds the IRS properly refiled its liens which causes the attorneys Nothing but Heartaches.  Their liens were inchoate because the lawsuit they started in 2004 was still pending without final resolution:

Patmon’s and Young’s interests in Holland’s assets, by contrast, are not choate. Any judgment for damages, constructive trust, or other remedy obtained in connection with the state-court action would not become choate until that judgment is entered and would not relate back to the time the action was filed to take priority over the federal tax liens….

The attorneys asked for Just One Last Look seeking to get the court to consider the super-priority allowed to attorney’s liens over the federal tax lien pursuant to IRC 6323(b)(8).  The problem with this argument is that they lack a retaining or charging lien upon which to establish the super-priority.  In other words, It’s the Same Old Song about their failed liens on the property.

Having lost on the substantive arguments, the attorneys requested a stay of the proceedings in federal court, hoping that their longstanding state court action would come to a conclusion and provide them with a better basis for relief and an escape from legal Quicksand.  In this regard they made three arguments for a stay in which they ask the court to Give Me Just a Little More Time.  First, they argued that granting summary judgment to the IRS at this point would be inconsistent with prior orders of the court.  Like a Nightmare the court finds that none of its prior orders prevent it from determining the merits of their claims now.  Second, they argue the court should abstain, essentially arguing Baby Don’t Do It.  The court finds that no exceptional circumstances warrant abstaining from the decision.  Third, they argue that this decision violates the Rooker-Feldman doctrine preventing federal courts from exercising jurisdiction in a manner that voids final state court judgments.  The court finds that its decision does not contradict any state court judgement, preventing the doctrine from applying and leaving the attorneys Standing in the Shadows of Love.

It is not clear from the opinion just how much of the interpleaded fund the IRS will recover and whether it will satisfy the large outstanding tax debt owed by Mr. Holland.  It is clear that Baby Love, Jimmy Mack and a whole host of greatest hits continue to have vitality as a basis for satisfying old debts.  These songs of love and loss continue to hold the interest of Motown fans and tax collectors.

Death of Taxpayer Extinguishes Claims for Wrongful Collection and Failure to Release Lien

The recent case of Pansier v United States addressed whether a taxpayer’s death extinguishes claims for improper collection and failure to release a lien. In deciding that the taxpayer’s death extinguished the claims, a federal district court focused on the text of Section 7432 and 7433 and the analogous statue applicable to damages for improper IRS disclosures of tax return information, as well as the principle that waivers of sovereign immunity are narrowly construed.

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A summary of the facts tees up the issue in the case. In 2017, the US sued in federal court and sought a judgment for Gary Pansier’s unpaid 1995 through 1998 assessed federal tax liabilities and for Joan and Gary Pansiers’ 1999 through 2006 and 2014 assessed federal tax liabilities. The Pansiers then filed for bankruptcy. The Pansiers then filed a separate lawsuit alleging that the statute of limitations on Gary’s 1996-98 liabilities had expired prior to the government’s collection suit. In that suit they sought approximately $28,000 in damages under Section 7432 for the IRS failure to release a federal tax lien and under Section 7433 for the IRS’s alleged unauthorized collection activities, both of which related to Gary’s separate 96-98 liabilities. 

While the Pansiers’ suit under Sections 7432 and 7433 was pending, Gary passed away. Joan filed a motion to substitute claiming that she as the surviving spouse was the sole representative and proper party in the action. The government filed a motion to dismiss, claiming that she was not the proper party, given that the alleged improper collection actions and failure to release the tax lien only pertained to Gary’s sole tax liabilities, even though some of the collection action reached marital property under Wisconsin law. 

The court agreed with the government. In reaching its decision the court looked to both statutes and their reference to the particular taxpayer:

Section 7432 provides that, when an officer or employee of the IRS “knowingly, or by reason of negligence, fails to release a lien . . . on property of the taxpayer, such taxpayer may bring a civil action for damages against the United States.”  (emphasis added). And Section 7433 states that, when an officer or employee of the IRS recklessly or intentionally, or by reason of negligence, “disregards any provision of [ Title 26], or any regulation promulgated under [ Title 26], such taxpayer may bring a civil action for damages against the United States.”  (emphasis added).

A the court notes, there is longstanding law where courts have routinely dismissed Section 7432 and 7433 claims where a party claims that improper IRS collection activities were undertaken to satisfy a spouse’s tax liability. 

The somewhat more difficult issue was whether Gary’s claims survived his death, and would allow the court under the Federal Rules of Civil Procedure to substitute Joan for Gary.  FRCP 25 provides the following: 

If a party dies and the claim is not extinguished, the court may order substitution of the proper party. A motion for substitution may be made by any party or by the decedent’s successor or representative. If the motion is not made within 90 days after service of a statement noting the death, the action by or against the decedent must be dismissed.

Pointing to the narrow language in 7432 and 7433 that allows claims only for “such taxpayer” the government opposed the motion. In deciding against Joan, the court noted that there were no cases it found that directly addressed the issue, but that courts have applied similar language in 7431 and refused to allow a substitution when the claim involved an alleged improper disclosure of tax return information. That statute also restricts suits for improper disclosure and provides:

If any officer or employee of the United States knowingly, or by reason of negligence, inspects or discloses any return or return information with respect to a taxpayer in violation of any provision of Section 6103 such taxpayer may bring a civil action for damages against the United States in a district court of the United States.

There is case law on the survivability of 7431 claims. For example, in US v Garrity,  a district court case from 2016, the government sought to collect a civil penalty from the estate of a taxpayer (as an aside whether a penalty survives death and can be collected is an important issue, one I discussed years ago in Death, Taxes and Civil Penalties: Does the Taxpayer’s Death End IRS’s Ability to Collect Penalties?, which Stephen Olsen and I discuss further in Saltzman & Book ¶7B. That issue has gotten lots of attention in recent years due in part to FBAR and other potentially large penalties). The estate in Garrity counterclaimed and sought damages under 7431 due to alleged improper IRS disclosure of return information. In deciding against the estate, the court stated that “[g]iven the clear text of the statute and the strict construction of waivers of sovereign immunity,” …”the private cause of action in Section 7431 is limited to claims brought by taxpayers whose return information has been disclosed.”

In deciding against allowing a substitution, the district court in Pansier looked to the case law under Section 7431 as well as the longstanding principle that waivers of sovereign immunity are to be narrowly construed against the government.  As such, the court granted the government’s motion to dismiss. While the government may pursue the estate for any tax liability, and even for possible civil penalties, this case shows that the government enjoys special status and is free from any consequences from alleged misconduct in collecting those taxes when the taxpayer was alive.