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.

Lien Interest in Insurance Proceeds Differs from Interest in Property Itself

In the case of Wolinsky v. Frye, No. 19-01009 (Bankr. D. Vt. 2020) the holder of a second mortgage competes against the IRS for the insurance proceeds resulting from a fire at the taxpayers’ home.  Even though the IRS had subordinated its lien to the second mortgage holder on the home, it argues that with respect to the insurance proceeds, the federal tax lien and the equitable lien of the mortgage holder attach simultaneously, giving the IRS a victory over the insurance proceeds.  The bankruptcy court agrees.

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This case involves more than one lien issue.  The first issue presented by the case is the subordination of the federal tax lien to the second mortgage.  This does not often happen.  The opinion gives few facts about the subordination but states that the IRS agreed to subordinate its lien for a payment of $120,000.  Between the time the taxpayers purchased the house and the time they sought a second mortgage, they incurred significant federal tax debt and the IRS filed notices of federal tax lien.  Very few second mortgage companies seek subordination of the federal tax lien in this situation, and we do not know why it happened here.  By agreeing to subordinate the federal tax lien, in return for a payment, the IRS gave away its priority position in the home to the second mortgage lender.

Sometime after the creation of the second mortgage, a home fire occurred.  Although the second mortgage lender required that the taxpayers insure their home for fire, it did not have itself named as the beneficiary of the insurance proceeds.  Only the first mortgage lender was named on the policy.  Because it was not named on the policy, the second mortgage lender held an equitable lien in the proceeds.

Prior to the fight over the insurance proceeds, taxpayers filed a chapter 13 petition in bankruptcy and subsequently converted the case to chapter 7.  The insurance proceeds from the fire became property of the estate against which the IRS and the second mortgage company each claimed an interest.  The parties filed cross motions for summary judgement seeking payment of the insurance proceeds.  The parties did not dispute that liens of each attached to the proceeds but only who had the superior priority.

The second mortgage holder argued first that its equitable lien on the insurance proceeds resulted directly from its lien on the property to which the federal tax lien was subordinate.  The IRS countered that though its lien was subordinate to the second mortgage holder’s lien on the home itself, that did not make its lien subordinate with respect to the insurance proceeds.  It argued that the court must look to the timing of the attachment of the respective liens to the proceeds, in other words their choateness with respect to the proceeds.  The second mortgage company, knowing that if the court framed the argument in this manner it might lose, argued that its claim was statutorily excepted from the choateness requirement pursuant to IRC 6323(c), a provision rarely litigated.

The court agreed with the IRS that the case involved the timing of the attachment of the liens to the insurance proceeds.  It found that the liens attached simultaneously to the insurance proceeds.  Based on V.J. Processors, Inc. v. Fireman’s Fund Ins. Cos., 679 F. Supp. 399, 401 (D. Vt. 1987), the court finds that the tie goes to the IRS in this situation.  That result matches the result of a fight between the IRS and a judgment lien creditor as decided by the Supreme Court in United States v. McDermott, 507 U.S. 448 (1993).

The court explains that the second mortgage holder’s argument regarding IRC 6323(c) does not work because a home mortgage is not a commercial financing security.  The purpose of IRC 6323(c) is to allow lenders to provide a line of credit.  A line of credit would not work if the filing of a federal tax lien immediately gave the IRS priority over the lender, since the lender could not watch for the filing of a notice of federal tax lien every moment of the day.  Essentially, this provision gives the lender a 45-day window to discover the filing of the federal tax lien and shut off the line of credit.  The court correctly decides that this commercial lending provision does not apply to the circumstances of this case.

While holding for the IRS, the court notes the unfairness of the result to the lender resulting strictly because of the change in the interest securing the property from the real estate to insurance proceeds.  Had the property been sold instead of destroyed, the second mortgage holder would have won any priority dispute.  The court says:

While the statute does not offer relief to the non-governmental creditors in this case, from an equitable perspective there is something troubling about this commercial transaction, in which the facts indicate (i) the IRS subordinated its interest in the real property to induce the Joint Bank Lienholders to make mortgage loans to debtors in financial distress, (ii) the Joint Bank Lienholders paid $120,000 in consideration of that subordination, (iii) the Joint Bank Lienholders each then made a mortgage loan, apparently in reliance on the subordination agreement, and (iv) when the property that was collateral for their loans was destroyed, the IRS declared its subordination agreement did not apply to the proceeds of the collateral and proclaimed its lien usurped the Joint Bank Lienholders’ interest in those proceeds. This seems inconsistent with the Remaining Parties’ expectations and intentions, and creates a result dependent on whether the Oneida Property was reduced to proceeds or was in existence at the time the Remaining Parties sought to enforce their respective rights against it, and whether the Debtors fulfilled their contractual duties to the Joint Bank Lienholders. The Joint Bank Lienholders ask this Court to do equity by turning over the Insurance Proceeds to them. The IRS responds that federal law controls and establishes very clear criteria, which the Joint Bank Lienholders simply have not met, in order to have priority over the IRS’ federal tax liens.

Cold comfort for the lender whose mistake here was not to be named on the insurance proceeds but to rely on its equitable lien.  The case demonstrates the sometimes peculiar results that lien law can produce, as property interests create outcomes that logic might not have dictated.  Because of the financial situation of the taxpayers, the insurance proceeds may provide the only source of recovery, leaving the second mortgage lender out in the cold.

Attaching the Federal Tax Lien to a Security

In United States v. Scherer, No. 2:19-cv-03634 (S.D. Ohio 2020) the district court reversed its earlier decision denying the IRS summary judgment on the issue of the attachment of its federal tax lien to stock transfer by the taxpayer to a trust.  It reversed its earlier opinion because the court found that the trust lacked valid ownership of the stock against a subsequent purchaser.  The opinion provides a rare glimpse at IRC 6323(b)(1) and a less rare, but still uncommon, situation of a district court judge reversing a decision on a motion for reconsideration, giving heart to everyone who files these types of motions.

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When I teach 6323, I try to convey the goals of the drafters of the 1966 Federal Tax Lien Act and the efforts of William T. Plumb, Jr., together with other leaders in the ABA Tax Section, to guide Congress to create a statute that caused the federal tax lien to operate smoothly with commercial interests.  Senator Long of Louisiana, who headed the Senate Finance Committee at the time of passage of the bill provides an eloquent explanation of the reason for and the goals of the legislation in the preamble available through the link above.  This legislation has withstood the test of time.  Relatively few changes to the provisions of the act and essentially no structural changes have occurred since its passage.  For those interested in a deeper understanding of the Act, an article in the Harvard Journal on Legislation provides insight drawn from the time of its creation.

IRC section 6321 and 6322 create the federal tax lien which the Supreme Court has observed was broadly meant “to reach every interest in property that a taxpayer might have.”  The trouble with the lien created by these two sections is that for all of its power and breadth, no one knows about it except for the IRS and the taxpayer (only the rare taxpayer will actually know about it, but the taxpayer does or should know that an unpaid liability to the IRS exists.)  Congress did not want to cripple commerce with a secretive but all powerful lien.  To temper the power of the lien and allow commerce to flow smoothly, Congress created IRC 6323, explaining the situations in which the IRS must make the lien public in order to defeat other creditors and purchasers and times when making it public would still not allow the federal tax lien to defeat the competing party.  IRC 6323 provides the masterpiece of the 1966 legislation, integrating the federal tax lien with commercial activity in a way that both makes sense and works well.

In subparagraph (a) Congress lists four parties that can defeat the federal tax lien until the IRS files public notice of the lien in the right place.  With these four parties, holders of security interests (think mortgage holders and UCC competitors), judgment lien creditors, purchasers and mechanic’s lien holders (think builders not auto mechanics), the IRS must win the race to the courthouse or lose its lien interest in specific property.  Most cases involving the federal tax lien involve IRC 6323(a).  The Supreme Court decision in McDermott v. United States provides a good example.

The Scherer case involves IRC 6323(b) where Congress lists 10 situations in which the party can defeat the federal tax lien even if the IRS had already gone to the courthouse and publicly recorded its lien.  The first of the 10, IRC 6323(b)(1), rarely ends up in litigation but that happens here.  This subparagraph provides:

(1) Securities

With respect to a security (as defined in subsection (h)(4))—

(A) as against a purchaser of such security who at the time of purchase did not have actual notice or knowledge of the existence of such lien; and

(B) as against a holder of a security interest in such security who, at the time such interest came into existence, did not have actual notice or knowledge of the existence of such lien.

Before going further, understanding the meaning of security in (h)(4) becomes necessary and understanding the meaning of purchaser in (h)(6) will also become necessary.  IRC 6323(h)(4) provides:

(4) Security

The term “security” means any bond, debenture, note, or certificate or other evidence of indebtedness, issued by a corporation or a government or political subdivision thereof, with interest coupons or in registered form, share of stock, voting trust certificate, or any certificate of interest or participation in, certificate of deposit or receipt for, temporary or interim certificate for, or warrant or right to subscribe to or purchase, any of the foregoing; negotiable instrument; or money.

IRC 6323(h)(6) provides:

(6) Purchaser

The term “purchaser” means a person who, for adequate and full consideration in money or money’s worth, acquires an interest (other than a lien or security interest) in property which is valid under local law against subsequent purchasers without actual notice. In applying the preceding sentence for purposes of subsection (a) of this section, and for purposes of section 6324

(A) a lease of property,

(B) a written executory contract to purchase or lease property,

(C) an option to purchase or lease property or any interest therein, or

(D) an option to renew or extend a lease of property,

which is not a lien or security interest shall be treated as an interest in property.

Lots of definitions to apply to the fact pattern at issue in the case.  Notice that securities include money.  This provision allows individuals against whom a federal tax lien has been recorded to go around buying things in grocery stores or other places of business without being stopped, because to stop them from purchasing items because of the recording of the lien would stop commerce.

Here the property at issue is not money but stocks.  The delinquent taxpayer transfers his interest in stock to a trust.  The stock clearly meets the definition of security just like the cash.  In general, we don’t want to hold up the transfer of stock any more than we want the federal tax lien to hold up the purchase of bread at the grocery store.  Even though the stock at issue meets the test of security, the statute requires a purchaser who did not know about the lien.

Here, the trust fails at this step of the test.  In reevaluating the case the court found the following:

… the Government is correct that, even if there was an equitable change in ownership, this does not suffice to make the Trust a protected “purchaser” of the WVHI stock under §§ 6323(b)(1)(A) and (h)(6). Section 6323(b)(1)(A) provides that a lien shall not be valid as against a “purchaser” of a security who at the time of purchase did not have actual notice or knowledge of the existence of such lien. 26 U.S.C. § 6323(b)(1)(A). Section 6323(h)(6), in turn, defines a “purchaser” as a person who, for adequate and full consideration in money or money’s worth, acquires an interest in property “which is valid under local law against subsequent purchasers without actual notice [of the acquisition].” 26 U.S.C. § 6323(h)(6). It follows that, if the Trust’s equitable ownership interest in the WVHI stock would not be valid under Ohio law against a subsequent purchaser who had no notice of the agreement between Defendant Scherer and the Trust, then the Trust cannot be a protected purchaser under §§ 6323(b)(1)(A) and (h)(6), and the Government’s lien would attach to the WVHI stock.

The court found that the trust’s equitable ownership interest in the stock would be invalid against a hypothetical subsequent purchaser without notice.  The problem with the protection the trust sought stemmed from the casual way in which the taxpayer tried to pass ownership.  The court further stated:

Defendant Scherer, however, never signed and physically delivered the WVHI stock certificate to the Trust. Consequently, because the Trust does not have an ownership interest in the WVHI stock that would be valid against a subsequent purchaser without notice under Ohio law, the Trust cannot be a protected purchaser of the WVHI stock within the meaning of §§ 6323(b)(1)(A) and (h)(6). …The Court, therefore, finds that the Government’s federal tax liens against Defendant Scherer for tax years 1990, 1991, and 1992 attach to the WVHI stock.

The rules defining purchaser exist to thwart efforts to pass stock to related parties.  Here, the casual nature of the attempt to pass the stock speaks to the relationship of the parties.  Even though Congress gave strong protection to securities, allowing them generally to pass back and forth in commerce unimpeded by the existence of a filed federal tax lien against one of the owners in a stream of stock ownership, limits to that ability to divest the federal tax lien from securities do exist.The Scherer case provides a situation in which the reach of the statutory protection did not reach far enough to protect this transfer.

If you have never taken the time to look through the ten provisions of 6323(b), it’s worth the effort.  In doing so notice the provisions that put limitations based on knowledge and other factors and those that do not.  The drafters tried to carefully describe the situations deserving protection.

Chapter 7 Brings an Opportunity to Use IRS Liens to Satisfy Unsecured Creditors

The Fifth Annual Tax Controversy Institute will be held online on July 17th.  This Institute is sponsored by the University of San Diego School of Law and the tax law firm of RJS Law.  Here is a link to further information about the Institute’s program and a place to sign up for virtual tickets.  The keynote speaker is Sharyn Fysk (Director of the IRS Office of Professional Responsibility), and the Institute is presenting an award to Professor Carr Ferguson acknowledging his lifetime of achievement in the tax field

The ABA Tax Section May meeting continues online.  Find information about the online program here.  It continues with two or three programs each week through the end of July.  Note that for readers of this blog many of the tax controversy programs from committees that focus on tax procedure occur toward the end of the program.  Here are some of those programs and the dates:  July 14  Civil & Criminal Tax Penalties – panel descriptions;  July 22  Court Procedure & Practice – panel descriptions;  July 29  Administrative Practice – panel descriptions; and  July 30  Standards of Tax Practice – panel descriptions.  You can purchase tickets to individuals committee sessions or to the overall meeting.


In the case of United States v. Hutchinson, 125 AFTR 2d 2020-1968, (EDCA 2020) the district court sustains the decision of the bankruptcy court avoiding portions of the IRS lien.  Based on the prior precedent in the circuit and the language of the statute, the outcome is not surprising.  The fact that the Department of Justice appealed the decision from the bankruptcy court suggests that it may press to take the matter further.  The outcome here results from Congressional efforts in the bankruptcy code to allow unsecured creditors to get paid before the IRS gets paid for a debtor’s bad acts.  Due to the timing of the filing of the federal tax liens at issue in this case and the IRS practice of paying down liabilities in the order of tax, penalty then interest, the IRS loses most of the value of its liens even though it had filed lien amounts for taxes exceeding the value of the equity.  A tough result for the IRS that the court could have explained better but a good result for creditors who might not have expected anything out of this bankruptcy case.

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 The case results from Congressional generosity in chapter 7 cases in order to provide something for the unsecured creditors.  A very high percentage of chapter 7 cases are “no asset” cases meaning that unsecured creditors get nothing.  Here, the trustee uses the IRS lien and the front-end loading of the penalties owed on the liabilities reflected in the lien to reach a favorable result for the unsecured creditors.

At the time of the filing of the bankruptcy, the IRS had the following liabilities owed to it for which it had filed a notice of federal tax lien:

Recording DateTaxInterest on TaxPenalty
05/23/2011$0.00$6,450.15$44,500.11
05/23/2011$62,913.27$17,794.31$87,599.43
07/25/2011$40,436.77$11,403.79$30,549.31
06/14/2016$67,050.11$4,938.42$42.00
06/14/2016$36,337.67$2,052.10$0.00
Total:$206,737.82$42,638.77$162,690.85

Bankruptcy Code section 724(a) provides “(a) The trustee may avoid a lien that secures a claim of a kind specified in section 726(a)(4) of this title.”  Section 726(a)(4) provides “fourth, in payment of any allowed claim, whether secured or unsecured, for any fine, penalty, or forfeiture, or for multiple, exemplary, or punitive damages, arising before the earlier of the order for relief or the appointment of a trustee, to the extent that such fine, penalty, forfeiture, or damages are not compensation for actual pecuniary loss suffered by the holder of such claim;”

The combination of these two sections allows the trustee to avoid a federal tax lien securing a penalty.  No one in the case disputed this result.  At issue in Hutchinson is the effect of avoiding the lien for the penalty.  The court stated that the issue in the case was “Whether the bankruptcy court erred in denying the government’s motion to abandon property of the bankruptcy estate based on the determination that avoided and preserved penalty portions of liens were not of inconsequential value to the estate.”

Later in the case the court stated the issue another way which perhaps provide more clarity regarding the actual dispute:

Here, the question is whether the tax and interest portions of the IRS’s five liens enjoy a higher priority over the penalty portions of the liens, despite each lien being comprised of tax, interest, and penalties at recordation. It appears that the law does not clearly delineate the extent to which certain categories of avoided and preserved liens might confer greater rights to the estate by operation of § 551, than rights the actual creditor would have held following avoidance of its lien. What priority do avoided penalty liens take? That is the question here.

The IRS filed a motion seeking a court order that the trustee abandon the property because the property was fully encumbered and would bring no value to the estate.  The taxpayer had property worth about $190,000.  A senior lien stood ahead of the IRS liens, leaving about $110-120,000 in value to which the federal tax liens attached.  As you can see from the values listed above in the chart regarding the IRS liens, the tax alone was over $200,000.  The IRS argued that because more tax was owed than the value of the equity, nothing existed for the trustee to administer.  The property should be jettisoned from the estate so that the IRS could go after the property to satisfy its lien interest.

Countering the IRS argument, the trustee said that because some of the lien was for penalties which the trustee could avoid, the avoidance should occur and the unsecured creditors should benefit from the avoidance. 

The statute provides no guidance regarding how the lien avoidance impacts the payment to the creditor.  The oldest liens get paid before the newer liens.  Looking at the oldest liens in the group of five, the amount of unpaid penalty on the older liens is substantial.  The trustee argues that he should approach the first lien and avoid the penalty amount of that lien.  This would put $44,500.11 into the pot for the unsecured creditors.  Then the trustee should go to the next lien and create a pro rata basis for treating that lien up to the value of the equity in the property.  If the first lien for a total of $51,950.26 eats into that much of the equity in the property, there is approximately $65,000 in equity left as the trustee moves to the second lien.  The trustee can avoid a pro rata amount of the second lien based on the percentage of the lien attaching to equity and the percentage of the penalty to the overall amount due on the lien.  This allows the trustee to avoid another $-X- from the second oldest recorded notice of federal tax lien which will go to the unsecured creditors.

Because the court did not engage in exactly the process I have described, I cannot say for certain that this is what it has held but I believe this was the trustee argument with which the court agreed.  The court notes that there is little or no case law on this issue but cited to a pair of earlier cases involving the avoidance provisions of B.C. 724 to support its conclusion that the bankruptcy court got it right.

The IRS argues that because the tax due on its liens exceeds the amount of the equity, the property should be abandoned without going through a test like the one described above. 

Because the specific fact pattern described here occurs infrequently, DOJ and the IRS may decide not to appeal the decision.  I did not read the briefs filed by DOJ which would have allowed me to come to a better understanding of the government’s argument.  The basic concepts determined by the bankruptcy court and the district court seem correct to me even though it creates a harsh result for the IRS in this situation.  Congress decided in section 724 to sacrifice the liens of governmental entities for the benefit of unsecured creditors.  It did not specify how the avoidance of the penalty part of the liens would work vis a vis the tax on the liens.  Working the liens from oldest to newest also makes sense to me.  So, the outcome makes sense. 

The court goes into an explanation of the interplay of BC 551 with BC 724 to allow unsecured creditors to step into the shoes of liens secured by penalties.  BC 551 preserves the position of the IRS lien for the unsecured creditors and does not allow junior lienholders to move up in this situation because the reduction of the IRS lien payment results from bankruptcy and not from any infirmity in the IRS lien itself.  I will not go through the whole BC 551 analysis here as it plays an important role for the unsecured creditors and for the decision of the court not to abandon the property but does not impact the outcome between the IRS and the trustee.  I agree with the court’s analysis of the way section 551 works generally and works specifically in this case.

Because of the absence of case law governing this situation, it will be interesting to see whether the government appeals.  The trial section clearly disagrees with the outcome as evidenced by its appeal of the bankruptcy court decision.  The case could result in an interesting discussion in the room of lies.

Taxpayer Fends Off Nominee Lien Challenge at Summary Judgment Stage

Court decisions on nominee liens occur infrequently and taxpayer victories in such cases occur quite rarely.  So, the decision in Dombrowski v. United States, No. 3:18-cv-11615 (E.D. Mich. 2020) provides a glimpse at what it takes to remove a nominee lien from a third party’s property.  We have previously discussed nominee liens here and here.  The procedural posture of this case has the court ruling on cross motions for summary judgment.  Because the court does not resolve the case on these motions, a second post on this case remains a possibility if the case goes to trial.  The rarity of this type of case makes discussion of the outcome of the summary judgment motions worthwhile.

As is true in any nominee case, the person seeking to remove the nominee lien intertwined her life and her finances with someone owing substantial tax liabilities. As you read the facts in this case you might ask yourself why someone would entangle their finances with someone who has this many problems with the IRS (and usually others), but the test for whether a nominee holding exist do not test for rational financial decisions but for real, as opposed to fake or apparent, financial actions. Here, the plaintiff convinces the court of the possibility of real financial consequences she has suffered.

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Ms. Dombrowski has lived with Mr. Matheson since 2006 though they have never married.  She lent him $171,000 in 2006 with funds pulled from her retirement account.  He promised to pay her back within months and gave a promissory note for 100% interest.  At approximately the same time her brother loaned Mr. Matheson almost the same amount on the same terms.  Later that year she loaned Mr. Matheson another $50,000.  The opinion does not say why she would do this.

The following year Mr. Matheson gave checks to Ms. Dombrowski and her brother to pay off the loan to each but asked them not to cash the checks.  They continued to loan Mr. Matheson money.  Meanwhile, Mr. Matheson ran up a tax debt to the IRS which now stands at over $3 million.

In 2013 Mr. Matheson defaulted on the mortgage on the property where he resided with Ms. Dombrowski.  On June 25, 2013, Mr. Matheson transferred $220,000 to Ms. Dombrowski and $80,000 to her brother.  She and her brother claim these payments were partial repayment of the previously loaned money.  The brother gave the money he received to Ms. Dombrowski on June 27, 2013.  On July 10, 2013 she purchased a house for $229,900 and the house was deeded in her name.  Mr. Matheson has essentially lived with her since the house was purchased.  In 2017 the IRS filed a nominee lien on the house taking the position that Ms. Dombrowski held the house as the nominee of Mr. Matheson.

Unlike the federal tax lien which the IRS files in the name of the taxpayer and not against specific property, a nominee lien names the taxpayer, the nominee and the specific property subject to the nominee lien.  Also unlike the federal tax lien which many collection employees may file without supervisor or Chief Counsel approval, the filing of a nominee lien requires specific approval from Chief Counsel’s Office.  Without knowing more than the brief facts recounted by the court and detailed above, it is easy to understand why the attorney reviewing this case would approve the nominee lien, though the existence of a valid loan could provide the basis for the transfer from the taxpayer to Ms. Dombroski.  The goal of the nominee lien is to preserve lien priority and not to resolve title.  Additionally, unlike the filing of the notice of federal tax lien, the filing of a nominee lien does not, according to the IRS, provide the nominee with the opportunity for a Collection Due Process hearing.  Guest blogger Lavar Taylor discussed this issue in a five part series.  Ms. Dombrowski brought this suit to quiet title and remove the nominee lien.

The IRS argued that Mr. Matheson’s transfer of $300,000 to Ms. Dombrowski and her brother in 2013 at a time when he owed the IRS over ten times that amount provided three bases for the IRS to pursue the property in order to collect on the outstanding liability owed to it.  First, the IRS argues that the transfer violates Michigan’s Uniform Voidable Transfers Act.  Second, it argues that the court could impose a resulting trust, and third it argues that the lien is proper because she held the property as a nominee for Mr. Matheson.

To prove a violation of the Michigan voidable transfers law the IRS must prove four elements: 1) transfer to an insider; 2) transfer made to pay an antecedent debt; 3) that Matheson was insolvent at the time of transfer; and 4) the recipient had reasonable cause to believe Matheson was insolvent.  Ms. Dombrowski first argued that the IRS action was time barred, but the court turned away this argument finding that even though the IRS was relying on a state cause of action, the federal statute of limitations applies.  She admitted three of the four elements of the statute but contested that she was an insider.  In declining to grant summary judgment to the IRS, the court determines that a jury must decide the question of fact regarding her insider status.  So, the IRS loses its effort to end the case on this basis.

Next, the court turns to the argument that the property is subject to a resulting trust.

A trust arises in favor of a debtor’s creditors when the debtor pays for property subsequently titled under a third-party’s name. Id.; see Advance Dry Wall Co., 218 N.W.2d at 868 (“[The] statute would create an equitable interest in [purchased] land in favor of [a] . . . creditor since the valuable consideration for the land was paid for by [the debtor] but the title was taken exclusively in the names of [third-parties].”). Such a transaction creates a presumption of fraudulent intent, and it is the third-party’s responsibility to produce evidence to rebut it. Mich. Comp. Laws § 555.8

Ms. Dombrowski logically argues that she bought the property with funds paid to her in repayment of prior loans and not with money owned by Mr. Matheson.  The court walks through the arguments available to each side on this issue before deciding that a jury must resolve this issue given the competing facts.

Lastly, the court addresses the nominee theory.  Given its decision regarding the first two theories, one might be tempted to predict where this issue will end, but the case takes a twist based on the legal theory upon which the IRS relied for proving the nominee theory.

Drawing on federal revenue caselaw that “the [IRS] may collect the tax debts of a taxpayer from the assets of his nominee, instrumentality, or alter ego,” the court in Porta-John analyzed the corporate relationships under a theory of nominee liability. Id. at 700 (citing G.M. Leasing Corp. v. United States, 429 U.S. 338, 350-51 (1977); Lemaster v. United States, 891 F.2d 115 (6th Cir. 1989)). The court relied on no Michigan law for its determination. Id. at 701. It relied upon opinions from the Northern District of New York, the District of Montana, and the Second Circuit, to set the following standard for nominee liability:

In order to establish that property is held by a nominee, the [c]ourt must consider six factors: (1) whether inadequate or no consideration was paid by the nominee; (2) whether the property was placed in the nominee’s name in anticipation of a lawsuit or other liability while the transferor remains in control of the property; (3) whether there is a close relationship between the nominee and the transferor; (4) whether they failed to record the conveyance; (5) whether the transferor retains possession; and (6) whether the transferor continues to enjoy the benefits of the transferred property.

It’s not often a leading case in a tax issue is named Porta-John. The court declined to follow the reasoning in the Porta-John case, because no Michigan case had cited to it and the 6th Circuit had not determined it applied.  Because state law controls the property interest and because the state law had not yet adopted the theory set out in the Porta-John case, the court here would not apply the law of that case to find a nominee situation. 

The Sixth Circuit mentioned that some courts have applied the Porta-John factors when evaluating questions of alter-ego liability. Id. at 253 n.2. Nonetheless, the Spotts court noted that “federal courts have looked to the decisions of other courts for guidance” only when “a forum state does not have clear law on the issue.” Id. at 253. The court held that a state did have “clear law” where it allowed the IRS to enforce its rights to tax debts through a constructive trust on third-party property. Id. Further, the court cautioned, even in cases where law outside the forum state can be used, “rigid adherence to [the Porta-John] factors may not be appropriate for every case.” Id. at 253 n.2. The unique facts of a case may not fit well within Porta-John’s factors, such as when the alleged nominee is a spouse, and courts may disregard Porta-John as needed. Id….

Michigan has “clear law” on alter-ego liability. Spotts, 429 F.3d at 253. Because Porta-John’s nominee theory is not derived from Michigan state law, summary judgment in favor of Plaintiff will be granted. Nat. Bank of Comm., 472 U.S. at 722; Fed. R. Civ. P. 56(a). There are no factual issues, and as a matter of law, Defendant’s Porta-John argument fails. Fed. R. Civ. P. 56(a).

So, the case moves forward on the first two theories, but the government’s Porta-John theory will have to wait for another day.  The IRS can raise this theory again on appeal if it loses the other issues.  It’s hard to say who will win because the case turns on facts not yet fully developed.  Ms. Dombrowski is a loser in some respects because she must expend time and effort to defend the property from taking.  Even if she ultimately wins, it will be a costly victory for her.  Similarly, for the IRS, clearing title to get to this property which will only satisfy a small portion of the overall liability is proving costly.  This is what happens when a title is clouded.