In their initial opinion, the 5^th Circuit adopted a definition of “an interest” used by several other Circuits; holding that “an interest” in the context of a wrongful levy suit requires a third party to hold “a fee simple or equivalent interest, a possessory interest, or a security interest in the property levied upon.” But, while determining what level of ownership interest is enough for a third party to bring a wrongful levy suit is a federal law question, determining what a third party actually owns is a state law matter. And here, the court was unable to determine—under Louisiana state law—what kind of ownership interest the third parties had at the time of the levy.

To briefly summarize the facts, Mr. Goodrich passed away with significant federal tax debt. After his death, a succession bank account was set up. The account included cash and later the proceeds from several post-death asset sales. This account was then levied upon by the Service. 

At the time of his death, Mr. Goodrich had a lifetime usufruct over various properties. A usufruct being the legal right to enjoy the use of property during the term of the usufruct (similar to the common law life estate, but duration can be shorter than a lifetime). Mr. Goodrich’s three children were the naked owners of the property subject to his usufruct. A naked owner owns the property, but they do not have the full rights to use the property. At the end of the usufruct, all the rights to the property revert to the naked owner (similar to a remainder interest at common law).

At the district court, the children prevailed in showing they were—as naked owners—the rightful owners of cash proceeds from certain post-death asset sales of usufruct property. This resulted in a portion of the levied funds related to those assets being returned.

However, the issue facing the 5^th Circuit on appeal revolved around what kind of state law property rights the children had in proceeds from a stock sale of usufruct property that had occurred years prior to Mr. Goodrich’s death. Or put another way, what rights the naked owners had in usufruct property that had already been consumed.

Under Louisiana law, when the usufruct ended, Mr. Goodrich was bound to “pay to the naked owner the value that the things had at the commencement of the usufruct or to deliver to him things of the same quantity and quality.” So, the children had some interest in the sales proceeds from the stock. But was it enough of an interest to sustain a wrongful levy claim?

The children argued that they were the actual owners of Mr. Goodrich’s cash funds up to the amount of the prior stock sale proceeds. However, the district court disagreed, finding under Louisiana law that the children were merely unsecured creditors. The 5^th Circuit though found the answer to this question unclear, certifying the following tongue twister to the Louisiana Supreme Court: “[d]oes a usufructuary’s testamentary usufruct of consumables render naked owners unsecured creditors of the usufructuary’s succession?”

In November, the Louisiana Supreme Court denied certification of the question stating that “[t]he certified question may be resolved under existing law and jurisprudence.” The court pointed to the Louisiana Civil Code and two state court appellate court decisions—one of those appellate decisions being the same ruling the district court had relied on in making their initial determination.

When the case returned to the 5^th Circuit, the court affirmed the district court’s decision that the children (as naked owners) had a claim against the father’s succession for the usufruct of consumables (the disposed stock). However, that claim under Louisiana law was only as unsecured creditors. Thus, the children were not the direct owners of the disputed funds in the bank account. And, as unsecured creditors, the children did not have an interest sufficient to sustain a wrongful levy claim related to those funds.

Conclusion

While this may seem like an ending that fizzled, the case shows the interplay of state and federal law upon lien and levy law under the Internal Revenue Code.  The Supreme Court in Aquilino v. United States, 363 U.S. 509 (1960) made clear that state law plays a large role.  Here, it’s hard to criticize the district or circuit court for the manner in which the case was handled.  The district court properly looked to state law to find the answer and based its decision on the state law it concluded applied to the case.  The Fifth Circuit, giving the children the full benefit of getting definitive state law precedent, sought guidance from the state Supreme Court and received a response that basically said the district court got it right. 

Not many clients hold usufructs, but many have some type of state law property interest.  Goodrich provides a great example of how the process should work while simultaneously making some of us glad we don’t practice in Louisiana having to tangle with this strange property creature called a usufruct.

Ultimately, the court adopted the definition used by several other Circuits, including the Seventh, Ninth, and Eleventh, that “an interest” in the context of a wrongful levy suit requires the third party to hold “a fee simple or equivalent interest, a possessory interest, or a security interest in the property levied upon.”

The court also explained that whether an interest exists is a jurisdictional question, because without an interest in the levied property, I.R.C. § 7426(a)(1)’s waiver of sovereign immunity does not apply—depriving the court of subject matter jurisdiction to hear the claim.

The case also reminds us that while the determination of what ownership interest qualifies a third party to bring a wrongful levy suit is a question of federal law, whether an ownership interest actually exists (i.e., what does the third party own) is determined by state property laws. And, thanks to Louisiana’s French history and civil law influences, the Goodrich case involves some state law property issues and terminology that will look quite foreign to most federal tax practitioners.

Facts of the Case

The taxpayer, Mr. Goodrich, passed away with significant federal tax debts. At the time of his death, Mr. Goodrich had a lifetime usufruct over various properties he had previously inherited from his deceased spouse. A usufruct is the right to enjoy the use of property during the term of the usufruct (similar to the common law life estate, but the duration can be shorter than a lifetime). Mr. Goodrich’s three children were the naked owners of the property subject to his usufruct. A naked owner owns the property, but they do not have the full rights to use the property. At the end of the usufruct, all the rights to the property revert to the naked owner, similar to a remainder interest at common law.

The properties at issue where Mr. Goodrich held a lifetime usufruct with the children as naked owners were: 1) mineral rights, proceeds of which were deposited in the estate bank accounts after Mr. Goodrich’s death; 2) furniture that was sold as part of an estate sale (including a master bathroom towel rack that somehow fetched $1,200); and 3) shares of stock that Mr. Goodrich had sold years earlier.

Sometime after Mr. Goodrich passed away, the IRS issued a levy to Mr. Goodrich’s estate bank accounts. At this point, an attorney for the estate argued to the IRS revenue officer via a phone conservation and a letter that the children owned all of the cash in the accounts, with Mr. Goodrich’s ownership rights having ceased at death and all rights reverting to the children as naked owners. However, the IRS did not release the levy and collected approximately $250,000 from the accounts, prompting the children to file the wrongful levy suit. 

With regard to the mineral rights income and furniture sold after Mr. Goodrich’s death, the district court agreed with the children that upon Mr. Goodrich’s death (and the termination of the usufruct), they became the full owners of the usufruct property. Thus, the proceeds of from the mineral rights and the proceeds from the sale of the furniture both occurring after Mr. Goodrich’s death belonged to the children—entitling the children to a return of those levied proceeds.  

However, the mineral rights and the furniture existed at the time of Mr. Goodrich’s death. More complicated were the shares of stock that Mr. Goodrich had held as usufruct that were sold prior to Mr. Goodrich’s death. The appeal to the Fifth Circuit focused on those stock shares.

As previously mentioned, Mr. Goodrich had inherited these shares as a usufruct from his deceased spouse. And, by the terms of his spouse’s will, Mr. Goodrich was allowed to sell or otherwise dispose of the shares during his lifetime. However, the will also stated that in the event of a disposition, the usufruct would not terminate but would attach to the proceeds of the disposition, including their reinvestment.

Further, under Louisiana law dealing with usufructs where the property is consumed or disposed of, when the usufruct ended Mr. Goodrich was bound “either to pay to the naked owner the value that the things had at the commencement of the usufruct or to deliver to him things of the same quantity and quality.” So, at Mr. Goodrich’s death, the children were entitled to something to compensate them for being deprived of the stock shares. But, what was the exact ownership interest that they had? And, would it rise to the level of “an interest” for purposes of bringing a 7426(a)(1) action?

Legal Dispute & Open State Law Questions

The children argued unsuccessfully at the district court that they were entitled to an amount of cash equal to the sales proceeds from when Mr. Goodrich sold the shares of stock (i.e., the children argued that they owned the cash in the estate bank accounts up to the share sales price). The district court instead determined that the children were unsecured creditors of the estate in an amount equal to the stock sales proceeds, making the levy on the bank accounts proper (since the IRS enjoys statutory priority over unsecured creditors when a tax lien arises as a matter of law). And, because the estate had insufficient funds to pay the entire tax debt, the children, as unsecured creditors, would receive nothing from the shares Mr. Goodrich previously sold (one might say they lost their shirt as naked owners).  

The children appealed, and the Fifth Circuit found that determining the relationship of the children as naked owners vis a vis the estate at the termination of the usufructuary to be unresolved by existing Louisiana law. The court also found it appropriate to certify to the Louisiana Supreme Court the question of what the children as naked owners owned upon the termination of the usufruct where the property was previously disposed. So, the Fifth Circuit certified the following questions to the Louisiana Supreme Court:

1. Does a usufructuary’s testamentary usufruct of consumables render naked owners unsecured creditors of the usufructuary’s succession?
2. If not, what is the naked owner’s relationship to those consumables?

The Louisiana Supreme Court’s resolution of these property law questions remains pending as of this writing. Ultimately, the resolution of these questions may not be very broadly applicable (only two states, Louisiana and Georgia, recognize usufructs). But, the case is an important reminder of what the Supreme Court said 36 years ago in United States v. National Bank of Commerce, 472 U.S. 713, 722 (1985) about federal tax levies: “[T]he federal statute ‘creates no property rights but merely attaches consequences, federally defined, to rights created under state law.”

Wrongful Levy Suits Background

In fiscal year 2017, the IRS served almost 600,000 levy requests according to the IRS Data Book. While this number has decreased substantially in recent years (there were over 1.4 million such levy requests in FY2015), the levy power does provide many opportunities for the IRS to seize property not owned by the liable taxpayer, but instead by an innocent third party.

In the event the innocent third party is aware of the potential issuance of a notice of levy, that party can attempt to convince a Revenue Officer that such property does not belong to the taxpayer. However, until the issuance of a notice of levy, the innocent third party likely has no advance knowledge of the IRS’s plans. 

Then, at the point the notice of levy is issued, it is likely fruitless for the innocent third party to attempt to convince the recipient of the levy to not turn over property to the government because Section 6332(d)(1) imposes personal liability on individuals who fail to remit property pursuant to a levy. As an additional incentive, Section 6332(e) provides the party surrendering the property with immunity against liability from any other party.

When a levy is issued, it attaches to a taxpayer’s entire interest in property unless the property is exempt. For payments that will arise after the issuance of the levy, the levy attaches to all amounts that are fixed and determinable at the time of levy. Examples of future payment streams that are potentially fixed and determinable include retirement benefits, pensions, interest payments, and—as in Gold Forever—royalty payments.

Once the levy is issued—regardless of whether property is actually surrendered—the third party has the option to file an administrative claim for wrongful levy with the IRS. Such a written request is required if damages beyond just a return of the levied property are sought. If the claim is unsuccessful or no claim is filed, the third party can bring a civil suit against the United States. For innocent third parties who have property levied by the IRS to satisfy another taxpayer’s liability, a suit against the United States under Section 7426(a) is the only judicial remedy available.

Prior to the 2017 tax act (a.k.a. TCJA), the limitations period (found in Section 6532(c)) for a return of wrongfully levied property action was a mere nine months from the date of the levy, which is the period applicable in Gold Forever. The TCJA extended this period to two years for new levies and for levies where the nine month period had not expired as of the date of the TCJA’s enactment. In cases where the third party makes a timely administrative claim for a return of levied property, the limitations period is extended until the earlier of twelve months from the date of filing the claim or six months from the IRS’s notice of disallowance.

Facts of the Case

Gold Forever is a music publisher owned by Edward Holland, Jr. Holland is famous for being a member of the Holland-Dozier-Holland songwriting and production team responsible for several hits from Motown’s top artists. Mr. Holland also owed the government over $19 million in unpaid taxes.

Gold Forever licensed its music catalog to Broadcast Music, Inc. (BMI) and Universal Music Publishing (Universal) and in exchange, received royalty payments. Due to this arrangement, the IRS issued notices of levy to BMI and Universal in August 2012 under the theory that Gold Forever was either the alter ego or nominee of Edward Holland. Soon after the notices of levy were issued, BMI and Universal began remitting payments to the IRS and this apparently continued for several years without any action by Gold Forever (although there was some dispute about the extent to which payments were made during this period).

In the present litigation, Gold Forever has denied ever being an alter ego or nominee of Mr. Holland and claimed that the majority of levied royalty payments were meant for other artists and not Mr. Holland. In addition, at oral argument before the Sixth Circuit, the attorney for Gold Forever speculated that the inaction on the levy from Gold Forever was due to a belief that the amounts due to it under the contracts with BMI and Universal were not worth litigating over.  

However, by 2016 and 2017, when BMI and Universal made additional royalty payments totaling almost $1 million to the IRS pursuant to the levy, Gold Forever decided to bring the Section 7426(a)(1) challenge in the Eastern District of Michigan seeking a return of those 2016 and 2017 payments.

District Court Proceedings

In district court, Gold Forever alleged that the 2016 and 2017 royalty payments were not amounts that were fixed and determinable as of August 2012 levies. Thus, the 2012 notices of levy could not have attached to these payments. Therefore, the IRS’s seizure of the 2016 and 2017 royalty payments could not have been pursuant to the 2012 notices of levy. Instead, the seizure of these payments should be viewed as a new, constructive levy, starting the limitations period for a wrongful levy claim anew and making Gold Forever’s action timely (although this argument was framed in the somewhat confusing context of what is “the meaning of the word levy”). Gold Forever also noted the due process issues that would arise if the government were able to seize after-acquired property with no post-deprivation opportunity to dispute the taking.

In response, the government’s argument was very straightforward. The notices of levy occurred in August 2012. Thus, because an administrative claim was not filed during the months after the notice of levy, the limitations expired nine months later in mid-2013. The code and regulations are quite clear that a notice of levy starts the limitations period. Section 6532(c) calculates the limitations period from “the date of the levy” and Treas. Reg. Section 301.6331-1(c) provides that the date of the levy is the date on which a mailed notice of levy is delivered. Section 7426(a)(1) itself notes that a wrongful levy action may be brought “whether such property has been surrendered.”

The government also contended that whether the 2012 levy notices actually attached to the 2016 or 2017 royalties was irrelevant. According to the government, because the royalty payments were surrendered pursuant to the 2012 notices of levy, those notices of levy started the limitations period.

The district court appears to have missed the underlying substance of Gold Forever’s argument that the 2012 notices of levy did not attach to the 2016 and 2017 payments and the later seizure of those funds should be viewed as a separate levy distinct from the 2012 notices of levy. Instead, the district court summarized Gold Forever’s position as one that revolved around word meanings, stating “Plaintiff argues that ‘the date of the levy’ may also refer to the date of a seizure, namely the funds paid in 2016 and 2017.” Based on this understanding, the court easily found for the government and determined that a notice of levy, not the actual seizure, starts the limitations period. The court did not discuss whether the 2012 levies attached to the 2016 and 2017 payments and whether the remittance of those funds—if not reached by the 2012 levies—could constitute a new constructive levy.    

Sixth Circuit

At the appellate level, it appears the government began to appreciate that whether the 2012 levy attached to the 2016 and 2017 payments could actually matter. At oral argument, counsel for the government acknowledged that there was insufficient information in the record below to determine whether the 2016 and 2017 royalty payments were fixed and determinable at the time of the 2012 levies.

Nonetheless, the government contended that Gold Forever could have filed a wrongful levy suit within nine months of the 2012 notices of levy to determine “whether the levy attached to its royalty rights.” Gold Forever, quite rightly in my opinion, pointed out the problems of the government’s argument that taxpayers should litigate the scope of a notice of levy to avoid the possibility of the IRS wrongfully using that levy to seize property in the future to which the government was not entitled.  

Alternatively, the government argued that if the levy did not reach the 2016 and 2017 payments to the government, then those amounts remitted to the IRS “were voluntary payments that cannot be recovered in a wrongful levy suit.” Instead of a wrongful levy suit, the government suggested Gold Forever’s only judicial remedy would be a third party civil action for release of an erroneous lien under Section 7426(a)(4), which would require a deposit by the taxpayer, contains much tighter deadlines, and – conveniently for the government in this case—would preclude the recovery of payments already made.

Again, this second argument from the government is quite troubling. Section 7426(h) authorizes additional damages in cases where an IRS employee negligently, recklessly, or intentionally takes a collection action in violation of the IRC. It would be an odd result if an IRS employee could knowingly demand after-acquired property be turned over pursuant to a notice of levy and then deprive the third party from being able to bring a suit for the return of the property because such payment was actually “voluntary.” It is further problematic in that the IRS would likely be using the carrot and stick provisions of immunity and personal liability under Section 6332 to convince parties to turn over property pursuant to a notice of levy and then later flip-flopping to argue it was not a levy at all.

In ruling for Gold Forever, the Sixth Circuit held that there was insufficient evidence in the record to determine whether the 2016 and 2017 royalties were fixed and determinable, and that whether they were would determine the outcome of the statute of limitations issue. The court explained:

Determining whether the 2012 levies attached to royalties acquired after the notices of levy is necessary to finding when the limitations period began to run for a wrongful levy action on those royalties. The government insists, without explanation, that determining the scope of the 2012 levies affects only the relief that could be awarded in the wrongful levy action and that considering the scope of the levies conflates “the statute of limitations with the merits of the claim.” The government’s concern is misplaced. Whether the levy attached to property is not part of the merits of a wrongful levy action—i.e., that the levy was made on property or a right to property in which the non-taxpayer has an interest. See Nat’l Bank of Commerce, 472 U.S. at 739 (quoting United States v. Rodgers, 461 U.S. 677, 695 (1983)). A levy attaching to property or the right to property is necessarily antecedent for the statute of limitations to begin running on a wrongful levy action concerning that property.

As for the government’s alternative argument that there could have been no levy if the 2012 notices did not attach to the 2016 and 2017 royalties, the court declined review since it was raised on appeal for the first time.

Final Thoughts

On remand, it will be interesting to see whether Gold Forever can convince the Court that the 2016 and 2017 royalty payments were not fixed and determinable at the time of the 2012 notices of levy. Nevertheless, it seems this is an issue a third party should have the opportunity to litigate. Otherwise, the possibility of improper IRS collection action pursuant to previously issued notices of levies would go potentially unchecked.

This case stands as good reminder for anyone who has a stream of payments currently being levied (and who might believe the applicable limitations period has passed) to take a closer look to confirm whether property levied today was a fixed and determinable amount at the date of the notice of levy. 

Additionally, when the IRS issues a notice of levy, parties should carefully evaluate what property is fixed and determinable at the time of the levy. And Gold Forever’s current litigation should cause third parties to at least consider proactive litigation under Section 7426(a)(1), even when the monetary amounts at stake appear small, if there is a possibility of increased payments at a future date. After all, if Gold Forever had prevailed in a suit in 2012 or 2013 under the theory that it was not an alter ego or nominee of Mr. Holland, the company would have avoided the after-acquired property issue of the 2016 and 2017 payments altogether.

Finally, if you happen to find yourself streaming Motown classics on your favorite streaming service, you can feel a little extra patriotic knowing that—at least for the time being—some of those royalties payments are going to help put a dent in those ever-increasing annual federal deficits.