Other 200004034: Chief Counsel summarizes tax lien, bankruptcy, and summons decisions

Plain-English summary

This Office of Chief Counsel bulletin reports recent court decisions rather than deciding a taxpayer's request. Its lead article discusses the Supreme Court's decision in Drye Family 1995 Trust v. United States: a valid disclaimer under state law did not keep a preexisting federal tax lien from reaching the taxpayer's right to inherit. The bulletin also gives shorter accounts of bankruptcy, lien priority, and IRS summons cases. It identifies itself as informational and not a directive.

Ruling snapshot

• Question: What did recent courts decide about federal tax liens and related collection issues?
• Outcome: Informational litigation summary; no taxpayer ruling.
• Key authorities: IRC §§ 6321, 6334, 6323, 7602, 7609; federal bankruptcy provisions discussed in the bulletin.

Full text (IRS public release)

Number: 200004034                                                December 2,1999
Release Date: 1/28/2000                                          UIL: 9999.98-00
CC:EL:GL:B2

GENERAL LITIGATION BULLETIN
Department of the Treasury                        Internal Revenue Service
Office of Chief Counsel

This Bulletin is for informational purposes. It is not a directive.

BULLETIN NO. 471                                                                                             DECEMBER 1999

                              HIGH AND DRYE
  Supreme Court Finds Tax Lien Attaches to Estate Property Despite Disclaimer

        In a unanimous decision only a month after oral argument, the Supreme Court ruled
that an individual’s state law disclaimer did not prevent pre-existing tax liens from attaching
to an inheritance, in Drye Family 1995 Trust v. United States, 1999 U.S. LEXIS 8238
(S.Ct. Dec. 7, 1999). This significant victory for the Government confirms the primacy of
the federal tax lien over state laws designed to protect property from the reach of creditors.
It resolves a split among the circuits over whether the federal tax lien under I.R.C. § 6321
attached to the taxpayer's right to inherit, if the taxpayer later disclaimed his inheritance
under state law.

        The taxpayer’s mother died intestate, leaving an estate of about a quarter of a
million dollars in real and personal property. At the time of his mother’s death, the taxpayer
was insolvent and owed over $325,000 in federal taxes. The Service had valid federal tax
liens against all of his property or rights to property. Six months after successfully
petitioning to be administrator of his mother’s estate, the taxpayer validly disclaimed all
interest in his mother’s estate under Arkansas law. The proceeds of the estate passed to
the taxpayer’s daughter, who promptly placed them in a spendthrift trust. The taxpayer
was one of the beneficiaries of the trust. The Service successfully levied against the trust
as the taxpayer’s nominee (the trust’s assets were held by a third party). The trust
responded by filing a wrongful levy action against the Service.

       The district court concluded that the Government held valid tax liens against all of
the taxpayer’s property and rights to property, which included the assets conveyed in the
mother’s estate. The court further found that the taxpayer’s disclaimer was invalid and
fraudulent as the trust was merely the taxpayer’s alter ego or nominee. On appeal, the
Eighth Circuit affirmed.

        The Eight Circuit began by reciting the well-established standard that state law
controls the nature of an interest in property, but federal law determines whether such a
right or interest is subject to a tax lien under I.R.C. § 6321. Disagreeing with Leggett v.
United States, 120 F.3d 592 (5th Cir. 1997) (applying Texas law, found an estate’s bequest
was merely an offer, not a property right), and Mapes v. United States, 15 F.3d 138 (9th Cir.
1994) (applying Arizona law, held timely renunciation prevents taxpayer from acquiring
interest in estate property), the court of appeals agreed with United States v. Comparto,
22 F.3d 455 (2d Cir. 1994) (applying New York law, held property interest vests upon
decedent’s death and so before renunciation). In Drye, the Eighth Circuit held that the pre-
existing federal tax liens attached to the taxpayer’s state law right to his share of the estate
at the time his mother died. The state law “fiction” of disclaimer cannot overcome the
federal consequences of the tax liens.

        The Eighth Circuit agreed that there were valid policy considerations favoring the
disclaimer’s precedence. However, the court of appeals noted that Congress clearly
intended section 6321 to reach any and all pecuniary interests to which a taxpayer may be
entitled to satisfy outstanding tax liability. Nor, the court determined, is any disclaimer
included in section 6334, which exempts specified property or rights, and no other, from
federal levy.

       The Supreme Court affirmed the Eighth Circuit in a unanimous decision by Justice
Ginsburg. The Court held for the Government that the "Code's prescriptions are most
sensibly read to look to state law for delineation of the taxpayer's rights or interests in the
property the Government seeks to reach but to leave to federal law the determination
whether those rights or interests constitute 'property' or 'rights to property' under section
6321." Applying that analysis, the Court observed that an expectancy to inherit, under
Arkansas law, is assignable (although the Court made clear that it was not deciding
whether assignability was a necessary feature of property for federal tax purposes). A right
to inherit or to "channel the inheritance to a close family member (the next lineal
descendant)" cannot simply be written off as a mere personal right to accept or reject a gift,
the Court concluded. According to the Court, that right was "property" or a "right to
property" subject to the Government's federal tax lien.

LIENS: State Law, Effect of

1.     BANKRUPTCY CODE CASES: Automatic Stay (§ 362): Tax Court Proceeding
       Durham Farms v. United States, 1999 Bankr. LEXIS 1514 (D. Or. Nov. 12, 1999)
       - The bankruptcy court held that the automatic stay does not apply to tax
       redetermination proceedings brought in Tax Court by TEFRA partners. Because
       there is no provision in the Bankruptcy Code for payment of federal taxes by a
       bankrupt partnership, the Tax Court proceedings cannot “concern” the bankrupt
       partnership within the meaning of B.C. § 362(a)(8).

2.     BANKRUPTCY CODE CASES: Determination of Tax Liability: Assessment of
       Tax Determined by Bankruptcy Court
       Klippel v. Internal Revenue Service, 84 AFTR2d ¶ 99-5592 (Bankr. D. N.J. Nov.
       18, 1999) - Bankruptcy court abstains from determining the dischargeability of an
       I.R.C. § 6672 Trust Fund Recovery Penalty liability in a no-asset Chapter 7,
     because the determination would have no effect on the administration of the
     bankruptcy case. The court held the debtor could seek a determination in any other
     appropriate forum, without involving the bankruptcy court in a determination that
     would serve no bankruptcy purpose.

3.   BANKRUPTCY CODE CASES: Exceptions to Discharge (§ 523)
     BANKRUPTCY CODE CASES: Priorities (§ 507)
     In re Gust, 1999 U.S. App. LEXIS 32154 (11th Cir. Dec. 9, 1999) - The 11th Circuit
     summarily upheld the district court’s decision in this case. The debtor argued that
     under B.C. § 523(a)(1)(A) the Government’s secured tax claim was dischargeable,
     relying on United States v. Victor, 121 F.3d 1383 (10th Cir. 1997). Victor held that
     by referencing section 507(a)(8), B.C. § 523(a)(1)(A) addresses only unsecured
     taxes for dischargeability purposes. The district court disagreed with this
     contention, finding section 523(a)(1)(A) focuses on the kind of tax described by
     section 507(a)(8) rather than the type of claim that may be filed. Therefore, a
     secured federal claim is not dischargeable under section 507(a)(8) in a chapter 7
     bankruptcy.

4.   BANKRUPTCY CODE CASES: Priorities (§ 507)
     In re Bennett, 237 B.R. 918 (Bankr. N.D. Tex. 1999) - Court held that a criminal
     restitution judgment was not entitled to priority treatment under B.C. § 507(a)(8).
     Debtor pled guilty to mail fraud and tax evasion charges, and was ordered to pay
     restitution. Subsequently, the debtor filed for bankruptcy. The United States neither
     filed a proof of claim nor objected to the debtor’s Chapter 7 discharge. The court
     found despite the language of 18 U.S.C. § 3613(c) (restitution is a lien “as if the
     liability of the person fined were a liability for a tax assessed under the Internal
     Revenue Code.”) that there is no specific reference to criminal restitution in the list
     of priorities under B.C. § 507. Further, the court held, the twin purposes of
     restitution - deterring and punishing the wrongdoer - are undermined when innocent
     creditors are required to help pay for a debtor’s criminal sanctions. Since the United
     States still retains a nondischargeable restitution judgment, it is not harmed.

5.   LIENS: Filing: Misnomer
     Villard v. United States, 176 F.3d 479 (5th Cir. 1999) (unpublished) - In an
     unpublished opinion, the Fifth Circuit affirmed that a federal tax lien filed against
     “White-Hall Windermere Company, Inc.” was effective against the taxpayer,
     Whitehall-Windermere Company, Inc., so as to defeat a subsequent judgment
     creditor’s lien.

6.   LIENS: Priority Over Attorneys
     Reed & Steven v. HIP Health Plan of Florida, Inc., 1999 U.S. Dist. LEXIS 17940
     (S.D. Fla. Oct. 7, 1999) - The district court adopted the magistrate judge’s report of
     September 7, 1999. In this case, an advertising agency sued a health care plan,
     then switched attorneys. The second counsel obtaining a favorable settlement
     which was subject to both attorneys’ liens. The Service, which had a lien against
     the health care plan, agreed that the second counsel was entitled to priority under
     I.R.C. § 6323(b)(8), but disputed payment to the advertising agency’s first set of
     attorneys. The court found that the first attorney’s charging lien was entitled to
     superpriority status under section 6323(b)(8) because Florida law provides that an
     attorney’s charging lien relates back to the time the attorney first began representing
     the client. The court also disagreed with the Service that the total attorneys’
     compensation was limited to the 40% standard adopted by Florida Bar Rules. The
     court found that since the advertising agency had two sets of attorneys, both were
     entitled to reasonable compensation.

7.   SUMMONSES:
     United States v. Nixon, 1999 U.S. Dist. LEXIS 17921 (S.D. Fla. Oct. 28, 1999) -
     Service issued summons to corporate officers regarding the corporation’s tax
     liability. The court quashed the summonses, finding the Service failed to comply
     with newly-enacted I.R.C. § 7602(c), which requires notice to the taxpayer prior to
     any contact with a third party. The Service, which did not send the required notice,
     argued that because of the close relationship of the officers to the taxpayer
     corporation, the officers were not third parties and section 7602 did not apply. The
     court disagreed, and further found no “good faith” exception to the requirements of
     the statute.

8.   SUMMONSES: Third Party Summonses: Notice to Person Identified
     Barmes v. United States, 1999 U.S. App. LEXIS 31401 (7th Cir. Dec. 2, 1999) -
     Seventh Circuit dismissed taxpayers’ petition to quash third-party summons. The
     Service issued a summons to the taxpayer’s bank, but did not provide them a copy.
     The taxpayers argued that since the summons was not issued solely in aid of
     collection, as required by I.R.C. § 7609(c)(2)(D), the summons was invalid. The
     court of appeals disagreed, holding that the statute did not contain the word “solely”
     and therefore, a summons issued for more than one purpose qualified for the
     section 7609 notification exception if one purpose of that summons was to aid in
     collection (as the revenue officer testified it did). The court also disagreed with the
     taxpayer’s argument that the Service qualifies for the exception to notification only
     if the subject of the third-party summons is also the taxpayer named in the
     assessment.

9.   SUMMONSES: Third Party Summonses: Right to Intervene or Proceeding to
     Quash
     Clay IV v. United States, 1999 U.S. App. LEXIS 32832 (6th Cir. Dec. 20, 1999) -
     Taxpayer’s suit to quash third-party recordkeeper summons was properly
     dismissed, the Sixth Circuit affirmed, because the taxpayer failed to file within the
     20 days allowed under I.R.C. § 7609(b)(2)(A). A proceeding to quash, as with any
     suit against the United States, requires waiver of the Government’s sovereign
     immunity. In this case, the Government’s waiver, and also the court’s jurisdiction,
     ends when the twenty-day limitation has run. The court of appeals found
     unpersuasive the taxpayer’s argument that Fed. R. Civ. P. 6(e) added three days
     to this period because notice of the summons was mailed to them. First, section
     7609(b)(2)(A) specifically mandates filing within 20 days notwithstanding any other
     law or rule of law. Second, Rule 6(e) provides additional time only for a “party,” and
     as no suit yet had been filed, the taxpayer could not be considered a “party.”