Annotations- State Exemption Law

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6334 Annotations: State Exemption Law- Levy

 

Property Exempt from Levy: State Exemption Laws

 

[99-2 USTC ¶51,006] Rohn F. Drye, Jr., et al. v. United States

Supreme Court of the United States, 98-1101, 12/7/99 , 120 SCt 474, Affirming a Court of Appeals decision, 98-2 USTC ¶50,651

152 F3d 892.

On Writ of Certiorari to the United States Court of Appeals for the Eighth Circuit.

[Code Secs. 6321 , 6323 and 6334 ]

Tax liens: Property subject to: Relinquishments and disclaimers: Validity and priority against third parties: Inherited property: Property exempt from levy: State exemption laws.--Federal tax liens attached to a delinquent taxpayer's interest in an estate, despite his disclaimer. Under state ( Arkansas ) law, the interest was a right to property because it had pecuniary value, was transferable and arose at the time the estate was created. State law also allowed an heir to nullify the interest by making a disclaimer that related back to the creation of the interest. However, once state law creates a property interest, federal law governs the application of tax liens. Federal law defines "property subject to liens" in the broadest possible terms, and Code Sec. 6334 does not exempt disclaimed property from liens. Thus, the liens attached to the interest immediately upon the creation of the estate, and they were unaffected by taxpayer's subsequent disclaimer.

Syllabus

In 1994, Irma Drye died intestate, leaving a $233,000 estate in Pulaski County , Arkansas . Petitioner Rohn Drye, her son, was sole heir to the estate under Arkansas law. Drye was insolvent at the time of his mother's death and owed the Federal Government some $325,000 on unpaid tax assessments. The Internal Revenue Service (IRS) had valid tax liens against all of Drye's "property and rights to property" pursuant to 26 U.S.C. §6321. Drye petitioned the Pulaski County Probate Court for appointment as administrator of his mother's estate and was so appointed. Several months after his mother's death, Drye resigned as administrator after filing in the Probate Court and county land records a written disclaimer of all interests in the estate. Under Arkansas law, such a disclaimer creates the legal fiction that the disclaimant predeceased the decedent, consequently, the disclaimant's share of the estate passes to the person next in line to receive that share. The disavowing heir's creditors, Arkansas law provides, may not reach property thus disclaimed. Here, Drye's disclaimer caused the estate to pass to his daughter, Theresa Drye, who succeeded her father as administrator and promptly established the Drye Family 1995 Trust (Trust). The Probate Court declared Drye's disclaimer valid and accordingly ordered final distribution of the estate to Theresa, who then used the estate's proceeds to fund the Trust, of which she and, during their lifetimes, her parents are the beneficiaries. Under the Trust's terms, distributions are at the discretion of the trustee, Drye's counsel, and may be made only for the health, maintenance, and support of the beneficiaries. The Trust is spendthrift, and under state law, its assets are therefore shielded from creditors seeking to satisfy the debts of the Trust's beneficiaries. After Drye revealed to the IRS his beneficial interest in the Trust, the IRS filed with the county a notice of federal tax lien against the Trust as Drye's nominee, served a notice of levy on accounts held in the Trust's name by an investment bank, and notified the Trust of the levy. The Trust filed a wrongful levy action against the United States in the United States District Court for the Eastern District of Arkansas. The Government counterclaimed against the Trust, the trustee, and the trust beneficiaries, seeking the reduce to judgment the tax assessments against Drye, confirm its right to seize the Trust's assets in collection of those debts, foreclose on its liens, and sell the Trust property. On cross-motions for summary judgment, the District Court ruled in the Government's favor. The Court of Appeals for the Eighth Circuit affirmed, reading this Court's precedents to convey that state law determines whether a given set of circumstances creates a right or interest, but federal law dictates whether that right or interest constitutes "property" or the "right[t] to property" under §6321.

Held: Drye's disclaimer did not defeat the federal tax liens. The Internal Revenue 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 §6321. Once it has been determined that state law creates sufficient interests in the taxpayer to satisfy the requirements of the federal tax lien provision, state law is inoperative to prevent the attachment of the federal liens. United States v. Bess [58-2 USTC ¶9595], 357 U.S. 51, 56-57, Pp. 5-11.

(a) To satisfy a tax deficiency, the Government may impose a lien on any "property" or "rights to property" belonging to the taxpayer. §§6321, 6331(a). When Congress so broadly uses the term "property" this Court recognizes that the Legislature aims to reach every species of right or interest protected by law and having an exchangeable value. E.g., Jewett v. Commissioner [82-1 USTC ¶13,453], 455 U.S. 305, 309. Section 6334(a), which lists items exempt from levy, is corroborative. Section 6334(a)'s list is rendered exclusive by §6334(c), which provides that no other "property or rights to property shall be exempt." Inheritances or devises disclaimed under state law are not included in §6334(a)'s catalog of exempt property. See, e.g., Bess [58-2 USTC ¶9595], 357 U.S. , at 57. The absence of any recognition of disclaimers in §§6321, 6322, 6331(a), and 6334(a) and (c), the relevant tax collection provisions, contrasts with §2518(a), which renders qualifying state-law disclaimers "with respect to any interest in property" effective for federal wealth-transfer tax purposes and for those purposes only. Although this Court's decisions in point have not been phrased so meticulously as to preclude the argument that state law is the proper guide to the critical determination whether Drye's interest constituted "property" or "rights to property" under §6321, the Court is satisfied that the Code and interpretive case law place under federal, not state, control the ultimate issue whether a taxpayer has a beneficial interest in any property subject to levy for unpaid federal taxes. Pp. 5-7.

(b) The question whether a state-law right constitutes "property" or "rights to property" under §6321 is a matter of federal law. United States v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 727. This Court looks initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer's state-delineated rights qualify as "property" or "rights to property" within the compass of the federal tax lien legislation. Cf. Morgan v. Commissioner [40-1 USTC ¶9210], 309 U.S. 78, 80. Just as exempt status under state law does not bind the federal collector, United States v. Mitchell [71-1 USTC ¶9451], 403 U.S. 190, 204, so federal tax law is not struck blind by a disclaimer, United States v. Irvine [94-1 USTC ¶60,163], 511 U.S. 224, 240, Pp. 7-9.

(c) The Eighth Circuit, with fidelity to the relevant Code provisions and this Court's case law, determined first what rights state law accorded Drye in his mother's estate. The Court of Appeals observed that under Arkansas law Drye had, at his mother's death, a valuable, transferable, legally protected right to the property at issue, and noted, for example, that a prospective heir may effectively assign his expectancy in an estate under Arkansas law, and the assignment will be enforced when the expectancy ripens into a present estate. Drye emphasizes his undoubted right under Arkansas law to disclaim the inheritance, a right that is indeed personal and not marketable. But Arkansas law primarily gave him a right of considerable value--the right either to inherit or to channel the inheritance to a close family member (the next lineal descendant). That right simply cannot be written off as a mere personal right to accept or reject a gift. In pressing the analogy to a rejected gift, Drye overlooks this crucial distinction. A donee who declines an inter vivos gift restores the status quo ante, leaving the donor to do with the gift what she will. The disclaiming heir or devisee, in contrast, does not restore the status quo, for the decedent cannot be revived. Thus the heir inevitably exercises dominion over the property. He determines who will receive the property--himself if he does not disclaim, a known other if he does. This power to channel the estate's assets warrants the conclusion that Drye held "property" or a "righ[t] to property" subject to the Government's liens under §6321. Pp. 9-11.

[98-2 USTC ¶50,651], 152 F. 3d 892, affirmed.

Justice GINSBURG

delivered the opinion of the Court.

This case concerns the respective provinces of state and federal law in determining what is property for purposes of federal tax lien legislation. At the time of his mother's death, petitioner Rohn F. Drye, Jr., was insolvent and owed the Federal Government some $325,000 on unpaid tax assessments for which notices of federal tax liens had been filed. His mother died intestate, leaving an estate with a total value of approximately $233,000 to which he was sole heir. After the passage of several months, Drye disclaimed his interest in his mother's estate, which then passed by operation of state law to his daughter. This case presents the question whether Drye's interest as heir to his mother's estate constituted "property" or a "righ[t] to property" to which the federal tax liens attached under 26 U. S. C. §6321, despite Drye's exercise of the prerogative state law accorded him to disclaim the interest retroactively.

We hold that the disclaimer did not defeat the federal tax liens. The Internal Revenue Code's prescriptions are most sensibly read to look to state law for delineation of the taxpayer's rights or interests, but to leave to federal law the determination whether those rights or interests constitute "property" or "rights to property" within the meaning of §6321. "[O]nce it has been determined that state law creates sufficient interests in the [taxpayer] to satisfy the requirements of [the federal tax lien provision], state law is inoperative to prevent the attachment of liens created by federal statutes in favor of the United States." United States v. Bess [58-2 USTC ¶9595], 357 U.S. 51, 56-57 (1958).

I.

A.

The relevant facts are not in dispute. On August 3, 1994 , Irma Deliah Drye died intestate, leaving an estate worth approximately $233,000, of which $158,000 was personalty and $75,000 was realty located in Pulaski County , Arkansas . Petitioner Rohn F. Drye, Jr., her son, was sole heir to the estate under Arkansas law. See Ark. Code Ann. §28-9-214 (1987) (intestate interest passes "[f]irst, to the children of the intestate"). On the date of his mother's death, Drye was insolvent and owed the Government approximately $325,000, representing assessments for tax deficiencies in years 1988, 1989, and 1990. The Internal Revenue Service (IRS or Service) had made assessments against Drye in November 1990 and May 1991 and had valid tax liens against all of Drye's "property and rights to property" pursuant to 26 U. S. C. §6321.

Drye petitioned the Pulaski County Probate Court for appointment as administrator of his mother's estate and was so appointed on August 17, 1994 . Almost six months later, on February 4, 1995 , Drye filed in the Probate Court and land records of Pulaski County a written disclaimer of all interests in his mother's estate. Two days later, Drye resigned as administrator of the estate.

Under Arkansas law, an heir may disavow his inheritance by filing a written disclaimer no later than nine months after the death of the decedent. Ark. Code Ann. §§28-2-101, 28-2-107 (1987). The disclaimer creates the legal fiction that the disclaimant predeceased the decedent; consequently, the disclaimant's share of the estate passes to the person next in line to receive that share. The disavowing heir's creditors, Arkansas law provides, may not reach property thus disclaimed. §28-2-108. In the case at hand, Drye's disclaimer caused the estate to pass to his daughter, Theresa Drye, who succeeded her father as administrator and promptly established the Drye Family 1995 Trust (Trust).

On March 10, 1995 , the Probate Court declared valid Drye's disclaimer of all interest in his mother's estate and accordingly ordered final distribution of the estate to Theresa Drye. Theresa Drye then used the estate's proceeds to fund the Trust, of which she and, during their lifetimes, her parents are the beneficiaries. Under the Trust's terms, distributions are at the discretion of the trustee, Drye's counsel Daniel M. Traylor, and may be made only for the health, maintenance, and support of the beneficiaries. The Trust is spendthrift, and under state law, its assets are therefore shielded from creditors seeking to satisfy the debts of the Trust's beneficiaries.

Also in 1995, the IRS and Drye began negotiations regarding Drye's tax liabilities. During the course of the negotiations, Drye revealed to the Service his beneficial interest in the Trust. Thereafter, on April 11, 1996 , the IRS filed with the Pulaski County Circuit Clerk and Recorder a notice of federal tax lien against the Trust as Drye's nominee. The Service also served a notice of levy on accounts held in the Trust's name by an investment bank and notified the Trust of the levy.

B.

On May 1, 1996 , invoking 26 U. S. C. §7426(a)(1), the Trust filed a wrongful levy action against the United States in the United States District Court for the Eastern District of Arkansas. The Government counterclaimed against the Trust, the trustee, and the trust beneficiaries, seeking to reduce to judgment the tax assessments against Drye, confirm its right to seize the Trust's assets in collection of those debts, foreclose on its liens, and sell the Trust property. On cross-motions for summary judgment, the District Court ruled in the Government's favor.

The United States Court of Appeals for the Eighth Circuit affirmed the District Court's judgment. Drye Family 1995 Trust v. United States [98-2 USTC ¶50,651], 152 F. 3d 892 (1998). The Court of Appeals understood our precedents to convey that "state law determines whether a given set of circumstances creates a right or interest; federal law then dictates whether that right or interest constitutes 'property' or the 'right to property' under §6321." Id. , at 898.

We granted certiorari, 526 U.S.-- (1999), to resolve a conflict between the Eighth Circuit's holding and decisions of the Fifth and Ninth Circuits. ¹ We now affirm.

II.

Under the relevant provisions of the Internal Revenue Code, to satisfy a tax deficiency, the Government may impose a lien on any "property" or "rights to property" belonging to the taxpayer. Section 6321 provides: "If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount . . . shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person." 26 U. S. C. §6321. A complementary provision, §6331(a), states:

"If any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary to collect such tax . . . by levy upon all property and rights to property (except such property as is exempt under section 6334) belonging to such person or on which there is a lien provided in this chapter for the payment of such tax." ²

The language in §§6321 and 6331(a), this Court has observed, "is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have." United States v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 719-720 (1985) (citing 4 B. Bittker, Federal Taxation of Income, Estates and Gifts ¶111.5.4, p. 111-100 (1981)); see also Glass City Bank v. United States [45-2 USTC ¶9449], 326 U.S. 265, 267 (1945) ("Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes."). When Congress so broadly uses the term "property," we recognize, as we did in the context of the gift tax, that the Legislature aims to reach " 'every species of right or interest protected by law and having an exchangeable value.' " Jewett v. Commissioner [82-1 USTC ¶13,453], 455 U.S. 305, 309 (1982) (quoting S. Rep. No. 665, 72d Cong., 1st Sess., 39 (1932); H. R. Rep. No. 708, 72d Cong., 1st Sess., 27 (1932)).

Section 6334(a) of the Code is corroborative. That provision lists property exempt from levy. The list includes 13 categories of items; among the enumerated exemptions are certain items necessary to clothe and care for one's family, unemployment compensation, and workers' compensation benefits. §§6334(a)(1), (2), (4), (7). The enumeration contained in §6334(a), Congress directed, is exclusive: "Notwithstanding any other law of the United States . . ., no property or rights to property shall be exempt from levy other than the property specifically made exempt by subsection (a)." §6334(c). Inheritances or devises disclaimed under state law are not included in §6334(a)'s catalog of property exempt from levy. See Bess [58-2 USTC ¶9595], 357 U.S., at 57 ("The fact that . . . Congress provided specific exemptions from distraint is evidence that Congress did not intend to recognize further exemptions which would prevent attachment of [federal tax] liens[.]"); United States v. Mitchell [71-1 USTC ¶9451], 403 U.S. 190, 205 (1971) ("Th[e] language [of §6334] is specific and it is clear and there is no room in it for automatic exemption of property that happens to be exempt from state levy under state law."). The absence of any recognition of disclaimers in §§6321, 6322, 6331(a), and 6334(a) and (c), the relevant tax collection provisions, contrasts with §2518(a) of the Code, which renders qualifying state-law disclaimers "with respect to any interest in property" effective for federal wealth-transfer tax purposes and for those purposes only. ³

Drye nevertheless refers to cases indicating that state law is the proper guide to the critical determination whether his interest in his mother's estate constituted "property" or "rights to property" under §6321. His position draws support from two recent appellate opinions: Leggett v. United States [97-2 USTC ¶50,635; 97-2 USTC ¶60,286], 120 F. 3d 592, 597 (CA5 1997) ("Section 6321 adopts the state's definition of property interest."); and Mapes v. United States, 15 F. 3d 138, 140 (CA9 1994) ("For the answer to th[e] question [whether taxpayer had the requisite interest in property], we must look to state law, not federal law."). Although our decisions in point have not been phrased so meticulously as to preclude Drye's argument, ⁴ we are satisfied that the Code and interpretive case law place under federal, not state, control the ultimate issue whether a taxpayer has a beneficial interest in any property subject to levy for unpaid federal taxes.

III.

As restated in National Bank of Commerce: "The question whether a state-law right constitutes 'property' or 'rights to property' is a matter of federal law." [85-2 USTC ¶9482], 472 U.S. , at 727. We look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer's state-delineated rights qualify as "property" or "rights to property" within the compass of the federal tax lien legislation. Cf. Morgan v. Commissioner [40-1 USTC ¶9210], 309 U.S. 78, 80 (1940) ("State law creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed.").

In line with this division of competence, we held that a taxpayer's right under state law to withdraw the whole of the proceeds from a joint bank account constitutes "property" or the "righ[t] to property" subject to levy for unpaid federal taxes, although state law would not allow ordinary creditors similarly to deplete the account. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. , at 723-727. And we earlier held that a taxpayer's right under a life insurance policy to compel his insurer to pay him the cash surrender value qualifies as "property" or a "righ[t] to property" subject to attachment for unpaid federal taxes, although state law shielded the cash surrender value from creditors' liens. Bess [58-2 USTC ¶9595], 357 U.S. , at 56-57. ⁵ By contrast, we also concluded, again as a matter of federal law, that no federal tax lien could attach to policy proceeds unavailable to the insured in his lifetime. Id. , at 55-56 ("It would be anomalous to view as 'property' subject to lien proceeds never within the insured's reach to enjoy."). ⁶

Just as "exempt status under state law does not bind the federal collector," Mitchell [71-1 USTC ¶9451], 403 U.S. , at 204, so federal tax law "is not struck blind by a disclaimer," United States v. Irvine [94-1 USTC ¶60,163], 511 U.S. 224, 240 (1994). Thus, in Mitchell, the Court held that, although a wife's renunciation of a marital interest was treated as retroactive under state law, that state-law disclaimer did not determine the wife's liability for federal tax on her share of the community income realized before the renunciation. See [71-1 USTC ¶9451], 403 U.S. , at 204 (right to renounce does not indicate that taxpayer never had a right to property).

IV.

The Eighth Circuit, with fidelity to the relevant Code provisions and our case law, determined first what rights state law accorded Drye in his mother's estate. It is beyond debate, the Court of Appeals observed, that under Arkansas law Drye had, at his mother's death, a valuable, transferable, legally protected right to the property at issue. See [98-2 USTC ¶50,651], 152 F. 3d, at 895 (although Code does not define "property" or "rights to property," appellate courts read those terms to encompass "state-law rights or interests that have pecuniary value and are transferable"). The court noted, for example, that a prospective heir may effectively assign his expectancy in an estate under Arkansas law, and the assignment will be enforced when the expectancy ripens into a present estate. See id., at 895-896 (citing several Arkansas Supreme Court decisions, including: Clark v. Rutherford, 227 Ark. 270, 270-271, 298 S. W. 2d 327, 330 (1957); Bradley Lumber Co. of Ark. v. Burbridge, 213 Ark. 165, 172, 210 S. W. 2d 284, 288 (1948); Leggett v. Martin, 203 Ark. 88, 94, 156 S. W. 2d 71, 74-75 (1941)). ⁷

Drye emphasizes his undoubted right under Arkansas law to disclaim the inheritance, see Ark. Code Ann. §28-2-101 (1987), a right that is indeed personal and not marketable. See Brief for Petitioners 13 (right to disclaim is not transferable and has no pecuniary value). But Arkansas law primarily gave Drye a right of considerable value--the right either to inherit or to channel the inheritance to a close family member (the next lineal descendant). That right simply cannot be written off as a mere "personal right . . . to accept or reject [a] gift." Brief for Petitioners 13.

In pressing the analogy to a rejected gift, Drye overlooks this crucial distinction. A donee who declines an inter vivos gift generally restores the status quo ante, leaving the donor to do with the gift what she will. The disclaiming heir or devisee, in contrast, does not restore the status quo, for the decedent cannot be revived. Thus the heir inevitably exercises dominion over the property. He determines who will receive the property--himself if he does not disclaim, a known other if he does. See Hirsch, The Problem of the Insolvent Heir, 74 Cornell L. Rev. 587, 607-608 (1989). This power to channel the estate's assets warrants the conclusion that Drye held "property" or a "righ[t] to property" subject to the Government's liens.

***

In sum, in determining whether a federal taxpayer's state-law rights constitute "property" or "rights to property," "[t]he important consideration is the breadth of the control the [taxpayer] could exercise over the property." Morgan [40-1 USTC ¶9210], 309 U.S. , at 83. Drye had the unqualified right to receive the entire value of his mother's estate (less administrative expenses), see National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. , at 725 (confirming that unqualified "right to receive property is itself a property right" subject to the tax collector's levy), or to channel that value to his daughter. The control rein he held under state law, we hold, rendered the inheritance "property" or "rights to property" belonging to him within the meaning of §6321, and hence subject to the federal tax liens that sparked this controversy.

For the reasons stated, the judgment of the Court of Appeals for the Eighth Circuit is

Affirmed.

¹ In the view of those courts, state law holds sway. Under their approach, in a State adhering to an acceptance-rejection theory, under which a property interest vests only when the beneficiary accepts the inheritance or devise, the disclaiming taxpayer prevails and the federal liens do not attach. If, instead, the State holds to a transfer theory, under which the property is deemed to vest in the beneficiary immediately upon the death of the testator or intestate, the taxpayer loses and the federal lien runs with the property. See Leggett v. United States [97-2 USTC ¶50,635; 97-2 USTC ¶60,286], 120 F. 3d 592, 594 (CA5 1997); Mapes v. United States, 15 F. 3d 138, 140 (CA9 1994); accord, United States v. Davidson [99-2 USTC ¶50,696], 55 F. Supp. 2d 1152, 1155 ( Colo. 1999). Drye maintains that Arkansas adheres to the acceptance-rejection theory.

² The Code further provides:

"Unless another date is specifically fixed by law, the lien imposed by section 6321 shall arise at the time the assessment is made and shall continue until the liability for the amount so assessed (or a judgment against the taxpayer arising out of such liability) is satisfied or becomes unenforceable by reason of lapse of time." 26 U. S. C. §6322.

³ See Pennell, Recent Wealth Transfer Tax Developments, in Sophisticated Estate Planning Techniques 69, 117-118 (ALI-ABA Continuing Legal Ed. 1997) ("The fact that a qualified disclaimer by an estate beneficiary is deemed to relate back to the decedent's death for state property law or federal gift tax purposes is not sufficient to preclude a federal tax lien for the disclaimant's delinquent taxes from attaching to the disclaimed property as of the moment of the decedent's death. . . . [T]he qualified disclaimer provision in §2518 only applies for purposes of Subtitle B and the lien provisions are in Subtitle F.").

⁴ See, e.g., United States v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 722 (1985) ("[T]he federal statute 'creates no property rights but merely attaches consequences, federally defined, to rights created under state law.' ") (quoting United States v. Bess [58-2 USTC ¶9595], 357 U.S. 51, 55 (1958)).

⁵ Accord, Bank One Ohio Trust Co. v. United States [96-1 USTC ¶50,188], 80 F. 3d 173, 176 (CA6 1996) ("Federal law did not create [the taxpayer's] equitable income interest [in a spendthrift trust], but federal law must be applied in determining whether the interest constitutes 'property' for purposes of §6321."); 21 West Lancaster Corp. v. Main Line Restaurant, Inc. [86-2 USTC ¶9516], 790 F. 2d 354, 357-358 (CA3 1986) (although a liquor license did not constitute "property" and could not be reached by creditors under state law, it was nevertheless "property" subject to federal tax lien); W. Plumb, Federal Tax Liens 27 (3d ed. 1972) ("[I]t is not material that the economic benefit to which the [taxpayer's local law property] right pertains is not characterized as 'property' by local law.").

⁶ Compatibly, in Aquilino v. United States [60-2 USTC ¶9538], 363 U.S. 509 (1960), we held that courts should look first to state law to determine " 'the nature of the legal interest' " a taxpayer has in the property the Government seeks to reach under its tax lien. Id. , at 513 (quoting Morgan v. Commissioner [40-1 USTC ¶9210], 309 U.S. 78, 82 (1940)). We then reaffirmed that federal law determines whether the taxpayer's interests are sufficient to constitute "property" or "rights to property" subject to the Government's lien. Id. , at 513-514. We remanded in Aquilino for a determination whether the contractor-taxpayer held any beneficial interest, as opposed to "bare legal title," in the funds at issue. Id. , at 515-516; see also Note, Property Subject to the Federal Tax Lien, 77 Harv. L. Rev. 1485, 1491 (1964) ("Aquilino supports the view that the Court has chosen to apply a federal test of classification, for the contractor concededly had legal title to the funds and yet in remanding the Court indicated that this state-created incident of ownership was not a sufficient 'right to property' in the contract proceeds to allow the tax lien to attach. In this sense Aquilino follows Bess in requiring that the taxpayer must have a beneficial interest in any property subject to the lien." (footnote omitted)).

⁷ In recognizing that state-law rights that have pecuniary value and are transferable fall within §6321, we do not mean to suggest that transferability is essential to the existence of "property" or "rights to property" under that section. For example, although we do not here decide the matter, we note that an interest in a spendthrift trust has been held to constitute " 'property' for purposes of §6321" even though the beneficiary may not transfer that interest to third parties. See Bank One [96-1 USTC ¶50,188], 80 F. 3d, at 176. Nor do we mean to suggest that an expectancy that has pecuniary value and is transferable under state law would fall within §6321 prior to the time it ripens into a present estate.

 

 

 

[79-1 USTC ¶9181]Allstate Insurance Company, Plaintiff v. W. D. "Donnie" Walker; United States of America; Internal Revenue Service; Ford Motor Credit Company; Chattanooga Federal Savings & Loan Association; Charles R. Ables; First Bank of Marion County, Tennessee; and Small Business Administration, Defendants

U. S. District Court, East. Dist. Tenn. , So. Div., CIV-1-78-72, 12/18/78

[Code Sec. 6323]

Lien for taxes: Priority of federal lien: Fire insurance proceeds.--A prior IRS tax assessment claim took priority over other creditors, all of whom were competing claimants for the proceeds of a fire insurance policy. The priority extended to the portion of the interpled funds attributable to both the personalty and realty losses respectively. Because the federal tax lien was filed first, the court ordered that disbursement of the proceeds be paid in satisfaction of the tax lien plus accrued interest from the date of the commencement of the trial to the end of December, 1978..

John T. Rice, Luther, Anderson , Cleary, Luhowiak & Cooper, 19th Flr. Commerce Union Tower , Chattanooga , Tenn. 37450 , for plaintiff. David E. Nelson, Jr., Wagner, Nelson & Weeks, 1418 First Tennessee Bldg., Chattanooga, Tenn. 37402, J. V. Crockett, Department of Justice, Washington, D. C. 20530, Horace L. Smith, Jr., 1114 First Tennessee Bldg., Chattanooga, Tenn. 37402, J. Harvey Cameron, Kelly, Leiderman, Cameron, Kelly & Graham, P. O. Box 488, Jasper, Tenn. 37347, John C. Cook, Assistant United States Attorney, Chattanooga, Tenn. 37402, William M. Ables, P. O. Box 270, South Pittsburg, Tenn. 37380, for defendants.

Findings of Fact and Conclusions of Law

WILSON, District Judge:

This is an interpleader action to determine the rights and priorities of the parties to the lawsuit in the proceeds of a certain fire insurance policy. The case was tried before the Court sitting without a jury. The Court now enters the following findings of fact and conclusions of law upon the stipulations of the parties as set forth in the final pretrial order, the record made upon the trial of the case and the orders heretofore entered in the case.

Findings of Fact

(1) This is an interpleader action wherein the original plaintiff, Allstate Insurance Company, paid into the registry of the court upon the filing of the lawsuit the sum of $112,500.00, representing the proceeds of a fire insurance policy. The parties defendant making adverse claims are as follows: The defendant Walker is a citizen and resident of Marion County, Tennessee. The defendants, the Internal Revenue Service and the Small Business Administration, are agencies of the United States . The defendant, the Ford Motor Credit Company, is a corporation organized under the laws of Delaware and having its principal place of business in the State of Michigan . The defendant, the Chattanooga Federal Savings and Loan Association, is a corporation chartered under the laws of the United States and having its principal place of business in Chattanooga , Tennessee . Charles R. Ables is a citizen and resident of Marion County, Tennessee. The First Bank of Marion County, Tennessee is a banking corporation organized under the laws of Tennessee and having its principal place of business in Marion County, Tennessee.

(2) Under date of October 31, 1977 , the plaintiff, Allstate Insurance Company, issued its homeowners insurance policy to the defendant, W. D. Walker, as named insured, insuring a residence belonging to the said Walker and located on Sweeden Cove Road, South Pittsburg, Tennessee, against fire and other loss. Under date of December 18, 1977 , the insured residence was destroyed by fire. Simultaneously with the filing of the lawsuit upon March 29, 1978 , Allstate Insurance Company deposited the sum of $112,500.00 in the registry of the court, representing the full proceeds due under its policy of insurance with regard to the abovestated fire loss. Of the total sum of $112,500.00 paid into court, the sum of $75,000.00 represents the proceeds of the insured loss to the residence, or loss of realty, and $37,500.00 represents the proceeds of the insured loss to the contents, or loss of personalty.

(3) Subsequent to the filing of this lawsuit an order agreed to by all parties in interest was entered directing the payment of the sum of $892.44 unto the law firm of Luther, Anderson, Cleary, Luhowiak & Cooper for initiating this interpleader action as counsel for Allstate Insurance Company, discharging all claims on the part of any party defendant against Allstate Insurance Company and dismissing Allstate Insurance Company as a party to the lawsuit (Court File #16). The sum of $892.44 paid to legal counsel for Allstate Insurance Company will be charged against that portion of the interpled funds representing the $37,500.00 proceeds from the insured loss to personalty.

(4) At the time of the filing of this lawsuit the defendant, Chattanooga Federal Savings and Loan Association, was asserting a claim against the interpled fire insurance proceeds as the holder of a first mortgage upon the insured residence and as having been named as such in the mortgage loss clause of the subject insurance policy. Subsequent to the filing of this lawsuit an order agreed to by all parties in interest was entered directing the payment unto Chattanooga Federal Savings and Loan Association from the interpled funds of the sum of $13,060.21 in full satisfaction of its claims and dismissing the said defendant as a party to the lawsuit (Court File #17). Chattanooga Federal Savings and Loan being a mortgage claimant against the realty, the sum of $13,060.21 paid to it will be charged against that portion of the interpled funds representing the $75,000.00 proceeds from the insured loss to the realty.

(5) Since the trial of this lawsuit an order agreed to by all parties in interest has entered directing the payment to the Small Business Administration from the interpled funds of the sum of $5,363.70 in full satisfaction of its claims and directing that a release of its second mortgage upon the insured property be entered (Court File $25). The sum paid unto the Small Business Administration is to be charged against that portion of the interpled funds representing the $75,000.00 proceeds from the insured loss to the realty.

(6) There remains for decision by the Court the claims of five defendants, W. D. Walker, the Internal Revenue Service, Ford Motor Credit Company, Charles R. Ables and the First Bank of Marion County . Each of the foregoing claimants asserts priority to a portion or all of the remaining interpled funds. Pending the resolution of the issues in this lawsuit the parties have by an agreed order deposited the interpled funds in interest bearing accounts (Court File #21).

(7) Under date of June 7, 1976 the United States of America, Internal Revenue Service, assessed taxes against the defendant, W. D. Walker, in the sum of $22,804.40, the taxes being assessed pursuant to 26 U. S. C. §6672. A notice of federal tax lien with regard to these taxes was duly filed in the Marion County Register's Office, Jasper, Tennessee , upon August 10, 1976 . The fact of filing the federal tax lien was properly indexed as required by law. These taxes remain due and unpaid in the amount of the original assessment and the notice of lien filed thereon has at all times since the date of filing remained of record and unsatisfied. As of the date of the trial (November 17, 1978) lien fees in the sum of $6.00 and interest in the sum of $3,723.28 had accrued upon the taxes, rendering a balance due upon the tax account as of that date in the total sum of $26,533.68. Interest continues to accrue upon the tax account at the rate of $3.75 per day from and after November 17, 1978 .

(8) Under date of October 13, 1977 the defendant, Ford Motor Credit Company, took final judgments against the co-defendant, W. D. Walker, in the total sum of $284,587.43. The judgments were taken in this court in the cases of Ford Motor Credit Company v. W. D. Walker, Civil Action No. 1-76-266, wherein a judgment in the sum of $89,524.14 was entered, and Ford Motor Credit Company v. W. D. Walker, Civil Action No. 1-76-267, wherein a judgment in the sum of $195,063.29 was entered. The judgments, together with interest accruing from the date of entry at the rate of 8% per annum, remain due and unpaid. Under date of October 25, 1977 the judgments were duly recorded in the Register's Office of Marion County, Tennessee as judgment liens against the property and assets of W. D. Walker. Under date of March 21, 1978 executions were issued in aid of collection in the above referred to cases and the executions were thereafter served upon the original plaintiff herein, Allstate Insurance Company, resulting in this interpleader action having been filed upon March 29, 1978 .

(9) Under date of January 18, 1974 the defendant, W. D. Walker, executed a note payable to Charles R. Ables, a co-defendant herein, the note being in the principal sum of $65,000.00 and being payable with interest at 6% per annum upon January 18, 1984 (Exhibit No. 9). The note is secured by deed of trust upon the residential property that is the subject of the fire loss here involved. The deed of trust recites that it is a third lien upon the property (presumably being subject to the prior security interest of the Chattanooga Federal Savings and Loan Association and the Small Business Administration). Notice of this note and trust deed having been given unto the plaintiff, Allstate Insurance Company, the plaintiff issued its policy rider on January 3, 1978 noticing Charles R. Ables as a loss payee under the mortgage clause of the policy.

The Court finds the facts with regard to the execution by the defendant Walker of the aforesaid note to the defendant Ables to be as follows. Charles R. Ables was first admitted to practice law in 1965 and at that time he began to practice law in South Pittsburg , Tennessee in association with his brother, Jerome Ables, who was a close personal friend of Walker . According to the testimony of Walker and of Charles Ables, they entered into an oral agreement in 1965 whereby Walker would pay Ables a retainer of $2400.00 a year for legal services to be rendered. The retainer was raised to $3600.00 a year in 1971 and to $4000.00 a year in 1974. No actual payments were ever made upon the oral retainer agreement. Rather, the $65,000.00 note executed in 1974 is represented as being an accumulation of past due annual retainers plus anticipated further annual retainers to the year 1984.

The evidence appears to preponderate in favor of the following facts with reference to the Ables note and his claim based thereon. The actual legal services rendered by Ables in return for the retainer over the past 12 years appear to have been minimal. Rather, it appears that Walker has been represented by legal counsel other than Ables upon most occasions when he had need of legal counsel, including most significant litigation in which he was involved during the period the retainer is represented as having been in effect. In fact, Walker , representing himself to be indigent, moved this Court to appoint counsel for him in the Ford Motor Credit Corporation litigation referred to in paragraph (8) above. (See Exhibit No. 14) As previously noted, no payments were ever made on the Ables retainer prior to the execution of the note and none have since been made. Finally, it would appear to be significant that the note and trust deed were executed by Walker less than a month prior to the filing of voluntary bankruptcy proceedings on the part of two automobile agencies in which he was a principal stockholder and officer and for which he had personally guaranteed the corporate debts to the Ford Motor Credit Corporation.

(10) Under date of April 12, 1976 the defendant, First Bank of Marion County , took a judgment against the defendant Walker in the Circuit Court for Marion County, Tennessee. The judgment became final upon March 31, 1978 when it was affirmed on appeal in the sum of $5,500.00 plus interest at 8% thereafter. This judgment was duly recorded in the Register's Office of Marion County, Tennessee upon April 17, 1978 .

(11) Under date of October 24, 1978 the defendant, W. D. Walker, executed a sworn document entitled "Claim for Exemptions" in which he asserted "that under the above decided code section (i.e., TCA §26-201 et seq.) he herewith claims as exempt the sum of $2,500.00 of the proceeds of the Allstate Insurance policy . . ." covering the personalty loss in the fire. (Exhibit No. 1) This claim appears to have been first filed with the Court (as an exhibit) on November 17, 1978 , the date of the trial.

Conclusions of Law

(1) The Court has jurisdiction of this interpleader action and of the parties pursuant to 28 U. S. C. §1335.

(2) As between the remaining competing claimants, W. D. Walker, United States of America-Internal Revenue Service, Ford Motor Credit Company, Charles R. Ables, and the First Bank of Marion County, the United States Internal Revenue Service tax assessment claim against W. D. Walker in the sum of $26,533.68, plus interest at the rate of $3.75 per day from and after November 17, 1978 to the date of the final judgment entered upon these findings of fact and conclusions of law, is entitled to take priority over the claims of each of the remaining claimants. This priority will extend both to that portion of the interpled funds attributable to the realty fire loss and that portion of the interpled funds attributable to the personalty fire loss.

As regards the claim of W. D. Walker to share in the interpled funds to the extent of a $2,500.00 personalty exemption asserted by him pursuant to state law (26 T. C. A. §201 et seq.), such state exemption laws are ineffective as against a tax claim asserted by the United States pursuant to 26 U. S. C. §6323. As provided in Treasury Regulation 301.6334-1(c) (26 C. F. R.)

". . . property exempt from execution under state personal or homestead exemption laws is, nevertheless, subject to levy by the United States for collection of its taxes."

As regards the claim of Ford Motor Credit Company to share in the interpled funds to the extent of its judgments against the defendant, W. D. Walker, such judgments were not entered until October 13, 1977 , were not recorded until October 25, 1977 , and execution was not levied thereon until March 21, 1978 , all being dates subsequent to the filing of the Internal Revenue Service tax assessment lien upon August 10, 1976 . The tax assessment lien of the Internal Revenue Service being first in time is also first in right and is accordingly entitled to take priority over the judgment liens of the Ford Motor Credit Company. United States v. City of New Britton [54-1 USTC ¶9191], 347 U. S. 81 (1954).

As regards the claim of Charles R. Ables to share in the interpled funds to the extent of any current balance claimed to be due upon the $65,000.00 note executed in his favor by the defendant Walker, the Court is of the opinion that the circumstances surrounding the execution of the note, including the lack of any fair consideration, the unusually long credit given the debtor, the delay in execution of the note until a time immediately prior to the filing of bankruptcy on the part of corporations in which Walker was a principal stockholder and officer and whose debts he had guaranteed, together with the evidence of insolvency on the part of Walker at the time of the execution of the note, rendered the note and trust deed given as security therefor fraudulent as to each of the parties claimant herein other than the defendant Walker. See Uniform Fraudulent Conveyances Act, T. C. A. §§ 26-308 through 321.

As regards the claim of the First Bank of Marion County to share in the interpled funds to the extent of its judgment against Walker, such judgment was not entered until March 31, 1978 and the judgment was not recorded until April 17, 1978 , both dates being subsequent to the filing of the Internal Revenue Service tax assessment lien upon August 10, 1976 . The tax assessment lien will accordingly take priority over the judgment lien of the First Bank of Marion County for the reasons heretofore stated as regards the judgment lien claims of the Ford Motor Credit Company.

The Court having concluded that the Internal Revenue Service tax assessment claim will take priority over the claims of each of the remaining claimants, the Internal Revenue Service claim will first be charged against and paid from any remaining portion of the interpled funds attributable to the personalty fire loss, with any balance of the claim being charged against and paid from the remaining portion of the interpled funds attributable to the realty fire loss.

(3) The judgment lien claims of the Ford Motor Credit Company in the total sum of $284,587.43 plus interest at 8% per annum from and after October 13, 1977 to the date of the final judgment entered upon these findings of fact and conclusions of law are entitled to take priority over the claims of the remaining defendants, W. D. Walker, Charles R. Ables, and First Bank of Marion County. The Ford Motor Credit Company judgment liens being prior in time to the liens of the First Bank of Marion County , they would for that reason take priority over the latter defendant's claims in accordance with the authority hereinabove cited. Likewise, for the reasons heretofore stated they will take priority over the claim of the defendant Ables. Finally, the judgment liens of the Ford Motor Credit Company would take priority over the exemption claim of the defendant Walker as executions upon the Ford Motor Credit Company judgments were issued and served some six months prior to Walker having filed his exemption claim. As provided in TCA §26-203 (effective May 5, 1978 ):

". . . A claim for exemption filed after the judgment has become final will have no effect as to an execution which is issued prior to the date the claim for exemption is filed, and as to such pre-existing execution the claim for exemption shall be deemed waived."

(4) Since the amount of the judgment lien claims of the Ford Motor Credit Company exceed the remaining interpled funds, it becomes unnecessary for the Court to adjudicate the priority rights as between the remaining parties defendant, W. D. Walker, Charles R. Ables, and First Bank of Marion County .

(5) Subject to correction to the extent of any interest that may have accumulated upon the interpled funds pursuant to an agreed order authorizing their deposit in an interest bearing account, the following will be the order and amount of disbursements to be made from the interpled funds pursuant to prior agreed orders and pursuant to these findings of fact and conclusions of law:

Interpled Funds (Less Accrued Interest).........       $112,500.00

Less Disbursements Heretofore Made:

To Luther Anderson, Cleary, Luhowiak & Cooper, Attorneys, for Legal

Services Rendered in Initiating Interpleader Action 

                 .................... $ 892.44

To 

Chattanooga

 Federal Savings & Loan Association as First Lien

Holder on Insured Property 

  ................................... $13,060.21

To Small Business Administration, an Agency of the 

United States

,

as Second Lien Holder on Insured Property ..............................        $ 5,363.70     -$ 19,316.35

Balance Remaining for Disbursement (Less Accrued Interest) .............                                         $ 93,183.65

Less Disbursement to be Made Pursuant to these Findings of Fact and

Conclusions of Law:

To United States of 

America

, Internal Revenue Service, Balance on Tax

Account, Including Accrued Interest to 
December 31, 1978
 

               ...............         $26,702.43

To Ford Motor Credit Company 

..........................             $66,481.22     $ 93,183.65

BALANCE..............................................     -0-

 

(6) The entry of a judgment upon these findings of fact and conclusions of law will await the redeposit in the registry of the court of the interpled funds, together with any accrued interest thereon. The accrued interest shall be added to the account of the Ford Motor Credit Company and disbursed accordingly. The Trustee heretofore appointed by the Court will redeposit the interpled funds and accumulated interest in the registry of the Court. Whereupon a judgment will enter in accordance with these findings of fact and conclusions of law.

 

 

 

 

[94-2 USTC ¶50,354] United States of America , Appellee v. Anthony Comparato, Individually and as the Administrator of the Estate of John Comparato, Mildred Comparato, Millicent Comparato, Diana Comparato Carlucci, Appellants

(CA-2), U.S. Court of Appeals, 2nd Circuit, 93-6237, 93-6293, 4/18/94 , 22 F3d 455, Affirming a District Court decision, 93-2 USTC ¶50,424

[Code Sec. 6321 ]

Lien for taxes: Settlement proceeds: Property rights: Renunciation.--The parents of a deceased child could not defeat IRS tax liens by renouncing their interest in escrow accounts representing settlement proceeds from malpractice actions relating to their son's death. Under state ( New York ) law, the parents acquired vested interests in the accounts at the time of their son's death. Once the IRS liens attached, they could not be displaced by subsequent state law renunciation of the parents' property rights to the accounts.

[Code Sec. 6334 ]

Levy and distraint: Vested interests: State law renunciation.--State ( New York ) law permitting renunciation of parents' interests in their deceased son's estate could not defeat an existing IRS lien on estate property. Once the parents had vested interests in escrow accounts holding the proceeds from malpractice actions relating to their son's death, federal law controlled whether the parents' interests were exempt from levy.

Zachary W. Carter, United States Attorney, Brooklyn, N.Y. 11201, Loretta C. Argrett, Assistant Attorney General, Gary R. Allen, Gilbert S. Rothenberg, Sara S. Holderness, Department of Justice, Washington, D.C. 20530, for appellee. Richard F. Thurston, Denver , Colo. , for appellants.

Before: TIMBERS, CARDAMONE, and KEARSE, Circuit Judges.

TIMBERS, Circuit Judge:

Appellants appeal from a summary judgment in favor of the government entered in the Eastern District of New York, Reena Raggi, District Judge. The court held that federal tax liens had attached to Anthony and Mildred Comparato's property interests in malpractice claims arising from their son's death. The court also held that Anthony and Mildred Comparato's renunciations of their interests in their son's estate did not defeat the federal liens because the liens attached prior to the attempted renunciations. Summary judgment was entered against Anthony and Mildred Comparato for their tax liabilities for the years 1974, 1975, 1976, and 1985.

Appellants contend that Anthony and Mildred Comparato's renunciations of their interests in their son's estate defeated the federal tax liens. They claim that, pursuant to New York law, their renunciations retroactively extinguished their interests in their son's estate.

We affirm.

I.

We summarize only those facts and prior proceedings believed necessary to an understanding of the issues raised on appeal.

The United States commenced this action to collect on tax assessments against Anthony and Mildred Comparato. Between 1985 and 1989, the Internal Revenue Service (IRS) assessed Anthony Comparato a total of $676,534.99 in taxes, interest, and penalties for the tax years 1974-1976 and 1981-1985. In 1989, the IRS assessed Mildred Comparato a total of $215,515.22 in taxes, interest, and penalties for the years 1974-1976 and 1981-1984.

Anthony and Mildred Comparato's principal asset is $650,000 held in escrow accounts pending the outcome of the litigation related to their tax obligations. This money represents the proceeds of the settlement of malpractice actions arising from the death of John Comparato--Anthony and Mildred Comparato's quadriplegic son who died intestate on March 30, 1984 . While John Comparato was still alive, a malpractice action which sought damages for pain and suffering was commenced in New York State Supreme Court, New York County . After John Comparato's death, the Queens County Surrogate's Court appointed Anthony Comparato as administrator of John's estate. As administrator, Anthony Comparato pursued the pain and suffering claim and commenced another action for wrongful death. Eventually, the pain and suffering claim was settled for $350,000. The wrongful death claim was settled for $500,000.

In 1989, Anthony Comparato petitioned the Surrogate's Court to approve the settlement and to permit payment of various expenses, including legal fees. He asked that the net proceeds be distributed equally between himself and his wife as John's statutory distributees. In August 1989, before the Surrogate's Court acted on this request, the IRS served notices of levy on Baron & Vesel, attorneys for the Comparato estate, citing tax liens against Anthony and Mildred Comparato. The Surrogate's Court entered an order permitting payment of $200,000 in attorney's fees, the remainder of the money ($650,000) to be deposited in eleven separate escrow accounts pending the outcome of Anthony and Mildred Comparato's challenge to the federal tax assessments.

On April 10, 1991 , Anthony and Mildred Comparato executed separate renunciations of their interests in John's estate pursuant to N.Y. Estates, Powers and Trusts Law, §2 -1.11 (McKinney 1981 & Supp. 1994). On September 23, 1991 , the Surrogate's Court permitted the renunciations to be filed, despite the fact that the renunciations had not been filed within the nine-month statutory period.

On July 21, 1992 , the Surrogate's Court permitted Diana and Millicent Comparato to intervene in the administration of their brother John's estate. Under New York law, they would succeed their parents as the statutory distributees of John. N.Y. Estates, Powers and Trusts Law, §4 -1.1(a)(5) ( McKinney Supp. 1994).

On July 15, 1992 , the government commenced this action which sought to reduce to judgment the tax liabilities of Anthony and Mildred Comparato. In a July 2, 1993 order, the court held that Anthony and Mildred Comparato, as the presumptive heirs and sole statutory distributees of their intestate son, acquired property interests in the proceeds of the malpractice claims as of the date of their son's death. The court also held that Anthony and Mildred Comparato could not renounce their interests in their son's estate to defeat the federal tax liens. The court granted summary judgment in favor of the government. On August 17, 1993 , the court entered a final judgment pursuant to Fed. R. Civ. P. 54(b) with respect to the assessments for the years 1974-1976 and 1985 against Anthony Comparato, and for the years 1974-1976 against Mildred Comparato. Enforcement of the judgment was stayed pending a final settlement order by the Surrogate's Court.

Appellants contend that Anthony and Mildred Comparato never had an interest in the settlement proceeds to which the federal tax liens attached as a result of their renunciations pursuant to New York law. The parties stipulated to dismissal of the cross-appeal.

II.

Section 6321 of the Internal Revenue Code provides that "[i]f any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty . . .) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person". 26 U.S.C. §6321 (1988). The scope of §6321 "is broad and reveals . . . that Congress meant to reach every interest in property that a taxpayer might have". United States v. National Bank of Commerce [85-2 USTC ¶9482 ], 472 U.S. 713, 719-20 (1985). Moreover, a tax lien attaches automatically at the time of the assessment and remains in effect until the liability is satisfied. 26 U.S.C. §6322 (1988). State law controls whether a taxpayer has an interest in property to which a lien may attach. Aquilino v. United States [60-2 USTC ¶9538 ], 363 U.S. 509, 512-13 (1960).

Appellants contend that Anthony and Mildred Comparato's renunciations of their interests in their son's estate retroactively extinguished any property interests they may have had in the malpractice claims. Absent the renunciations, appellants do not dispute that Anthony and Mildred Comparato had property interests in the malpractice claims as the presumptive heirs and statutory distributes of their intestate son. Instead, appellants rely on New York law, which provides that "[a]ny beneficiary of a disposition may renounce all or part of his interest". N.Y. Estates, Powers and Trusts Law, §2 -1.11(b)(1) ( McKinney 1981). In New York , a renunciation is deemed "retroactive to the creation of the disposition" and it "has the same effect with respect to the renounced interest as though the renouncing person had predeceased the creator or the decedent". N.Y. Estates, Powers and Trusts Law, §2 -1.11(d) ( McKinney Supp. 1994). This statute creates a legal fiction that allows distributees to avoid attachment by creditors or the payment of taxes. In re Estate of Scrivani, 455 N.Y.S.2d 505, 509, 116 Misc. 2d 204, 207-08 (Sup. Ct. N.Y. County 1982).

Appellants rely on §2 -1.11 in contending that Anthony and Mildred Comparato's renunciations resulted in Diana and Millicent Comparato becoming the exclusive owners of the malpractice claims as of John's death on March 30, 1984 . Since this date preceded the IRS's assessments against Anthony and Mildred Comparato, appellants contend that Anthony and Mildred Comparato did not have an interest in the malpractice claims pursuant to §2 -1.11 at the time the federal tax liens attached. We reject this contention.

The court properly held that, once the federal liens attached to Anthony and Mildred Comparato's interests in the malpractice actions, their subsequent renunciations pursuant to state law were not effective against the federal liens. United States v. Mitchell [71-1 USTC ¶9451 ], 403 U.S. 190, 203-04 (1971) (a state law renunciation could not defeat a federal tax lien that attached to property rights that vested prior to the renunciation). The court held that both Anthony and Mildred Comparato had a vested interest in the settlement proceeds from the malpractice claims. Obviously, the government could have enforced the liens against Anthony and Mildred Comparato prior to the attempted renunciations. We hold that, once state law provided both Anthony and Mildred Comparato with a vested interest in the proceeds of the malpractice actions, federal law controlled whether their interests were exempt from levy by the United States . United States v. Rodgers [83-1 USTC ¶9374 ], 461 U.S. 677, 683 (1983) ("[O]nce it has been determined that state law has created property interests sufficient for federal tax lien[s] to attach, state law 'is inoperative to prevent the attachment' of such liens") (quoting United States v. Bess [58-2 USTC ¶9595 ], 357 U.S. 51, 56-57 (1958)).

Section 6334(c) of the Internal Revenue Code provides that no property is exempt from levy other than property specifically made exempt by §6334(a) . 26 U.S.C. §6334 (1988 & Supp. IV 1992). Since §6334(a) does not provide an exemption for Anthony and Mildred Comparato's interests in their son's estate, the federal tax liens are effective against their interests despite their subsequent renunciations pursuant to §2 -1.11. Mitchell, supra, [71-1 USTC ¶9451 ], 403 U.S. at 205 (§6334 does not provide "for automatic exemption of property that happens to be exempt from state levy under state law"). We reject appellants' contention that the retroactive ownership provision in §2 -1.11 may defeat federal tax liens that attached prior to the attempted renunciations. Rodriguez v. Escambron Dev. Corp. [84-2 USTC ¶9698 ], 740 F.2d 92, 98 (1 Cir. 1984) (the legal fiction of retroactive ownership recognized in the adverse possession statute could not be invoked to defeat federal liens). We affirm the court's decision that Anthony and Mildred Comparato could not renounce their interests in their son's estate to defeat federal tax liens that attached prior to their attempted renunciations.

III.

To summarize:

We hold that the court properly held that appellants' renunciations of their interests in their deceased son's estate did not defeat federal tax liens that attached prior to the renunciations.

Affirmed.

 

 

[97-2 USTC ¶50,635] Nelda Huebner Leggett, In the Matter of the Estate of Nelda Huebner Leggett, Deceased, et al., Plaintiffs v. United States of America, Defendant- -Appellee v. Patricia Huebner Schuette, Defendant-Appellant

(CA-5), U.S. Court of Appeals, 5th Circuit, 96-41103, 9/4/97 , 120 F3d 592, 120 F3d 592. Reversing a District Court decision, 96-2 USTC ¶50,698 ; 96-2 USTC ¶60,249

[Code Secs. 6321 and 6323 ]

Lien for taxes: Property subject to: Inherited property: Beneficiaries: Disclaimer: Application of state law.--A federal tax lien on property held by a decedent's estate that was imposed with respect to a beneficiary's tax liabilities was extinguished when the beneficiary executed a timely disclaimer of her interest in the property. Since state ( Texas ) law recognizes no property interest in the right to accept a bequest, the beneficiary lacked a property interest to which the tax lien could attach. Thus, the provision under state law that disclaiming beneficiaries are to be treated as having predeceased the decedent was applicable.

Before: POLITZ, Chief Judge, and HIGGINBOTHAM and SMITH, Circuit Judges.

SMITH, Circuit Judge:

In this tax case, we review a judgment that Patricia Huebner Schuette had a state property interest in property bequeathed to her by her aunt, despite the fact that she had filed a timely disclaimer and never took possession of, or exercised control over, the property. The district court held that a federal tax lien had attached to the property and the disclaimer was ineffective. We reverse.

I.

The relevant facts are not in dispute. In 1995, Schuette owed the Internal Revenue Service ("IRS") nearly $20,000. In May 1995, Schuette's aunt, Nelda Leggett, died testate, leaving one-twentieth of her estate, or $19,500, to Schuette. In June 1995, executors were appointed for Leggett's estate. The executors have distributed all of the estate's assets to the beneficiaries, except for Schuette's share. ¹

In August 1995, Schuette filed a disclaimer of all rights and interests in Leggett's estate. She believes that her disclaimed share should go to her children, Melissa Ann Oakes and Donald Van Schuette II. In September 1995, the estate filed in county court a petition to quiet title and for declaratory judgment. Specifically, the estate requested that the court declare that the IRS has no lien against the estate's property.

The IRS removed the case to federal court. ² Because the facts were uncontested, all parties moved for summary judgment. The IRS asked the court to rule that its lien is valid, and Schuette asked the court to hold that the United States has no interest in the property. The estate expressed disinterest in this question but requested attorney's fees and costs under Tex. Civ. Prac. & Rem.Code Ann. §37.009 ( Vernon 1986) (authorizing the award of fees and costs in a declaratory action case when "equitable and just").

In August 1996, the district court held in favor of the IRS. Instead of deciding the fees issue, the court sua sponte remanded it to the state court. This had the effect of disposing of all claims in the federal case.

II.

A.

The only issue before us is whether the district court correctly interpreted federal and state law in determining whether a federal lien attached to Schuette's share of Leggett's estate. Questions of law resolved on summary judgment are reviewed de novo. See BellSouth Telecomms., Inc. v. Johnson Bros. Corp., 106 F.3d 119, 122 (5th Cir.1997).

When a person fails to pay his taxes, all property rights that he has or acquires thereafter immediately and automatically are subject to a federal tax lien, see 26 U.S.C. §6321, that is not subject to any state laws that govern ordinary liens or to any perfection requirements, see United States v. Security Trust & Sav. Bank [50-2 USTC ¶9492], 340 U.S. 47, 51, 71 S.Ct. 111, 113-14, 95 L.Ed. 53 (1950). Section 6321 is intended to be broad in scope and applies to every interest the taxpayer has in property. See United States v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 719-20, 105 S.Ct. 2919, 2923-24, 86 L.Ed.2d 565 (1985). The section does not, however, create or define what constitutes a property interest. Instead, state law determines whether a taxpayer has a property interest to which a federal lien may attach. See id. at 722-23, [85-2 USTC ¶9482], 105 S.Ct. at 2925-26; United States v. Bess [58-2 USTC ¶9595], 357 U.S. 51, 55, 78 S.Ct. 1054, 1057, 2 L.Ed.2d 1135 (1958). Therefore, we must decide whether, under Texas law, Schuette ever had a property interest in Leggett's estate.

B.

1.

Texas probate law contains two provisions that bear on our determination. The Texas Probate Code provides that "when a person dies, leaving a lawful will, all of his estate devised or bequeathed by such will, and all powers of appointment granted in such will, shall vest immediately in the devisees or legatees of such estate and the donees of such powers. . . ." Tex. Prob.Code Ann. §37 ( Vernon Supp.1997). This rule prevents any lapse in title, insures that someone always is responsible for property taxes, allows family settlements agreements, see In re Estate of Hodges, 725 S.W.2d 265, 267 (Tex.App.--Amarillo 1986, writ ref'd n.r.e.), guarantees that the beneficiaries will receive any income generated by the estate, see Hurt v. Smith, 744 S.W.2d 1, 6 (Tex.1987), and prevents a beneficiary from criminal prosecution for using estate property, see Palmer v. Texas, 764 S.W.2d 332, 334 (Tex.App.--Houston [1st Dist.] 1988, no pet.).

Texas law also provides for the possibility of a disclaimer or renunciation of an inheritance:

Any person . . . who may be entitled to receive any property as a beneficiary and who intends to effect disclaimer irrevocably . . . shall evidence same as herein provided. A disclaimer evidenced as provided herein shall be effective as of the death of decedent and shall relate back for all purposes to the death of the decedent and is not subject to the claims of any creditor of the disclaimant. Unless the decedent's will provides otherwise, the property subject to the disclaimer shall pass as if the person disclaiming . . . had predeceased the decedent. . . .

Tex. Prob.Code Ann. §37A(flush) (Vernon Supp.1997). A disclaimer must follow a certain form, see id. §37A(a), and is irrevocable, see id. §37A(d). It must be made within nine months of death, see id. §37A(a), and cannot be made if the disclaimant has used the property, see id. §37A(g). A disclaimer is distinct from an assignment, which is a gift from an assignor to an assignee of inherited property. See id. §37B(d).

These provisions are somewhat contradictory. Section 37 states that the intended beneficiary had a vested property right from the moment of death, while section 37A teaches that the intended beneficiary never had a property interest at all. Determining which provision is real and which is the fiction decides this issue.

2.

There are two plausible ways to view the statutory scheme. We could regard §37 as the reality and §37A as a legal fiction. Under this view, the intended beneficiaries own the estate's property at the moment of death. If one of them files a valid disclaimer, the property is transferred to other beneficiaries. The legislature, cognizant of the tax consequences of such a transfer, adopted the legal fiction that the intended beneficiary never owned the property. The IRS urges this view, which we will call the "Transfer Theory."

The second possibility is that §37A is the reality and §37 is the legal fiction. Under this theory, property at death goes to the estate of the decedent. The intended beneficiaries may accept or reject their inheritances. If one accepts, the law engages in the legal fiction that he owned the property from the moment of death, thus ensuring the continuity of title and responsibility to pay taxes. Schuette urges this theory, which we will call the "Acceptance-Rejection Theory."

The difference is vital to the outcome of the case. Under the Transfer Theory, Schuette had a property right in Leggett's estate, so the federal lien attached and prevented her from making a disclaimer. Under the Acceptance-Rejection Theory, Schuette never had a property right, as she never accepted the inheritance, so there was nothing to which a federal lien could attach.

C.   

At common law, a beneficiary of a will had the power to accept or reject a legacy or devise. The reason was that no person could be made an owner against his consent. An heir at law, on the other hand, became the owner of the property, irrespective of whether he wanted it. Presumably, a contrary rule would allow an heir to defeat an entail.

This distinction had two negative effects. First, it forced heirs to take possession of property they did not want. ³ Second, it had unintended tax consequences. A disclaiming beneficiary of a will was not subject to gift tax liability, see, e.g., Brown v. Routzahn [1933 CCH ¶9231], 63 F.2d 914, 917 (6th Cir.1933), while a disclaiming heir was subject to tax liability, see, e.g., Hardenbergh v. Commissioner [52-2 USTC ¶10,859], 198 F.2d 63, 66 (8th Cir.1952), aff'g [CCH Dec. 18,456], 17 T.C. 166, 1951 WL 326 (1951).

The purpose of the disclaimer law is to rectify this common-law anomaly by putting an heir in the same position as a beneficiary of a will. That is, the purpose is to state that no person, whether heir at law or intended beneficiary of a will, can be forced to take inherited property against his will. See Unif. Disclaimer Of Transfer By Will, Intestacy Or Appointment Act §1 comment, 8A U.L.A. 166, 166-68 (1993). This, of course, is the Acceptance-Rejection Theory.

The Texas courts have adopted this view of §37A: "This "relation back' doctrine is based on the principle that a bequest or gift is nothing more than an offer which can be accepted or rejected." Dyer v. Eckols, 808 S.W.2d 531, 533 (Tex.App.--Houston [14th Dist.] 1991, writ dism'd by agr.). In fact, "acceptance of the inheritance occurs "only if the person making such disclaimer has previously taken possession or exercised dominion and control of such property in the capacity of beneficiary.' " Id. at 534 (quoting Tex. Prob.Code Ann. §37A(f) (Vernon Supp.1991)).

Because the Dyer court adopted the Acceptance-Rejection Theory, it discarded the notion that a disclaimer could be a fraudulent transfer, reasoning that a transfer is impossible unless the "transferor" had rights in the thing "transferred." Because a disclaimant "never possesses the property," he cannot transfer it. Id. ; accord Simpson v. Penner (In re Simpson), 36 F.3d 450, 452-53 (5th Cir.1994) (per curiam) (stating that this is the law in Texas ).

This settles the instant dispute. Under Texas law, Schuette had the right to accept Leggett's intended gift by taking possession of it, by exercising control and dominion over it, or by taking no action within the set time. She also had the right to reject Leggett's intended gift by filing a valid disclaimer within nine months. This right of decision was not, itself, a property right under Texas law. Because Schuette rejected the intended gift, she never had a property right. Therefore, the federal lien had nothing to which to attach.

III.

A.

Texas 's disclaimer statute is based on a uniform act and, therefore, is similar to acts in other states. We recognize that the Second and Ninth Circuits have come to different conclusions from each other, interpreting New York and Arizona law, respectively. Compare United States v. Comparato [94-2 USTC ¶50,354], 22 F.3d 455, 458 (2d Cir.1994) (holding that a disclaimer was rendered ineffective by a federal tax lien) with Mapes v. United States , 15 F.3d 138, 141 (9th Cir.1994) (holding that, because of a timely disclaimer, the federal tax lien did not attach). Because New York law is substantially different from Arizona 's or Texas 's, these cases are reconcilable.

The Second Circuit, citing In re Estate of Scrivani, 116 Misc.2d 204, 455 N.Y.S.2d 505 (N.Y.Sup.Ct.1982), stated that the New York statute "creates a legal fiction that allows distributees to avoid attachment by creditors or the payment of taxes." Comparato [94-2 USTC ¶50,354], 22 F.3d at 457. The view that the disclaimer is a legal fiction is the Transfer Theory and supports the holding that a property right existed before the disclaimer.

In Scrivani, the conservator of Julia Molinelli, an incompetent person, sought to renounce Molinelli's inheritance. See 116 Misc.2d at 204-05, 455 N.Y.S.2d 505. The problem was that a transfer of a "resource considered available" would have made Molinelli ineligible for Medicaid benefits. N.Y. Soc. Serv. Law §366(5)(a) (McKinney 1992 & Supp.1997). The court, therefore, was forced to determine whether a renunciation of an inheritance constitutes the transfer of a resource.

At first, the court appeared to follow the Texas view that "[t]he law forces no one to accept a gift." Scrivani, 116 Misc.2d at 208, 455 N.Y.S.2d 505. The court, however, then held that the Molinelli had "an inchoate property interest" in the right to accept the inheritance. Id. at 209, 455 N.Y.S.2d 505; cf. Adam J. Hirsch, The Problem of the Insolvent Heir, 74 Cornell L.Rev. 587, 601-03 (1989) (arguing that Scrivani is internally contradictory). Therefore, the court reasoned, renouncing the inheritance would constitute the transfer, or rather the waste, of an available resource. ⁴

Because the Comparatos had a property interest in their right to accept the inheritance, the federal tax lien attached to it. Therefore, the Comparatos could not destroy that asset by disclaiming the underlying inheritance. It should be evident, however, that this conclusion derives from the manner in which the New York courts have interpreted that state's disclaimer statute.

As we have explained, Texas law follows the Acceptance-Rejection Theory and does not recognize a property interest in the right to accept a bequest. Our decision today, therefore, is not in conflict with Comparato.

B.

Similarly, the Ninth Circuit's decision in Mapes does not actually conflict with Comparato. There, the court was construing an Arizona statute that had not (and still has not) been interpreted by its courts. Thus, the Ninth Circuit assumed that Arizona 's view of its statutory scheme would follow the majority rule that Texas follows. ⁵ Thus, it may be presumed that Arizona , unlike New York , follows the Acceptance-Rejection Theory and does not recognize a property interest in the right to accept a bequest.

The fact that three states have adopted similar statutory schemes does not necessarily mean that the law functions the same way in each state. New York law creates a property interest in an intended beneficiary's right to accept a gift and may follow the Transfer Theory. Arizona and Texas do not. It is one of the complexities (and, ultimately, one of the strengths) of the federal system that different states may interpret similar statutes in very different ways.

IV.

A.

We pause to address two of the IRS's arguments for ignoring the plain import of Texas law in determining the existence of a state property right. In United States v. Irvine [94-1 USTC ¶60,163], 511 U.S. 224, 114 S.Ct. 1473, 128 L.Ed.2d 168 (1994), the Court held that the disclaimer of a remainder interest in a trust after a reasonable time had passed was a taxable gift, even though the interest was created before the passage of the gift tax. See id. at 226, [94-1 USTC ¶60,163], 114 S.Ct. at 1475. The Court's interpretation of the gift tax does not dictate this court's interpretation of §6321.

Section 6321 adopts the state's definition of property interest. Title 26 U.S.C. §2511(a), which defines "transfer" and "property" for purposes of the gift tax, does not adopt state law. Instead, it aims to reach "every species of right or interest protected by law and having an exchangeable value." Jewett v. Commissioner [82-1 USTC ¶13,453], 455 U.S. 305, 309, 102 S.Ct. 1082, 1086, 71 L.Ed.2d 170 (1982) (quoting S.REP. NO. 72-665, at 39 (1932); H.R.REP. NO. 72-708, at 27 (1932)).

In dictum, the Court recognized the conundrum that we face today and the Second and Ninth Circuits have faced in the past:

Although a state-law right to disclaim with such consequences might be thought to follow from the common-law principle that a gift is a bilateral transaction, requiring not only a donor's intent to give, but also a donee's acceptance, state-law tolerance for delay in disclaiming reflects a less theoretical concern. An important consequence of treating a disclaimer as an ab initio defeasance is that the disclaimant's creditors are barred from reaching the disclaimed property. The ab initio disclaimer thus operates as a legal fiction obviating a more straightforward rule defeating the claims of a disclaimant's creditors in the property disclaimed.

Irvine [94-1 USTC ¶60,163], 511 U.S. at 239-40, 114 S.Ct. at 1481-82 (citations omitted). The Court recognized that the right to disclaim might, under state law, be based on the Acceptance-Rejection Theory and, therefore, not be a legal fiction. The Court then pointed out that allowing a late disclaimer, ⁶ on the other hand, can be explained only as a rule aimed at frustrating creditors.

Because the Texas statute does not allow late disclaimers, it is based solely on the Acceptance-Rejection Theory. Thus, treating this rule as a non-fiction, as Texas caselaw requires, is fully consistent with the principles laid down in Irvine .

B.

In United States v. Mitchell [71-1 USTC ¶9451], 403 U.S. 190, 191, 91 S.Ct. 1763, 1765, 29 L.Ed.2d 406 (1971), Anne Goyne Mitchell, upon divorce, renounced her right to the proceeds of the marital community (and the corresponding obligation to pay the debts of that community). ⁷ Mitchell argued that, because she had renounced the community income, she was not responsible for the corresponding tax liability. See id. at 192, [71-1 USTC ¶9451], 91 S.Ct. at 1765-66.

The Court noted that tax liability follows ownership and, therefore, if Mitchell ever had ownership of the income, she was liable for the tax. See id. at 196-97, [71-1 USTC ¶9451], 91 S.Ct. at 1767-68. The Court proceeded as we do today, examining the state law in great detail. See id. at 197-203, [71-1 USTC ¶9451], 91 S.Ct. at 1768-71. The Court determined that, under Louisiana law, the wife had a property interest in the community's income from the moment of inception, rather than "a mere expectancy." Id. at 199, [71-1 USTC ¶9451], 91 S.Ct. at 1769 (quoting Phillips v. Phillips, 160 La. 813, 107 So. 584, 588 (1926), overruled by Creech v. Capitol Mack, Inc., 287 So.2d 497, 510 (La.1973)).

It should be evident that we have followed the same methodology as did the Mitchell Court . Like that Court, we have examined state law to determine whether it creates a property interest. Unlike the statutory scheme considered in Mitchell , Texas law did not create a property interest for Schuette in Leggett's estate. Although the IRS correctly argues that Mitchell "underscored the supremacy of federal law with respect to the taxation of state created property interests," Mitchell does not disturb the principle that a federal tax lien cannot attach in the absence of a state-created property interest.

V.

In closing, we note that Congress easily can expand the IRS's lien power, if it so desires. For example, Congress can follow what it did with §2511(a), and define property more broadly than state law does. Alternatively, Congress simply can prohibit persons subject to §6321 from filing disclaimers. We decline the IRS's invitation to rewrite the law ourselves, as that power lies exclusively in the legislative branch. See Rodriguez v. INS, 9 F.3d 408, 414 (5th Cir.1993).

REVERSED.

¹ In August 1995, the estate sold certain property. In exchange for the IRS's release of its lien against that property, the estate paid the IRS 1/20 of the proceeds, or $2,515.95. The IRS credited this money against Schuette's debt and rejected the estate's request for a refund. Although our opinion makes it evident that the IRS's position was incorrect, neither party challenges these actions on appeal. We leave the proper resolution of this issue to whatever further proceedings there may be among the parties.

² Under 28 U.S.C. §2410(a)(1), federal district courts have jurisdiction over actions to quiet title to land on which the United States claims to have a lien. Under 28 U.S.C. §1444, such actions are removable.

³ There are many situations, in addition to Schuette's, in which a person rationally might prefer not to accept an inheritance. For example, a person might be offered a plot of real property with several troublesome tenants. The cost in time and aggravation of dealing with the tenants easily might outweigh the value of the property.

⁴ See Scrivani, 116 Misc.2d at 209, 455 N.Y.S.2d 505; see also In re Molloy v. Bane, 214 A.D.2d 171, 175, 631 N.Y.S.2d 910 (N.Y.App.Div.1995) (stating, under similar facts, that "petitioner's renunciation of a potentially available asset was the functional equivalent of a transfer of an asset").

⁵ See Mapes, 15 F.3d at 141; see also Robert M. Hoffman & Aaron L. Mitchell, Deceptive Trade Practices and Commercial Torts, 45 SW. L.J. 1667, 1710 (stating that Texas follows the majority rule); cf. Frances Slocum Bank & Trust Co. v. Matter of Estate of Martin, 666 N.E.2d 411, 415 (Ind.Ct.App.1996) (adopting Dyer).

⁶ In Irvine , the disclamation occurred 62 years after the trust's creation. See [94-1 USTC ¶60,163], 511 U.S. at 226-27, 114 S.Ct. at 1475. Texas law, by contrast, prohibits a disclaimer filed more than nine months after death. See TEX. PROB.CODE. ANN. §37A(a) ( Vernon Supp.1997). It is worth noting that the disclaimer in Comparato was filed over seven years after the devisor's death. See [94-2 USTC ¶50,354], 22 F.3d at 456.

⁷ See La. Civ.Code art. 2410 (1870) ("Both the wife and her heirs or assigns have the privilege of being able to exonerate themselves from the debts contracted during the marriage, by renouncing the partnership or community of gains.").

 

 

 

[82-2 USTC ¶9610] United States of America , Plaintiff v. Heman H. McGuire, et al., Defendants

U. S. District Court, East. Dist. Ky. , Catlettsburg, Civ. Act. No. 77-170, 552 FSupp 503, 8-6-82

[Code Sec. 6334]

Lien for taxes: Levy: Garnishment of teacher retirement benefits: Exemption from levy.--Payments made under a state-created teacher retirement fund are not exempt from federal tax levy, and the IRS was therefore entitled to garnishee those benefits to satisfy an unpaid federal tax assessment that had been reduced to judgment.

United States Attorney, Lexington , Ky. 40501 , for plaintiff. Ora Duval, P. O. Box 543, Olive Hill, Ky. 41164, for Heman McGuire, Rufus Lisle, Harbison, Kessinger, Lisle & Bush, 400 Bank of Lexington Bldg., Lexington, Key., for Dawn McGuire, Robert M. Beck, Jr., 101 East Vine St., Lexington, Ky. 40507, for Lorraine B. McGuire.

BERELSMAN, District Judge:

The matter is before the court on the defendant's motion for summary judgment.

On 9/10/75 , the U. S. Tax Court entered decisions determining an income tax liability against defendant of $180,981.92 plus interest for 1949 through 1961. On 12/30/77 the U. S. brought this action in this court to reduce the federal income tax assessment against defendant to judgment, to set aside a conveyance of stock as being a fraud on creditors, and to foreclose the federal tax lien against that stock. On 4/17/78 , this court entered judgment against defendant in favor of the U. S. in the amount of $111,778.10. Accordingly, the remaining issues in this case are the latter two.

In a separate administrative action, the I. R. S. initiated garnishment proceedings on defendant's teacher retirement benefits. Pursuant to these proceedings, the U. S. has collected $7,756.32 from these benefits and will continue to collect on these benefits at a rate of $309.78 per month. The defendant has responded by filing for a summary judgment in this action.

The defendant states that the payments to plaintiff are exempt from legal process by plaintiff under KRS 161.700 which provides that the retirement benefit is "exempt from any state or municipal tax, are not subject to execution, garnishment, attachment or other process . . ." Defendant claims that since defendant has not assigned these benefits, they are being illegally garnished by plaintiff. Accordingly, defendant requests a refund of $7,756.32 and an order requiring plaintiff to cease and desist this mode of collection.

The plaintiff argues that since no cross-claim or counterclaim has been filed by defendant, this relief cannot be granted. Further arguing this in a permissive counterclaim, plaintiff contends defendant has failed to establish jurisdiction as is required.

Also, plaintiff argues that the claim is barred by 26 USC 7421(a) which provides (except for exceptions inapplicable in this case) "No suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person . . ." This section is inapplicable if it is clear that under no circumstances could the Government ultimately prevail and if equity jurisdiction exists. However, these exceptions are not met.

The plaintiff replies by stating that there is no inconsistency between KRS 161.700 and the IRS's right to collect taxes. He is not seeking an injunction; just that plaintiff be ordered to stop exercising an illegal action, and restoration of the money already collected.

Analysis

Defendant should have filed his claim as a counterclaim, rather than as a motion for summary judgment. However, for purposes of this analysis, it shall be treated as if there had been a proper filing of a counterclaim and motion for summary judgment.

Assuming defendant followed proper procedure, however, a counterclaim, like any other claim against the U. S. can be made only when the Government has waived its immunity from suit on that claim. 6, Wright & Miller, Federal Practice & Procedure, §1427. In the present case, though, 26 USC §7421(a) expressly prohibits this action.

The object of this section is to withdraw jurisdiction from the state and federal courts to entertain suits seeking injunctions prohibiting the collection of federal taxes. The specific purpose is to permit the U. S. to assess and collect taxes allegedly due without judicial intervention and to require that the legal rights to the disputed sum be determined in a suit for refund. Enochs v. Williams Packing Co. [62-2 USTC ¶9545], 370 U. S. 1 (1962). The Court in Enochs did, however, note the section did not apply if two conditions were met: (1) if it is clear that under no circumstances could the Government ultimately prevail and (2) equity jurisdiction exists. See Hendrix v. U. S. [73-2 USTC ¶9723], 327 F. 2d 967 (6th Cir. 1964).

The first condition is not met; it is not clear that the Government cannot prevail. The only exemptions from a federal tax levy are provided in 26 USC §6334(a). These exemptions do not include a state created retirement fund. Thus, the enforcement of the levy is authorized by the Internal Revenue Code.

Further, the argument offered by the plaintiff, that the funds are exempted by KRS 161.700, is without merit. The courts have widely recognized that a state cannot exempt property from the income tax created by Congress. Kiefenderf v. Commissioner [44-1 USTC ¶9323], 142 F. 2d 723 (9th Cir. 1944); Knox v. Great West Life Assur. Co. [53-1 USTC ¶9247], 109 F. Supp. 207 (D. C. Mich. 1952), aff'd [54-1 USTC ¶9373] 212 F. 2d 784 (6th Cir. 1954). The Kentucky Attorney General recognized this rule in concluding that the teacher retirement benefits at issue here were not exempt from levy by the U. S. Government. OAG-67-424 (copy attached).

Since this condition of the exception to §7421 is not met, the exception does not apply; both conditions must be met. It should be noted, though, that defendant does not even allege irreparable harm, an element of equity jurisdiction. Accordingly, the action is barred by §7421.

Although not presented by defendant, it could be argued that concerning the request of return of the benefits already collected, defendant is seeking a refund, which is not barred by §7421. However, before an income tax refund suit can be maintained in a federal district court, there must be full payment of the assessment and a claim for refund with the Secretary which was rejected. 26 USC §7422; Flora v. U. S. [60-1 USTC ¶9347], 362 U. S. 145 (1959); Drake v. U. S. [73-1 USTC ¶16,087], 355 F. Supp. 710 (E. D. Mo. 1973). In the present case, these are not met, nor alleged to have been met.

The court having thoroughly considered the issue to determine whether this action is barred by 26 USC §7421 is of the opinion that the action is barred. In accordance therewith,

IT IS ORDERED that defendant's motion for summary judgment be, and it is, hereby overruled.

 

 

 

[88-1 USTC ¶9186] In re Vernon Carl Jackson, Debtor. Glen Theodore Bailey, Debtor

U.S. District Court, Dist. Colo. in Bankruptcy, 85 B 00247 J, 86 B 11923 M, 10/30/87 , 80 BR 213

[Code Sec. 6334 --Result unchanged by the Tax Reform Act of 1986 ]

Lien for unpaid taxes: Levy against personal property: Exemption from levy: Application of exemption: Reclassification of government's claim: Secured v. unsecured claim.--Wages and personal property belonging to a debtor in bankruptcy were considered exempt from levy under the law, but were not exempt from lien. A federal district court in Colorado determined that the exemption prohibited the involuntary seizure of this property by the government, but it did not destroy the property interest, or lien. Consequently, if the debtor voluntarily disposed of the property, the government could assert its lien and receive payment for the delinquent taxes. Accordingly, the court denied the taxpayer's motion to reclassify the government's claim from secured to unsecured. Penalties, considered punitive in nature, were not entitled to priority status.

Edward I. Cohen, 1845 Sherman St. , Denver , Colo. , for debtors. John A. Weeda, Special Assistant United States Attorney, Department of Justice, Denver, Colo., George P. Eliopoulos, Department of Justice, Washington, D.C. 20530, for I.R.S.

MEMORANDUM OPINION AND ORDER

 

BRUMBAUGH, Bankruptcy Judge:

THESE MATTERS come before the Court on the Debtors' Motions to Reclassify a Claim of the Internal Revenue Service (1) from a secured to an unsecured priority claim, and (2) to reclassify any pre-petition penalties from a secured or priority claim to a general unsecured claim. There are common legal issues in both cases and therefore the Court will rule on them jointly.

In re Jackson--85 B 00247 J

 

The parties agree that absent bankruptcy the I.R.S. has a perfected lien on all the personal property of the Debtor and that the I.R.S. claim is for 1982 income tax and it is composed of $2,234.52 in taxes, $677.34 in pre-petition interest, and $892.45 in pre-petition penalty. They further agree that the Debtor has a net equity of $161.32 in an automobile and that he owns furniture valued at $1,150.00 and personal effects valued at $125.00. Finally, it is agreed that the Debtor had, at the time of filing his petition, $460.00 due in wages, that he is paid monthly, and that he has three dependent children.

Debtor asserts that he is entitled to claim as exempt all of his personal property and wages under 26 U.S.C. §6334 . That section provides in pertinent part as follows:

(a) Enumeration--These shall be exempt from levy--

(1) Wearing apparel and school books. . . .;

(2) Fuel, provisions, furniture, and personal effects . . . as does not exceed $1,500.00 in value; . . .

(9) Minimum Exemption for wages, salary, and other income. . . .

(d) Exempt Amount of Wages, Salary, or Other Income.--[basically the exemption is $75.00, plus $25.00 for each child, per week.].

If these exemptions are applied then all of the Debtors' personal property and wages would be exempt except the $161.32 equity in the automobile.

The I.R.S. argues that even though this property is exempt from "levy" it is not exempt from the I.R.S. "lien".

26 U.S.C. §6331(b) reads as follows:

The term "levy" so used in this title includes the power of distraint and seizure by any means. . . .

The Fifth Circuit Court of Appeals in InterFirst Bank of Dallas, N.A. v. U.S. [85-2 USTC ¶9635 ], 769 F.2d 299 (5th Cir. 1985) held that "levy", as contemplated in this section, is a forcible means of extracting taxes from a recalcitrant taxpayer. 769 F.2d at 305. The Court distinguished "levy" from "assessment and demand" in that case.

Likewise, "levy" must be distinguished from "lien" which is provided for in 26 U.S.C. §6321 . If "levy" and "lien" were synonymous, there would be no necessity for both §6321 and §6331 .

In discussing §6334 , William T. Plumb, Jr., also noted that there is a distinction between these two terms when he stated "For unexplained reasons, exemption is provided only from levy, not from the lien itself, so theoretically the Government could circumvent this limited sanctuary by initiating a judicial action to foreclose its tax lien, but cases of this type cannot be found in the reports." W. Plumb, Jr., Federal Tax Liens (Am. Law Institute--Am. Bar Assoc. 3d ed., p. 21).

A similar situation appears in the law of the State of Colorado . Colorado 's citizens' property is exempt from "levy and sale under writ of attachment or writ of execution" on personal property (§13-54-102, C.R.S.). The Colorado Supreme Court in Weare v. Johnson, 20 Colo. 363, 3 P. 374 (1894) said "If it is exempt from execution, it must of necessity be exempt from the lien of the judgment, as a judgment lien that cannot be enforced is of no avail." (20 Colo. at 367). Later the Colorado Court of Appeals held that "while property may be exempt from levy, there is no statute which exempts it from lien." Noxon v. Glaze, 11 Colo. App. 503 at 505 (1898). The statement in the Weare case assumed that the only time a judgment lienholder could be paid on account of his lien would be by execution. That assumption is wrong, because a lienholder can simply wait until the judgment debtor voluntarily sells the property and then steps forward to claim his share of the proceeds.

Thus, although Colorado state law is not controlling here, it does give some credence to the argument that the exemptions under 26 U.S.C. §6334 apply only to "levies" and not to "liens".

Even Black's Law Dictionary (4th Ed.), recognizes the difference between "levy" and "lien". "Levy" is a verb meaning "to assess; raise; execute; exact; collect; gather; take up; seize". While "lien" is a noun denoting a "charge or security or encumbrance upon property".

Thus 26 U.S.C. §6334 may prohibit the involuntary seizure of certain property by the I.R.S., it does not destroy the property interest, or lien, granted by 26 U.S.C. §6321 . If a debtor chooses to voluntarily dispose of property, the I.R.S. is entitled to assert its lien and receive payment. Therefore, the motion to reclassify the I.R.S. claim from secured to unsecured on the basis of 26 U.S.C. §6334 must be denied.

Next, the Debtors assert that under 11 U.S.C. §507(a)(7)(G), the penalty portion of the I.R.S. claim should be reclassified from secured priority to general unsecured claims.

This Court has previously held that under 11 U.S.C. §507(a)(7)(G) pre-petition interest on taxes has priority as a penalty which is not punitive in nature, but is intended to compensate the United States for its inability to use the money it is owed. In re Reich, 66 B.R. 554 (Bankr. Colo. 1986). That case, however, did not discuss the status of a "penalty" assessed by the I.R.S. in addition to interest.

Here, in addition to interest, the I.R.S. has assessed a "penalty" (see the Proofs of Claim filed herein), under 26 U.S.C. §6651 . Section 507(a)(7)(G) has two requirements for inclusion of a penalty as part of a priority claim. It must be related to the priority claims itself, and it must be "in compensation for actual pecuniary loss". Penalties, as assessed here, bear no relation to any actual pecuniary loss, but are instead punitive in nature. Thus, these "penalties" are not entitled to priority under §507(a)(7)(G).

This, however, is not determinative of the secured status of these penalties. 26 U.S.C. §6321 provides that the I.R.S. shall have a lien for the taxes, interest, or assessable penalty. Thus, the I.R.S. lien may include these penalty amounts. Under 11 U.S.C. §506(a), the amount of the I.R.S. lien is dependent upon the value of the property securing the lien, and cannot exceed that value. In the case of Debtor Jackson, his property subject to the I.R.S. lien is valued as follows:

 

 

Automobile .................................................. $  161.32

Furniture ... ...............................................  1,150.00

Personal Affects..  .........................................    125.00

Wages .............. ........................................    460.00

                                                               ---------

                                                              $1,896.32

 

The I.R.S. claim is for $3,804.31. Thus, the I.R.S. claim is secured for only $1,896.32 and is unsecured in the amount of $1,907.99.

In re Bailey--86 B 11923 M

The parties have stipulated to the following facts. The Debtor has property valued as follows:

Wages due at petition ...................................... $  456.00

Wearing apparel ............................................    100.00

Savings bonds ..............................................    250.00

Household goods ............................................    850.00

                                                              ---------

    Total .................................................. $1,656.00

 

If the exemption of 26 U.S.C. §6334 is applied, all of the Debtor's property and wages would be exempt except $597.67.

However, as determined supra, although the property may be exempt from levy, it is not exempt from the I.R.S. lien in 26 U.S.C. §6321 .

Again, however, the lien is only valid to the extent of the value of the property under 11 U.S.C. §506(a). Here, the I.R.S. claim is for $5,554.92. Thus, the I.R.S. claim is secured for only $1,656.00 and is unsecured in the amount of $3,898.92. And, of course, any "penalties" are not entitled to priority under §507(a)(7)(G).

It is, therefore,

ORDERED that in Case No. 85 B 00247 J the I.R.S. is a secured creditor to the extent of $1,896.32 and is unsecured in the amount of $1,907.99.

FURTHER ORDERED that in Case No. 86 B 11923 M the I.R.S. is a secured creditor to the extent of $1,656.00 and is unsecured in the amount of $3,898.92.

FURTHER ORDERED that "penalties", as opposed to "interest" on the I.R.S. claims herein are not entitled to priority under 11 U.S.C. §507(a)(7)(G).

FURTHER ORDERED that the Debtors herein shall file amended plans, motions and statements to reflect the rulings herein within twenty (20) days, failing which the case or cases will be dismissed without further notice or hearing.

 

 

[91-1 USTC ¶50,151] In re Kenneth William Bolin and Brenda Joyce Bolin, Debtors

U.S. Bankruptcy Court, West. Dist. Ark. , El Dorado Div., 89-11041M, 3/15/91

[Code Secs. 6321 and 6334 ]

Bankruptcy and reorganization: Lien for taxes.--

The IRS's objection to confirmation of a bankruptcy plan of reorganization was sustained, where the debtors attempted to avoid the IRS's lien on property covered by a state law exemption. The government's lien could not be avoided because a state law that otherwise exempts certain property from levy has no effect on a federal tax lien. In addition, the IRS was entitled to allocate its lien to the oldest taxes owed by the debtors in order to maximize its total recovery.

ORDER

MIXON, Bankruptcy Judge:

On March 8, 1989 , Kenneth William Bolin and Brenda Joyce Bolin filed a voluntary petition for relief under the provisions of chapter 13 of the United States Bankruptcy Code. The debtors filed a proposed plan of reorganization on March 24, 1989 , and filed a first and second modification to their plan on June 30, 1989 . The Internal Revenue Service (IRS) filed an objection to confirmation of the plan, and the parties submitted the matter to the Court on written stipulations and briefs.

The proceeding before the Court is a core proceeding pursuant to 28 U.S.C. §157(b)(2)(B) and (L), and the Court has jurisdiction to enter a final judgment in this case.

The relevant facts are summarized from the petition and stipulations as follows. The scheduled assets, including assets claimed as exempt, were valued at $25,035.00, and the exempt assets were valued at $16,535.00. The IRS did not file an objection to the debtors' claim of exemption.

On May 31, 1988 , the IRS filed a notice of federal tax lien with the Circuit Clerk of Ashley County, Arkansas, for the following:

                 Date of

     Tax Period Assessment

1040  
12-31-82
   
7-06-87
     3,809.73

1040  
12-31-83
   
7-06-87
    10,076.80

1040  
12-31-84
   
7-06-87
     5,372.59

1040  
12-31-85
   
7-06-87
     3,837.35

1040  
12-31-86
   
4-27-88
     1,116.89

                           ----------

                           $24,183.36

 

On June 1, 1989 , the IRS filed a proof of claim for taxes, penalties, and interest in the sum of $27,820.40 calculated as follows:

                                         Interest to

      Tax Period  Tax Amount  Penalty   Petition Date

1040   
12-31-82
      -0-        679.21      1,790.54

1040   
12-31-83
    5,067.00   3,268.95      4,391.24

1040   
12-31-84
    3,914.00   1,163.02      1,988.07

1040   
12-31-85
    3,180.00     835.96      1,097.54

1040   
12-31-86
      -0-        148.44        296.43

                  ----------  --------  -------------

       Subtotals.  12,161.00   6,095.58      9,563.82

        Total Tax, Penalty and

        Interest .....................   $ 27,820.40

 

The debtors' plan stated that the claim of the IRS was the sum of $24,947.93. The plan treated the claim of IRS as follows:

Class III--Internal Revenue Service should be treated as a secured claimant as to the taxes due for the years 1982 through 1986, which are not hereinafter treated in CLASS IV. They shall retain their lien securing their claim and they shall be paid not less than the allowed amount of their claim over the life of the Plan. The maximum amount of their secured claim shall be limited to the value of the security on which they hold a valid and unavoided lien, with interest being allowed on that claim only to the extent that the security exceeds the amount of the claim, and the amount of their claim shall exclude penalties. In accordance with 11 U.S.C. §522(f), the Order of Confirmation shall avoid any liens of the Internal Revenue Service as to the exempt property of the Debtors which comes within the categories of 11 U.S.C. §522(f)(2)(A), (B) and (C).

Class IV--IRS shall be treated as a general, unsecured claimant, without priority, as to:

(a) That portion of the 1984 income tax which they concede in their Objection to Confirmation to be unsecured and nonpriority;

(b) That portion of their claim which exceeds the value of the security;

(c) That portion of their claim as to which their lien is avoided pursuant to 11 U.S.C. §522(f)(2); and

(d) Penalties, all of which are deemed punitive in nature.

The plan of the debtors is further modified to increase the amount of the monthly payments to the Plan from $402.98 to $452.98 per month, and to provide that the Plan shall extend over a period of five (5) years rather than three (3) years as initially proposed, in order to pay the claim of Internal Revenue Service in full.

The IRS alleges that it holds a secured claim on the property which the debtor claims as exempt in the sum of $16,535.00 for taxes, interest and penalties as follows:

1982 ..................................................  $2,469.75

1983 ..................................................  12,727.19

1984 ..................................................   1,338.06

The parties do not dispute that the value of the debtors' property to which the tax lien attached is the sum of $16,535.00. The IRS claims a priority unsecured claim for the balance of its claim in the total sum of $11,285.40.

The issues as stated by the parties are as follows:

a. Whether the lien of the IRS can be avoided under 11 U.S.C. §522(f)(1) as a "judicial lien" impairing the exemptions of the Debtors;

b. Whether the lien of the IRS can be avoided under 11 U.S.C. §522(f)(2) as a nonpossessory, nonpurchase money security interest in household furnishings and implements or tools of the trade of Kenneth Bolin;

c. Whether the IRS may allocate its claim between secured and unsecured in order to maximize its recovery and the specific years to which the IRS secured claim should be applied and, within each of such years, the specific portions (taxes, penalties and/or interest) of the claim to be given secured status;

d. Whether any portion of the unsecured IRS claim should be accorded priority status, and the amount thereof;

e. Whether the statutory additions (penalties) are entitled to payment under the Plan in the same manner as, and with the same classification as, the underlying tax liabilities; and

f. Whether the Debtors' second modification of Plan should be confirmed by the Court.

AVOIDANCE OF TAX LIEN

Unless the holder of a secured claim accepts the debtor's chapter 13 plan or the debtor surrenders the property securing the claim, a chapter 13 plan must meet the requirements of 11 U.S.C. §1325(a)(5)(B) regarding secured claims. Section 1325(a)(5)(B) provides that:

(B)(i) . . . the holder of such claim retain the lien securing such claim; and

(ii) the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim[.]

In this case, the debtors' plan proposes to use the avoiding powers provided in 11 U.S.C. §522(f) to avoid the IRS tax lien as a judicial lien that impairs an exemption claimed under state law. ¹ Both parties presented arguments on whether a tax lien is a judicial lien or a statutory lien; however, such a determination is unnecessary. A federal tax lien, arising under 26 U.S.C. §6321 , gives the United States a lien on all property and rights to property of the taxpayer, including property acquired by the taxpayer after the lien arises. Shawnee State Bank v. United States [84-1 USTC ¶9513 ], 735 F.2d 308, 310 (8th Cir. 1984). The lien attaches to the debtor's property that is otherwise exempt from levy under state law. No provision of state law may exempt property from a federal tax lien. United States v. Barbier [90-1 USTC ¶50,107 ], 896 F.2d 377 (9th Cir. 1990); Herndon v. United States [74-1 USTC ¶16,127 ], 501 F.2d 1219, 1222-23 (8th Cir. 1974). See 26 U.S.C. §6334 . ² The IRS federal tax lien cannot be avoided under 11 U.S.C. §522(f) because the debtors' state law exemption has no effect on the federal tax lien.

In addition, even if the IRS federal tax lien could be avoided under 11 U.S.C §522(f), this cannot properly be effected by a mere statement in the debtors' plan that the lien is avoided. See In re Beard [90-1 USTC ¶50,260 ], 112 Bankr. 951 (Bankr. N.D. Ind. 1990). A debtor is required to file the appropriate pleading required by the Bankruptcy Rules, which is either a motion or complaint, and the creditor is entitled to notice and a hearing to determine whether a creditor's lien is avoided. See In re Beard [90-1 USTC ¶50,260 ], 112 Bankr. 951, 954-55 (Bankr. N.D. Ind. 1990); Bankruptcy Rules 4003(d), 7001, and 9014. Therefore, the IRS objection to confirmation as to the avoidance of its tax lien is sustained.

ALLOCATION OF LIEN

Under the Internal Revenue Code, tax returns are due on April 15 of the year following the calendar year for which the tax is due. 26 U.S.C. §6072(a) . Since this case was filed March 8, 1989 , the taxes due for the years 1982, 1983, and 1984 were due more than three years before the date the petition was filed and are not entitled to priority status under 11 U.S.C. §507(a)(7)(A). However, the IRS argues that it may allocate its lien to the oldest taxes in order to maximize its recovery, and this position is well supported by the authorities. See Liddon v. United States [71-2 USTC ¶9591 ], 448 F.2d 509 (5th Cir. 1971), cert. denied, 406 U.S. 918 (1972); Pacific Nat'l Ins. Co. v. United States [70-1 USTC ¶9238 ], 422 F.2d 26 (9th Cir.), cert. denied, 398 U.S. 937 (1970); In re Buzek, 116 Bankr. 82, 83 (Bankr. N.D. Ohio 1990); In re Mikrut [87-2 USTC ¶9661 ], 79 Bankr. 404, 407 (Bankr. W.D. Wis. 1987); In re Junes, 76 Bankr. 795 (Bankr. D. Or. 1987), aff'd [89-1 USTC ¶9383 ], 99 Bankr. 978 (Bankr. 9th Cir. 1989). The objection to confirmation as to the allocation of the IRS lien is sustained.

PRIORITY UNSECURED CLAIM

To be confirmed, a chapter 13 plan must propose to pay, in full, any unsecured claim that is a priority claim pursuant to 11 U.S.C. §507 , unless the creditor consents to a different treatment. 11 U.S.C. §1322(a)(2). See In re Carter, 74 Bankr. 613, 615-16 (Bankr. E.D. Pa. 1987); In re Driscoll, 57 Bankr. 322, 327-28 (Bankr. W.D. Wis. 1986); 5 Collier on Bankruptcy ¶1322.03 (15th ed. 1990).

Treatment of prepetition tax liabilities is provided for in 11 U.S.C. §507 , which provides, in relevant part, as follows:

(a) The following expenses and claims have priority in the following order:

(7) seventh, allowed unsecured claims of governmental units, only to the extent that such claims are for--

(A) a tax on . . . income . . .

(i) for a taxable year ending on or before the date of the filing of the petition for which a return, if required, is last due, including extensions after three years before the date of the filing of the petition[.]

. . .

(G) a penalty related to a claim of a kind specified in this paragraph and in compensation for actual pecuniary loss.

A claim entitled to priority under section 507(a)(7) is not dischargeable. See 11 U.S.C. §523(a)(1)(A).

The IRS asserts that, if the Court determines that its unsecured claim is entitled to priority status under section 507(a)(7), the statutory additions of interest and penalties should be accorded the same priority status as the underlying taxes.

Prepetition interest on a tax liability is considered to be part of the IRS's priority claim. In re Larson [88-2 USTC ¶9590 ], 862 F.2d 112, 119 (7th Cir. 1988); United States v. Stowe [90-2 USTC ¶50,559 ], 121 Bankr. 549, 552 (N.D. Ind. 1990); In re Stonecipher Distribs., Inc., 80 Bankr. 949, 950 (Bankr. W.D. Ark. 1987); In re Mikrut [87-2 USTC ¶9661 ], 79 Bankr. 404, 407-09 (Bankr. W.D. Wis. 1987); In re Healis, 49 Bankr. 939, 942 (Bankr. M.D. Pa. 1985). However, when the IRS assesses penalties in addition to the interest, the penalties are considered to be punitive in nature, rather than as compensation for actual pecuniary loss to the government and do not have the same priority status as the underlying tax. In a chapter 7 case, a tax penalty claim is subordinate to claims of general unsecured creditors. 11 U.S.C. 507(a)(7)(G); 3 Collier on Bankruptcy ¶507.04 (15th ed. 1990). Tax penalty claims ³ may be subordinated in a chapter 11 or a chapter 13 case if warranted by the equities of the case pursuant to 11 U.S.C. §510, even if the IRS is not guilty of misconduct. See Schultz Broadway Inn v. United States [90-2 USTC ¶50,594 ], 912 F.2d 230 (8th Cir. 1990); In re Buzek, 116 Bankr. 82, 84 (Bankr. N.D. Ohio 1990); Mikrut [87-2 USTC ¶9661 ], 79 Bankr. at 407; Healis, 49 Bankr. at 942; In re Hernando Appliances, Inc., 41 Bankr. 24, 25 (Bankr. N.D. Miss. 1983).

Subordination may also be applicable to a secured claim for tax penalty. See Schultz Broadway Inn. v. United States [90-2 USTC ¶50,594 ], 912 F.2d 230 (8th Cir. 1990); In re Virtual Network Servs. Corp., 902 F.2d 1246 (7th Cir. 1990). But see Burden v. United States [90-2 USTC ¶50,598 ], 917 F.2d 115 (3d Cir. 1990).

Although the issue of subordination may be raised under the terms of a chapter 13 plan ⁴ the bankruptcy court must determine the equities of the case to determine if subordination is warranted. See Schultz Broadway Inn. v. United States [90-2 USTC ¶50,594 ], 912 F.2d 230 (8th Cir. 1990). This issue cannot be decided because the parties did not address this issue in their stipulation.

The debtors are granted twenty days to file a modified plan consistent with this opinion.

IT IS SO ORDERED.

¹ The state exemptions are provided for in Ark. Code Ann. §16 -66-218 (Supp. 1987); Ark. Const. art. 9, §§2 and 3 .

² Although certain personal property of the taxpayer is exempted from administrative levy or seizure by the IRS, "all property and rights to property, whether real or personal, belonging to the [taxpayer]" remain subject to the IRS's federal tax lien. 26 U.S.C. §§6321 , 6334(a) , 6334(c) . Federal tax liens may be secured by property exempt from levy under section 6334(a) . See, e.g., United States v. Barbier [90-1 USTC ¶50,107 ], 896 F.2d 377, 378-79 (9th Cir. 1990).

³ Subordination may also apply to the portion of IRS' claim that represents interest on the penalty assessment.

⁴ Bankruptcy Rule 7001(8).

 

 

 

[2000-2 USTC ¶50,596] Richard R. Morgan, Sandra S. Morgan, Debtors

U.S. Bankruptcy Court, East. Dist., N.C., Wilson Div., 00-02529-8-JRL, 6/20/2000

220 F3d 353.

[Code Secs. 6321 , 6334 and 6871 ]

Bankruptcy: Tax liens: Avoidance of: State exemption laws: North Carolina. --

Married debtors' motion to avoid two federal tax liens pursuant to section 522(f)(1) of the Bankruptcy Code was denied. That provision allows debtors to avoid judicial liens to the extent that they impair exemptions to which the debtors would otherwise be entitled; however, exempt property remains encumbered by perfected prepetition tax liens. Bankruptcy Code section 522 cannot be used to avoid federal tax liens, which do not qualify as judicial liens because they arise by operation of law and not by virtue of any judgment. Moreover, the applicable state ( North Carolina ) exemptions statute does not apply to claims of the federal government or its agencies; instead, tax liens are governed by exemptions from levy set forth in Code Sec. 6334 .
ORDER

LEONARD, Bankruptcy Judge:

This chapter 13 case is before the court on the debtors' motion to avoid two federal tax liens pursuant to §522(f)(1) of the Bankruptcy Code. This motion is appropriate for decision without a hearing.

The two tax liens at issue have an aggregate value of $35,323 and are identified in paragraph 2 of the motion as "judicial tax liens." The liens are subsequently described in more detail as: 1) a "filed . . . tax lien" in the approximate amount of $6,851, recorded in Book 79, Page 252 in the Wayne County Courthouse, and 2) a "judgment" in the approximate amount of $28,472, recorded in Book 77, Page 126 in the Wayne County Courthouse. Because the debtors' motion is brought under §522(f)(1), the court assumes for purposes of this motion that both liens have been reduced to judgment. ¹

A federal tax lien arises by operation of law if the taxpayer fails to pay a tax liability after the Internal Revenue Service ("Service") makes a demand for payment. 26 U.S.C. §6321. The lien arises in favor of the United States and attaches to "all property and rights to property" belonging to the taxpayer. Because it is created by operation of law, a federal tax lien is not valid as to third parties "until notice thereof" has been filed in the manner provided by state law. 26 U.S.C. §§6321(a) and (f). Thus, tax liens are created and perfected through a two step process. The assessment of taxes by the Service creates a tax lien that is valid as between the taxpayer and the United States . The Service then perfects this lien as to the rest of the world by properly filing a Notice of Federal Tax Lien.

Like most states, North Carolina has adopted the Uniform Federal Lien Registration Act. See N.C. Gen. Stat. §44-68.10 and following. Under this statute, the Service perfects a federal tax lien as to real property by filing a Notice of Lien in the office of the clerk of superior court of the county in which the real property is located. N.C. Gen. Stat. §44-68.12(b). After the Notice of Lien is filed, the Service's lien rights in the taxpayer's property are fixed, without need for the entry and docketing of any subsequent judgment. It follows that a federal tax lien is a statutory lien, as opposed to a judicial lien--even if the underlying tax debt is subsequently reduced to judgment. See, e.g., Rench v. United States (In re Rench), 129 B.R. 649 (Bankr. D. Kan. 1991).

Section 522 of the Bankruptcy Code recognizes the special nature of tax liens, specifically providing that the debtor's exempt property remains encumbered by a pre-petition "tax lien, notice of which is properly filed. . . ." 11 U.S.C. §522(c)(2)(B). North Carolina 's exemptions statute, N.C. Gen. Stat. §1C-1601, expresses this concept as well. Section 1C-1601(e)(1) provides that "[t]he exemptions provided . . . are inapplicable to claims . . . [o]f the United States or its agencies as provided by federal law." As a result of this section, the North Carolina exemptions statute has no application to federal tax liens, which are instead governed by the separate set of exemptions from levy contained in the Internal Revenue Code. See 26 U.S.C. §6334.

Section 522(f)(1)(A) allows a bankruptcy debtor to avoid a judicial lien to the extent that lien impairs an exemption to which the debtor would otherwise be entitled. There are two distinct reasons why this section cannot be used to avoid a federal tax lien. First, tax liens--which arise by operation of law and not by virtue of any judgment--are not judicial liens. See also 11 U.S.C. §101(36). Second, because §522 and North Carolina 's exemptions statute have no application to tax liens, it is impossible for a tax lien to impair an exemption to which the debtor would otherwise be entitled.

Based on the foregoing, the debtors' motion to avoid tax liens is denied.

So Ordered.

¹ Taxes are not normally collected by judgment. Instead, §6331 of the Internal Revenue Code gives the Service the right to collect taxes by levy if notice is given in the manner provided by statute. 26 U.S.C. §6331.