Georgia

---

 

[96-1 USTC ¶50,158] In re Hydro-Chem Processing, Inc. and Engineered Steel Products of Atlanta, Inc., Debtors. John W. Ragsdale, Jr., as Trustee, Plaintiff v. Blaw Knox Corp., Electralloy Corp., The Export-Import Bank of The U.S., Fisher Controls International, Inc., Fisher Controls Company of Canada, Ingersoll Rand Co., Manior Electroalloys Corp., Radnor Alloys, Inc., Smither Equipment, Inc., Georgia Department of Labor, Internal Revenue Service, et al., Defendants

U.S. Bankruptcy Court, No. Dist. Ga., Atlanta Div., 91-82431, 10/10/95, 190 BR 129

[Code Sec. 6323 ]

Validity of lien: Priority: Bankruptcy: Judgment creditors: State law.--

Under federal law, the IRS's claim for a bankrupt corporation's unpaid taxes had priority over the claims of two judgment lien creditors who obtained their judgments after the IRS recorded its tax lien even though, under state (Georgia) law, the creditors had equal priority with two other creditors who obtained judgments before the IRS. Thus, the IRS was entitled to funds from the liquidation of the bankruptcy estate, as determined by the dates on which the liens were recorded. However, in order to ensure that the junior judgment lien creditors were not deprived of their state law property rights, the senior judgment lien creditors whose claims had priority over the IRS's lien were deemed to have captured a fund equal to the amount of their claims which was distributed pro rata among all four creditors.

Donald R. Harkleroad, Harkleroad & Hermance, P.C., 229 Peachtree St. , Atlanta , Ga. 30303 , for debtor. John W. Ragsdale, Jr., 229 Peachtree St. , Atlanta , Ga. 30303-1629 , for trustee.

ORDER

MURPHY, Bankruptcy Judge:

This adversary proceeding is before the court on Trustee's motion for summary judgment. Trustee proposes in the motion for summary judgment a distribution, based upon the priority of the relevant liens of the claimants, of certain encumbered funds in Trustee's possession as a result of liquidation of Debtor's estate. The issue presents a conflict of lien priority law between Georgia state law and federal law, as a sizable IRS tax lien falls, chronologically, in the middle of four state liens which state law accords equal priority.

The following facts appear to be undisputed:

1. Trustee holds a fund in the amount of $675,175.22 (the "Fund"), which represents the net proceeds from the sale of property of the Debtor to Pro-Quip Corporation.

2. The Fund is subject to numerous liens. ¹ The total of the liens asserted against the Fund exceeds the amount of the Fund. The liens relevant to Trustee's motion are:

a. Export-Import Bank of the U.S. ("Eximbank"), pursuant to a UCC-1 financing statement filed in Cherokee County Superior Court January 31, 1989: $96,603.57

b. State of Georgia Department of Labor ("Georgia Labor"), pursuant to writs of Fieri Facias filed in Cherokee County Superior Court January 4, 1991 and February 26, 1991: $17,759.11

c. Blaw Knox Corporation ("Blaw Knox"), pursuant to a writ of Fieri Facias filed in Cherokee County Superior Court April 19, 1991, on a judgment obtained April 16, 1991: $89,408.08 (plus postpetition interest)

d. Ingersoll Rand Company ("Ingersoll") pursuant to a writ of Fieri Facias filed in the Cherokee County Superior Court June 7, 1991 , on a May 9, 1991 judgment obtained from Fulton County Superior Court: $94,440.88

e. Radnor Alloys, Inc., ("Radnor"), pursuant to a writ of Fieri Facias filed in Cherokee County Superior Court June 7, 1991, on a judgment obtained May 28, 1991: $115,607.84

f. Manior Electralloys Corporation ("Manior") pursuant to a writ of Fieri Facias filed in Cherokee County Superior Court June 11, 1991 on a judgment obtained from the Lorrain County, Ohio Court of Common Pleas, domesticated in Georgia in Cherokee County Superior Court June 11, 1991: ² $82,323.57 (plus postpetition interest)

g. The United States of America ("IRS"), pursuant to a Notice of tax lien filed in Cherokee County Superior Court June 21, 1991 : approximately $800,000

h. Electralloy Corporation ("Electralloy"), pursuant to a writ of Fieri Facias filed in Cherokee County Superior Court July 29, 1991, on a judgment obtained July 9, 1991: $210,993.00

i. Fisher Controls International, Inc. and Fisher Controls Company of Canada (collectively "Fisher"), pursuant to a writ of Fieri Facias filed in Cherokee County Superior Court July 30, 1991, on a judgment obtained July 30, 1991: $461,166.76

j. Smither Equipment, Inc. ("Smither"), pursuant to a writ of Fieri Facias filed in Fulton County Superior Court Sept.13, 1991, on a judgment obtained from the State Court of Fulton County ³ 8/30/91: $39,957.19 (plus prepetition post-judgment interest)

Trustee suggests that the admin istrative expenses to be paid from the Fund should be allocated pro rata among the secured creditors receiving distributions from the fund.

The priority of Eximbank , Georgia Labor, and Blaw Knox appears to be undisputed. The dispute arises with respect to the remaining claims, i.e. those of Ingersoll, Manior, Radnor, IRS, Electralloy, Fisher and Smither. All of those claimants except IRS are judgment lien creditors.

DISCUSSION

All the claimants and Trustee clearly and cogently presented their respective positions in this contest of lien priorities for purposes of payment. Rather than recount the respective positions of each creditor, the dispute will be framed, initially, by a description of the positions maintained by the Trustee, which includes the positions of Trustee, Ingersoll, Manior, Radnor, and IRS, and by Fisher, which includes the positions of Fisher and Electralloy.

Trustee proposes that the priority of the above-described liens should be based upon the dates the liens were recorded. If Trustee's position is accepted, the Fund will be depleted by the IRS claim, leaving nothing for Fisher, Electralloy and Smither, as each of those claims were recorded after the IRS claim was recorded. Fisher asserts that application of Georgia law would require that all of the judgment liens for which the judgments were obtained at the same term of court should be considered of equal date, and therefore, of equal priority. Fisher, however, further proposes that, in order to accord effect to both federal and state law, those claimants whose liens were recorded before the IRS tax lien will be deemed to have captured a fund in which the later claimants will share pro rata. Although the facts which have emerged during the course of the proceedings on Trustee's motion for summary judgment will require some refinement of the result proposed by Fisher, Fisher's position has merit.

Pursuant to 11 U.S.C. §724(b) , only lienholders whose liens are senior to a federal tax lien may obtain a distribution of property of the estate ahead of the IRS. Additionally, federal tax law provides that when a notice of tax lien has been duly recorded, the IRS lien takes priority over all other liens (with certain exceptions not applicable to the facts in this proceeding). 26 U.S.C. §6323 . Internal Revenue Regulations further provide that a judgment lien will take priority over a tax lien only if (a) it has been previously determined in amount, and (b) appropriately recorded or docketed, "[i]f recording or docketing is necessary under local law before a judgment becomes effective against third parties." Internal Revenue Regulation (26 C.F.R.) §302.6323(h)-1(g). Trustee thus advocates determination of the seniority of the various judgment liens based upon the date those liens were recorded.

Under Georgia law, no judgment lien is effective against third parties until the judgment is entered on the General Execution Docket (GED) for the Superior Court of the county in which the judgment debtor is a resident. O.C.G.A. § 9-12-81 . When so recorded, however, for priority purposes, the judgment lien relates back to the date of rendition of the judgment and is considered of equal date (and, therefore, equal priority) with other perfected liens arising from judgments rendered at the same term of court. O.C.G.A. § 9-12-87 ; National Bank of Georgia v. Morris-Weathers Co., 248 Ga. 798 (1982). ⁴ Pro rata distribution from property subject to more than one judgment lien is appropriate where the aggregate amount of the liens exceeds the value of the property. Wellington v. Lenkerd Co., 157 Ga. App. 755 (1981).

The relevant term of court in Cherokee County (the Blue Ridge Circuit) commenced the second Monday in May, May 13, 1991 , and ended August 31, 1991 . The relevant terms of court in Fulton County (the Atlanta Circuit) commenced the first Monday in May, May 6, 1991 , and ended June 30, 1991 (Ingersoll), and began the first Monday in July, July 1, 1991 , and ended August 31, 1991 (Smither). Therefore, it appears that the judgments of Manior, Radnor, Electralloy, and Fisher were all rendered during the same term of Cherokee County Superior Court and, thus, are of equal date and priority with the Radnor judgment, rendered May 28, 1991, which was the earliest judgment obtained in that term of court. As the Ingersoll judgment was rendered during a different, earlier term of court, it stands alone and prior to the later Cherokee County judgments. Eads v. Southern Surety Co. 178 Ga. 348 (1934). As the Smither judgment was rendered during a different, later term of court, it is subordinate to liens on judgments obtained during an earlier term of court. ⁵ Id. [See chart at Figure 1].

                           Figure 1

                          *                           Relevant

                       Dollar                        County and

             Mode of   Amount    Dates of Fi.Fa è    1st Day of

Creditor    Perfection (000's)       Judgment        Court Term

Eximbank    U.C.C.

            Cherokee    $  96  n/a (1989) n/a        n/a

Ga.

 Labor   FiFa

            Cherokee    $  18  (
1/04/91
 & 
2/26/91
)   (prior)

Blaw Knox   FiFa

            Cherokee    $  89  4/19/91 è 
4/16/91
     (prior)

Ingersoll   FiFa               (judgment 
Fulton
)     

Fulton

            Cherokee    $  94  6/07/91 è 5/09/91     5/6/91

                      *  *  *  *  *  *  *

Radnor      FiFa                                     Cherokee

            Cherokee    $ 116  6/07/91 è 5/28/91     5/13/91

Manior      

Ohio

 è                                   Cherokee

            Cherokee    $  82  6/11/91               5/13/91

IRS         Tax Lien-

            Cherokee    $ 800  6/21/91               n/a

Electralloy FiFa                                     Cherokee

            Cherokee    $ 211  7/29/91 è 7/9/91      5/13/91

Fisher      FiFa                                     Cherokee

            Cherokee    $ 461  9/30/91 è 7/30/91     5/13/91

                      *  *  *  *  *  *  *

Smither     FiFa                                     

Fulton

            

Fulton

      $  40  9/13/91 è 8/30/91     7/1/91

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

 *  Amounts used are rounded in thousands, based upon the

amounts set forth in Trustee's brief. This chart does not

constitute a conclusion by this court that a claim is allowed

in a particular amount.

 

A complication arises, however, because the IRS tax lien is interposed between the judgments of Manior and Radnor, and the judgments of Electralloy and Fisher. Without dispute, the liens of Manior and Radnor are senior to the IRS tax lien. Also, without dispute, the IRS lien is senior to the liens of Electralloy and Fisher, as those liens were neither determined as to amount nor recorded prior to the recordation of the Notice of tax lien. The refined issue, therefore, is whether this court can give effect to both the federal law and the state law applicable to determination of priority of liens.

A firmly held principle of bankruptcy law is that, except in those areas specifically addressed by Congress in a federal statute, property rights in a debtor's assets are determined in accordance with state law. Butner v. U.S. , 440 U.S. 48 (1979).

Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests by both state and federal courts within a State serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving "a windfall merely by reason of the happenstance of bankruptcy." (Citations omitted.)... [T]he federal bankruptcy court should take whatever steps are necessary to ensure that the [secured creditor] is afforded in federal bankruptcy court the same protection he would have under state law if no bankruptcy had ensued.

Id. at 55, 56. Therefore, to the extent that state law may be given effect in defining a claimant's interests in property of a debtor, the court has a duty to apply state law to assure that the claimant is not deprived of those state law property rights.

Essentially this court has three choices as to determining the priority of the liens in this case: First, apply only federal law and, therefore, look only to the dates the liens were recorded, with the result that Fisher and Electralloy get nothing and lose the benefit of their rights under state law to equal priority with Radnor and Manior. Second, apply only state law and, therefore, move Fisher and Electralloy ahead of IRS, with the result that Radnor, Manior, Electralloy and Fisher share pro rata in the balance of the Fund remaining after payment in full of the first four claimants and IRS loses its federal law priority and receives nothing. Third, apply federal law to determine that the IRS claim has priority over the Electralloy and Fisher claims, with the result that Electralloy and Fisher receive none of the funds to which the IRS is entitled; then apply state law by creating a fund equal to the amount of the claim of Radnor plus the claim of Manior and then distributing the fund pro rata among Radnor, Manior, Electralloy and Fisher.

This court is bound by the Supremacy Clause ⁶ to apply federal law to determine the priority of the claim of the IRS. U.S. v. Rodgers [83-1 USTC ¶9373 ], 461 U.S. 677 (1982). Therefore, only the third choice fulfills the bankruptcy court's duty to employ the federal law applicable to the federal tax claim and also assure that the state court judgment lien claimants are not deprived of their state law property rights. The application of state law is especially appropriate in the instant case as the state law, O.C.G.A. § 9-12-87 , is intended to achieve a purpose also intended by the Bankruptcy Code: to achieve equality of distribution among creditors by avoiding a "race to the courthouse." See, National Bank of Georgia v. Morris-Weathers Co., 248 Ga. 798 (1982). Creditors who obtain judgments in the same term of court in the same county have equal lien priority on their writs of Fieri Facias.

Trustee also proposed in his motion for summary judgment that the admin istrative expenses allocated to and payable from the Fund should be allocated pro rata among the claimants who receive payment from the Fund. The responses of Blaw Knox and Ingersoll oppose allocation of admin istrative expenses among the claimants to the Fund.

Section 506(c) provides:

The trustee may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim.

Section 724(b) provides that property subject to tax liens shall be distributed first to senior lienholders and next to priority claimants asserting claims under §507(a)(1) -(7). Administrative expenses are accorded priority under §507(a)(1) . The plain language of both §506 and §724 appears to contemplate that admin istrative expenses are a separate claim against the relevant property. Under §506, the trustee's costs and expenses are deducted ahead of payment of the secured creditor's claim. In re Afco Enterprises, Inc., 35 B.R. 512 (Bankr. D. Utah 1983). Under §724 , admin istrative expenses are deducted after payment of secured creditors' claims but before payment of a tax lien.

Under neither §506 nor §724 is a pro rata assessment against each of the claimants an option. In the instant case, this court cannot approve such a procedure without consent of all the claimants. As objections to the Trustee's proposal have been raised, it cannot be approved. Accordingly, it is hereby

ORDERED that Trustee's motion for summary judgment is granted in part and denied in part: With respect to the Fund identified above, Trustee may distribute the Fund as follow:

(a) Payment in full to Eximbank;

(b) Payment in full to Georgia Labor;

(c) Payment in full to Blaw Knox;

(d) Payment in full to Ingersoll;

(e) Creation of a fund equal to the amount of the allowed secured claim of Radnor plus the amount of the allowed secured claim of Manior. From that fund shall be paid pro rata, the claims of Radnor, Manior, Electralloy and Fisher;

(f) Payment of priority claimants as provided in 11 U.S.C. §724(b)(2) ; and

(g) The remaining balance of the Fund to the IRS.

As the validity, priority and extent of liens has thus been finally determined pursuant to the above-captioned complaint filed pursuant to Rule 7001, it is further

ORDERED that issues regarding allowance of claims, including admin istrative expenses and other priority claims, will be determined on appropriate motion or other pleading filed in the main case.

IT IS SO ORDERED.

¹ In the original complaint, Trustee named 70 lien claimants as defendants. As a result of either consent order or default judgment, the majority of the original defendants have no lien or interest of any kind in the Fund.

² This representation of the facts as to Manior's judgment lien differs slightly from Trustee's statement of undisputed facts, but is based upon the documents in Manior's answer.

³ Only Smither's judgment was recorded in Fulton County rather than Cherokee County . Smither's judgment is perfected pursuant to O.C.G.A. 9-12-B1, however, because Debtor was a resident of Fulton County as well as Cherokee County . No party to this proceeding has argued that Smither's claim lacks validity or priority because it was recorded in Fulton County instead of Cherokee County .

⁴ The case specifically rejected the holding in the case of In re Tinsley, 421 F. Supp. 1007 (M.D. Ga. 1976), which held that the single date and sole criterion for measuring priorities between competing judgment liens and for determining the effect of a judgment on the title to real property was the date of recordation of the judgment.

⁵ The overlapping dates of the relevant terms of court set forth above illustrate an anachronism in the use of terms of court as a vehicle for determining priority of judgment liens. Smither's lien relates back to the August 30, 1991 judgment date. Because the term of court to which it dates for priority purposes began July 1, however, it becomes a "different, later" term of court. In fact, however, Cherokee's similar term of court, which began May 13 and ended August 31 in 1991, encompasses two terms of Fulton Court , the earlier of which began May 6 and the later of which ended August 31. Thus a lien obtained through a judgment rendered August 31 in Cherokee County would be prior to a lien obtained by judgment rendered August 30 in Fulton , because Fulton 's relevant term of court did not begin until July 1.

Recent technological advances in transportation and telecommunication, as well as the proliferation of multi-county, multi-state and multi-national companies, render it increasingly likely that competing judgment liens will be obtained from different circuits with different terms of court. Because of the non-standardization of terms of various courts set forth in the Georgia Code, Ingersoll wins full payment in this lien contest because it was able to obtain its Fulton judgment before the Cherokee County Superior Court's term even began. Similarly, Smither loses this lien contest even though it obtained its judgment before the end of the Cherokee term of court, because it filed in Fulton County , where new terms of court commence every two months.

⁶ U.S. Const., Art. VI, cl. 2.

 

 

[91-2 USTC ¶50,540] John E. Tompkins, as Executor of the Last Will and Testament of Steven M. Tompkins, Deceased, Plaintiff-Appellee v. The United States of America , Defendant-Appellant, Internal Revenue Service, Defendant

(CA-11), U.S. Court of Appeals, 11 Circuit, 90-8825, 11/8/91, Affirming a District Court decision, 90-2 USTC ¶50,400

[Code Secs. 6323 , 7425 and 7426 ]

Liens: Validity: Priority of claims: Discharge.--A seller's lien in a wraparound mortgage survived his purchase of the real estate at a nonjudicial foreclosure sale, although he failed to give notice to the IRS prior to the sale. Under state ( Georgia ) law, the seller's lien retained its priority over the federal tax lien because the mortgage lien did not merge with the underlying fee. The IRS was properly enjoined from levying on and selling the real estate.

Stanley E. Harris, Jr., Karsman, Brooks & Callaway, P.C., 301 W. Congress St., Savannah, Ga. 31412, James P. Gerard, Julia R. Friedman, Oliver, Maner & Grey, 218 W. State St., Savannah, Ga. 31401, for plaintiff-appellee. Elizabeth Sullivan, Gary R. Allen, David M. Moore, Brian C. Griffin, Ernest J. Brown, Department of Justice, Washington, D.C. 20530, for defendant-appellant.

Before FAY, EDMONDSON and COX, Circuit Judges.

EDMONDSON, Circuit Judge:

In this action to quiet title, defendant-appellant Internal Revenue Service appeals an adverse district court summary judgment enjoining the IRS from seizing the property in question and holding that plaintiff-appellee's interest in the property is superior to that of the IRS. We affirm.

Background

In September 1985, plaintiff-appellee Tompkins sold real property in Georgia to the Hildreths, retaining a purchase money wraparound security interest. ¹ At the time of the purchase, the Hildreths owed money to the Internal Revenue Service, and the IRS had a properly filed lien on all Hildreth property, including after-acquired property. As a result, when the Hildreths acquired Tompkins' property, the IRS also acquired a lien on that property; its lien, however, was subordinate to Tompkins'. ²

Within a year, the Hildreths defaulted, and Tompkins foreclosed, exercising his right under the security deed and state law to conduct a non-judicial foreclosure sale. In 1986, Tompkins purchased the property at the foreclosure sale for the amount of its secured interest plus fees, approximately $100,000. Although the sale was publicly advertised according to Georgia law, the IRS received no specific, individualized notification as defined in Section 7425 of the Internal Revenue Code, 26 U.S.C.A. §7425(c)(1) . Both parties agree that one of the consequences of this oversight was continuation of the IRS lien after the sale. 26 U.S.C.A. §7425(b)(1) .

In 1989, the IRS levied upon and seized the property in partial satisfaction of the Hildreths' unpaid federal income tax liabilities. Shortly thereafter, Tompkins brought this action to quiet title, asserting the levy was wrongful and seeking to enjoin sale of the property. The district court granted summary judgment for Tompkins, concluding that his lien not only survived the foreclosure sale, but also remained superior to the IRS lien.

Tompkins' Lien

State law traditionally governs the definition of property interests to which a federal tax lien may attach. United States v. Rodgers [83-1 USTC ¶9374 ], 461 U.S. 677, 683, 103 S.Ct. 2132, 2137, 76 L.Ed.2d 236 (1983); Acquilino v. United States [60-2 USTC ¶9538 ], 363 U.S. 509, 512-14, 80 S.Ct. 1277, 1279-80, 4 L.Ed.2d 1365 (1960); United States v. Brosnan [60-2 USTC ¶9516 ], 363 U.S. 237, 240-42, 80 S.Ct. 1108, 1110-11, 4 L.Ed.2d 1192 (1960). Before we can evaluate the priority of the liens, we must first determine Tompkins' post-foreclosure sale property rights.

State law usually dictates that senior lienors become fee owners when they purchase at a foreclosure sale conducted on their own lien. In states that adhere to the merger doctrine, the lesser estate (or lien) "merges" into the greater estate and is thereby extinguished. Because the merger doctrine varies in its application from state to state, the former senior lienor's property interest depends upon how applicable state law treats merger.

Despite general codification of the merger doctrine, ³ "an intent not to merge will be presumed and will control" in the state of Georgia. Gosnell v. Waldrip, 158 Ga.App. 685, 282 S.E.2d 168, 170 (1981) (emphasis added). In addition, "in the absence of proof to the contrary, [the presumption will be] that [the mortgagee or senior lienor] intended what would best accord with his interests." Barron Buick, Inc. v. Kennesaw Fin. Co., 105 Ga.App. 451, 124 S.E.2d 918, 921 (1962) (quoting 59 C.J.S. 681, Mortgages, §441 ).

This equitable exception to the merger doctrine has been decisive in many Georgia cases. See Fraser v. Martin, 195 Ga. 683, 25 S.E.2d 307 (1943) ("Whenever a merger will operate inequitably, it will be prevented. The controlling consideration is the intention, expressed or implied, of the person in whom the estates unite.") (citation omitted); Pope v. Hammond, 168 Ga. 818, 149 S.E. 204 (1929) (no merger "if the continued existence of the mortgage is necessary to protect against intervening liens").

Both Tompkins and the IRS agree that Tompkins never manifested an intent to merge lien and fee. Tompkins' best interests compel the exception and not merger; otherwise, his entire interest in the property exception and not merger; otherwise, his entire interest in the property can be wiped out by the IRS, with no relief from his continued liability as holder of the first mortgage. The only realistic conclusion under Georgia law is that no merger of the lien and fee took place when Tompkins bought the property at foreclosure; his lien continues.

Our decision is consistent with those reflecting state merger law comparable to Georgia 's. See, e.g., United States v. Colorado [89-1 USTC ¶9260 ], 872 F.2d 338 (10th Cir.1989) (applying Colorado law); First Am. Title Ins. Co. v. United States [88-2 USTC ¶9408 ], 848 F.2d 969 (9th Cir.1988) (applying California law).

Nor do we act inconsistently with the two circuit cases concluding that merger extinguished the senior lien. United States v. Polk [87-2 USTC ¶9432 ], 822 F.2d 871 (9th Cir.1987), was resolved on the basis of Arizona law, which considers the senior lienor's intent irrelevant. Id. at 874. In Southern Bank of Lauderdale County v. IRS [85-2 USTC ¶9670 ], 770 F.2d 1001 (11th Cir.1985), cert. denied sub nom. Mid-State Homes, Inc. v. United States, 476 U.S. 1169, 106 S.Ct. 2890, 90 L.Ed.2d 977 (1986), the applicable law was the law of Alabama, which espouses merger. Id. at 1007. Although Alabama acknowledges equitable exceptions to merger, Bay Minette Prod. Credit Assoc. v. Federal Land Bank, 442 So.2d 47, 49 (Ala.1983), in Southern Bank these exceptions were never briefed by counsel nor addressed by the court in the context of defining the senior lienor's property interests. "Instead, after the court determined that [merger had occurred and] the liens did not survive the sale, the lienors apparently argued that Alabama law would provide equitable relief on the priority issue." First Am. Title Ins. Co. [88-2 USTC ¶9408 ], 848 F.2d at 971-72 (emphasis added).

Because federal law governs the priority of a tax lien against other claims to property, Rodgers [83-2 USTC ¶9374], 461 U.S. at 683, 103 S.Ct. at 2137 (citations omitted), we agree with the panel in Southern Bank that state equitable principles cannot override federal priority standards. But a case is not binding precedent for any proposition that was not then before the court, and priority and property are two distinct issues. Southern Bank, therefore, does not preclude our consideration of state law in determining property interests. Accord First Am. Title Ins. Co. [88-2 USTC ¶9408 ], 848 F.2d at 971-72. Southern Bank is limited and should be understood as authority only for the issues before that panel. Our approach here--relying on a state-law equitable exception to the merger doctrine--has been adopted by every other circuit that has addressed the issue we address. Applying Georgia law means that Tompkins' lien survives.

Failure to Notify Under 26 U.S.C.A. §7425

The argument that Tompkins' property rights (or lack thereof) post-sale can be determined by section 7425 runs counter not only to case law, but also to the plain language of the statute itself, which is entitled, appropriately, "Discharge of Liens," not "Priority of Liens." Nowhere does section 7425 indicate that the priority status of the tax lien changes when no notice (or improper notice) is given. Instead, the statute says that the sale, or ensuing title, is "made subject to and without disturbing [the federal] lien or title" (emphasis added). ⁴

The enactment of section 7425 came about in part because Congress believed that the interests of the United States were insufficiently protected where, pursuant to state law, junior federal tax liens were being extinguished without notice to the United States . S. Rep. No. 1708, 89th Cong., 2d Sess., reprinted in 1966 U.S. Code Cong. & Admin. News 3722, 3748. If any pre-emptive effect was intended by Congress, we believe it is limited to preemption of local laws which would completely discharge the government's junior interest without clear notice to the government.

Notice provides the government with the "opportunity to review its position and determine the appropriate action without placing an undue burden on a foreclosing creditor." Id. If notice of a non-judicial foreclosure sale is properly given and the United States consents to the sale, the sale divests the property of the government lien. 26 U.S.C.A. §7425(c)(2) . Even when the United States does not consent, proper notice gives effect to local law, which, in most cases, operates to discharge the junior liens. 26 U.S.C.A. §7425(b)(2) . The survival (not the elevation) of inferior federal tax liens is the penalty Congress intended to impose on senior lienholders who fail to give the presale notice prescribed by section 7425 . See First Am. Title Ins. Co. [88-2 USTC ¶9408 ], 848 F.2d at 972-73. This penalty allows the IRS to maintain the status quo of its lien, as well as benefit from future increases in the value of the property.

Priority of Liens

Having determined that both the Tompkins lien and the IRS lien continue following the foreclosure sale, we return to federal law to determine the priority of those interests. See Rodgers [83-1 USTC ¶9374 ], 461 U.S. at 683, 103 S.Ct. at 2137 (citations omitted). According to the Federal Tax Lien Act, the former senior lien remains superior because it was properly perfected under state law before the IRS lien. 26 U.S.C.A. §6323(a) , (h)(1) ; see also Aetna Ins. Co. v. Texas Thermal Indus., Inc. [79-1 USTC ¶9287 ], 591 F.2d 1035, 1038 (5th Cir.1979) (per curiam).

We therefore hold as a matter of law that Tompkins' lien survived his purchase at the non-judicial foreclosure sale, although he failed to give notice to the IRS before the sale. Furthermore, Tompkins' lien retains its priority over the federal tax lien, and the government was properly enjoined from levying on and selling the real property in question.

The district court is AFFIRMED.

¹ The property was sold for $99,500, 90% of which was deferred. The deferred amount was secured by a purchase money, wraparound mortgage on the property. Under this type of arrangement, the mortgagee, Tompkins, remained liable on a superior (first) mortgage despite his sale of the property, but he used the payments received from his purchaser/mortgagor, the Hildreths, to make payments on the first mortgage.

² A tax lien is generally subordinate to a previously perfected security interest in real property, such as a prior mortgage. 26 U.S.C.A. §6323(a) .

³ O.C.G.A. §44 -6-2.

⁴ Only the most torturous stretch of the phrase "subject to" would permit section 7425 to be interpreted as defining priority levels, and that interpretation requires ignoring the words "without disturbing" the lien.

 

 

[77-2 USTC ¶9594]Colonial Baking Company of Atlanta , a Delaware Corporation v. United States of America

U. S. District Court, No. Dist. Ga. , Atlanta Div., C76-2066a, 8/5/77

[Code Sec. 6323--result unchanged by '76 Tax Reform Act]

Tax liens: Levy: Priorities: Bank Accounts: Judgment lien.--A tax lien had priority to certain bank accounts over that of a judgment creditor. Under Georgia law the judgment creditor had not reached the status of a lien creditor against the accounts since it had not commenced a garnishment action against either bank. The federal tax lien was perfected as of the date of filing and it had priority over any inchoate claim by the judgment creditor.

Dennis M. Hall, Lipshutz, Zusmann, Sikes, Pritchard & Cohen, 1795 Peachtree Rd., NE, Atlanta, Ga. 30309, for plaintiff. John W. Stokes, Jr., United States Attorney, Sherman R. Johnson, Assistant United States Attorney, Atlanta , Ga. , George Rita, Department of Justice, Washington , D. C. 20530, for defendant.

Order of Court

MOYE, District Judge:

This is an action to set aside a levy by the Internal Revenue Service on certain bank accounts. Plaintiff, Colonial Baking Company of Atlanta , a Delaware corporation, licensed and doing business in Georgia , alleges that it had a prior perfected judgment lien on the funds which were levied upon. The case is presently before the Court on cross motions for summary judgment. Defendant seeks dismissal of the action. Plaintiff seeks an order directing defendant to pay to plaintiff a sum sufficient to satisfy plaintiff's judgment from the funds obtained as a result of defendant's levy.

The undisputed facts in this case are as follows: On April 1, 1975 , plaintiff recovered a judgment in the Civil Court of Fulton County against Ralf's Country Stores, Inc., a Georgia corporation. The judgment fi. fa. was recorded on the General Execution Docket of the Superior Court of Fulton County on April 23, 1975 . On March 12, 1976 , and April 9, 1976 , notices of tax liens were filed and recorded in Fulton County by the Internal Revenue Service. A levy was made by Internal Revenue Service agents on July 14, 1976 , against the bank accounts of Ralf's Country Stores, Inc., at the First Citizens Bank of Fayetteville at Fayetteville , Georgia , and the Fairburn Banking Company in Fairburn , Georgia .

Plaintiff contends that the levy by Internal Revenue Service agents was wrongful in that plaintiff's recorded judgment created a lien in its favor prior to the notice of lien by the Internal Revenue Service. Therefore, plaintiff asserts, it is entitled to satisfy its judgment out of the funds seized by the Internal Revenue Service.

The defendant maintains that bank accounts which were levied upon were choses in action and that under the law of Georgia , a judgment does not become a choate lien upon a chose in action until a judgment creditor garnishes the chose in action. Based on the fact that plaintiff did not commence garnishment proceedings prior to the filing of the tax liens, defendant argues that plaintiff has no interest in the bank accounts which were levied upon.

The law is clear that summary judgment may be granted only where no genuine issue as to any material fact exists. Poller v. Columbia Broadcasting System, 368 U. S. 464 (1962). In this case, the only question to be decided is whether, as a matter of law, plaintiff has a choate judgment lien upon the bank accounts so as to have priority over the subsequently recorded federal tax lien.

Defendant's tax lien is based on the Internal Revenue Code, 26 U. S. C. §6321, which provides for a general lien in favor of the United States upon all of the property and rights to property belonging to any person who fails to pay any tax after demand for payment. However, a federal tax lien will be invalid against a prior judgment lien which has become choate before the tax lien arises. Such a lien is considered to be choate if the identity of the lienor, the property subject to the lien and the amount of the lien are established. United States v. New Britain , 347 U. S. 81 (1954).

The effect of a lien in relation to a provision of federal law for the collection of debts owing to the United States is always a federal question. Hence, although the classification by a state court of a lien as perfected is entitled to weight, it is subject to reexamination. On the other hand, if the state court itself describes the lien as unperfected or inchoate, that classification is practially conclusive. U. S. Security Trust and Savings Bank, 340 U. S. 47 (1950); Illinois v. Campbell , 329 U. S. 362 (1946).

In Georgia , it is settled that money placed on general deposit in a bank creates a chose in action in the depositor. Macon National Bank v. Smith, 170 Ga. 332 (1930); Fulton County v. Wright, 146 Ga. 447 (1917); McGregor v. Battle , 128 Ga. 557 (1907). Furthermore, a judgment alone does not create a lien on a chose in action; a lien on a chose in action is created only by the service of a summons of garnishment and the lien dates from the date of the service of summons, and not from the judgment. Armour Packing Co. v. Wynn, 119 Ga. 683 (1904); General Lithographing Co. v. Sight and Sound Projectors, Inc., 128 Ga. App. 304 (1973).

The facts of this case show that plaintiff did not commence a garnishment action against either bank. Therefore, it has never reached the status of lien creditor against the accounts in either bank. The federal tax lien was perfected as of the date of filing and it had priority over any inchoate claim by plaintiff.

Accordingly, the Court finds that the seizure of the bank accounts by the Internal Revenue Service was lawful. Defendant's motion for summary judgment is hereby GRANTED; plaintiff's motion for summary judgment is DENIED.

 

 

[54-1 USTC ¶9299]United States of America v. Claude E. Ridley, Mrs. Dimple Gray Ridley, sometimes known as Mrs. Dimple G. Ridley and as Mrs. Dimple Ridley, L. B. Ridley and W. A. Ridley

In the United States District Court, Northern District of Georgia, Atlanta Division, Civil Action No. 4718, 120 FSupp 530, March 20, 1954

Accounting periods and methods: Net worth increase: Apportionment over several years.--In a suit by the United States alleging that the taxpayers, husband and wife, owed taxes, and that other defendants claimed liens against or interests in property belonging to the taxpayers, the United States asserted its liens against such property and asked for a receiver and injunction and that the claims of the taxpayers and other defendants be determined and the government's liens foreclosed. The taxpayers questioned the correctness of the tax assessment which had been based on the net worth and expenditures method for the years 1939 through 1951. Taxpayers had kept no records and filed no returns. The method used by the Commissioner for determining the time that income was received was based entirely upon the time of expenditure, and this resulted in a great difference in the taxes assessed in the various years. Because there was evidence that the taxpayers' earnings were about equal in each of the taxable years, 1942 through 1951, the Court, after making some adjustment of estimated expenditures in favor of the taxpayers, distributed the income evenly over 1939-1951, so that the opening net worth as of December 31, 1941, was increased by at least $42,414.44.

Lien for taxes: Property subject to lien: Another's interest in property.--Pursuant to an oral contract, relatives of the husband (the other defendants) did some work on the husband's farm on the understanding that they would receive a half-interest if they would go in there and "clean up". It was held that the defendants had acquired no interest in the land, equitable or oterwise, since the contract was too vague and uncertain to be capable of enforcement.

Priority of liens: Materialmen's and laborers' liens.--The relatives also agreed with the husband that they would furnish material and labor in erecting two houses on other property of the husband and that they would receive payment on sale. The Court held that there was no evidence that laborers' or materialmen's liens had been obtained and ordered that the goverment's liens be foreclosed. The Court saw no necessity for a receiver or injunction.

Lien for taxes: Property subject to lien: Joint ownership.--The interest of the husband in joint ownership bonds was subject to the government's claim for taxes owed.

Additions to tax in case of nonpayment: Failure to file declaration of estimated tax: Double penalties.--An addition of 10% to the tax was made for failure to file a declaration or to pay the installment of the estimated tax. However, the Court refused to apply the 6% addition for substantial underestimation for the reason that the taxpayer had made no underestimation (having filed no returns) and that he had suffered "the greater sanction of 10%." BACK REFERENCES: §39.294-54FED ¶1 at 54FED ¶544 CCH 1524.3195.

Jas. W. Dorsey, United Attorney, Post Office Box 912, Atlanta 1, Ga., for plaintiff. Hal Lindsay, M. Neil Andrews, 924 Healy Building, Atlanta , Ga. , for defendants.

SLOAN, District Judge:

The United States brings this complaint in equity alleging that the Commissioner of Internal Revenue has made tax assessments against the defendant, Claude Ridley, for the years 1942 through 1951, inclusive, which taxes, penalties and interest amount to $106,674.37.

Asserting its lien for taxes on described property, the United States alleges that the other named defendants claim liens against or interests in the described property.

Alleging further that the defendant, Claude Ridley, was likely to encumber or transfer the property, the plaintiff prays for a receiver and injunction and that the claims of the defendants be determined and the plaintiff's liens foreclosed.

The defendants make answer. The defendant, Claude Ridley, denies the correctness of the tax assessments; denies fraud or intent to evade the payment of tax and prays that this Court determine the amount of taxes due. The other defendants each assert some claim upon or interest in some of the described properties and seek a determination thereof.

Findings of Fact

The defendants, Claude Ridley and Mrs. Dimple Ridley are husband and wife. They are about forty years of age and were married about twenty years ago and have no children. Neither has any education and can neither read or write. They have lived on a farm all of their lives and have raised some cotton and corn, hay, produced a few chickens and eggs, and sold some milk and butter. So far as can be determined, they never raised in excess of three to four bales of cotton or two to three hundred bushels of corn in any one year. Their marriage apparently took place about 1934, and in 1937 Claude Ridley, together with Nathan Ridley, entered a plea of guilty in the District Court of the United States for the Northern District of Georgia to the offense of possession of 113 gallons of illicit liquor, the containers not having affixed thereto revenue stamps, and it appears that from this time on the defendant, Claude Ridley, was engaged in the illegal liquor traffic, both manufacturing and selling. Though this business may not have been continuous, the evidence not disclosing the facts in this respect, the circumstances indicate a fairly continuous illicit liquor business.

Both Claude Ridley and his wife were frugal to the point of miserliness; had no luxuries of life, and the barest necessities. From the evidence, and from their appearance, it is determined, with reasonable certainty, that they have lived frugually through the years and have spent little for living expenses, the Court being of the opinion, and here finds, that the expenditures of Claude Ridley and his wife, Dimple Ridley, for living expenses during the years 1937, 1938, 1939, 1940, 1941, 1942, 1943, 1944, 1945, 1946, 1947 and 1948 did not exceed the sum of $1,000.00 per year, and that during the years 1949, 1950 and 1951 that said expenditures did not exceed the sum of $1500.00 per year.

Claude Ridley and his wife saved their money and some years later purchased a small farm upon which there was situated a residence and a small store building, the same containing fifteen to twenty acres of land. This farm apparently was placed in the name of the wife, Dimple Ridley, and for many years they have lived on the farm and have operated the country store, selling groceries and gasoline. No records were kept of the amount of income or of the business transacted, and it is impossible to determine accurately the amount of income received by Claude Ridley, nor is it possible to determine accurately the years in which the income was received. It does appear, and the Court finds, that during the years 1942 through 1951, the defendant, Claude Ridley, and his wife, Dimple Ridley, purchased United States Savings Bonds in the sum of $98,550.00; real estate in the sum of $23,030.50; an automobile-truck $1425.00; spent for building materials and for the improvement of real estate, $2,199.83; deposited $1,308.00 in cash in the bank; expended $1,750.00 in the construction of a grist mill building; all of such purchases and expenditures were made from taxable income received by Claude Ridley during the years 1937 through 1951, inclusive.

[Construction of Income]

In 1952 a special agent of the Internal Revenue Service, United States Department of Internal Revenue, commenced an investigation of the tax liability of Claude Ridley, and finding that no records had been kept by Claude Ridley, and that it was impossible to determine his income with accuracy since no records were kept, said special agent began the investigation by talking with the taxpayer, examining the public records of Murray and Whitfield counties, examining the bank records and the bond purchases by the said Claude Ridley, and determined that the best method by which to compute the taxable income of Claude Ridley would be the net worth and nondeductible expenditures method and accordingly the investigator adopted that method of determining the income and computing the tax, and in so doing, the special agent determined the year that the purchases were made and the year that the other expenditures were made and charged said amounts as income in the year in which the purchases or expenditures were made. The special agent testifying that he was unable to find money or property belonging to Claude Ridley prior to 1942, fixed as the opening net worth as of December 31, 1941, nothing, and although he determined from investigation that the said Claude Ridley did in January, 1942, purchase United States Government Bonds in the sum of $7,500.00, he charged the said sum of $7,500.00 as having been earned and received by the said Claude Ridley in the year 1942, and taxable as such.

The method used by the special investigator for determining the time that income was received by Claude Ridley was based entirely upon the time of the purchase or expenditure, and this has resulted in a great difference in the taxes assessed in the various years. For instance, for 1942 a tax of $2,584.00, besides interest and penalties is assessed, while in the year 1943, a tax of $181.28 is assessed. In 1947 a tax of $15,277.54 is assessed, while in 1948 a tax of $483.00 is assessed, the amount of income allocated in each year being based entirely upon the amount of the purchases or expenditures in that year.

There is in evidence the positive testimony of Claude Ridley and his wife that their earnings were about equal in each of the years. There is no evidence of greater income in one year than in another (except the date of the expenditures).

From and including the year 1937, the first year that the evidence shows Claude Ridley to have been in the illicit liquor business, his sources of income were substantially the same from 1937 through 1951, inclusive, said sources of income being: (1) From the illicit liquor business; (2) the farming operations, and (3) the country store and filling station.

It appears without dispute that Claude Ridley did not deposit his money in banks but kept it in cash, all payments for bonds and real estate being made in cash. It appears that on one occasion that he carried from six thousand to six thousand five hundred dollars in coins to the bank for the purchase of bonds and that the coins had been buried for so long that they were in bad shape, rusted and corroded.

During the ten year period from 1942 through 1951, inclusive, Claude Ridley made expenditures for investment of approximately one hundred twenty thousand dollars, while during the same period only thirteen hundred and eight dollars was deposited in any bank.

These circumstances corroborating the testimony of the taxpayer as to receipt of income, in the opinion of the Court, entitles the testimony of the taxpayer to credit. Furthermore, in the absence of proof to the the contrary, it is more logical and reasonable to believe that the income received was in substantially equal amounts in each of the years from 1937 through 1951 inclusive. The evidence preponderates to this theory. From the evidence it is not clear just how much money was expended in the purchase of United States Government Bonds. However, looking to the defendants' answer to the amended complaint, it appears from paragraphs 5 and 6 thereof that the defendants admit purchasing said bonds at a cost of $102,300.00, while it appears from the original complaint that of said sum $3,750.00 of said bonds were redeemed, so that the expenditures for the purchase of United States Government Bonds, for tax purposes, would be $98,550.00. The Court therefore finds that the total income of Claude Ridley for the years 1937 through 1951 was as follows:

Purchases, deposits and expenditures

1942 through 1951, inclusive:

Savings Bonds ...........................         $ 98,550.00

Realty Purchased ........................           23,030.50

Improvements on 

Rogers

 Subdivision

Property ................................            2,179.83

1/2 Cost of Grist Mill ..................            1,750.00

Automobile Truck ........................            1,425.00

Bank Deposits ...........................            1,308.00

Total Expenditures ......................         $128,243.33

 

This makes a total income, except for living expenses of $128,243.33, which income, under the findings here made, will be divided equally over the fifteen year period from 1937 through 1951, inclusive, which will give to Claude Ridley an opening net worth as of December 31, 1941 of $42,414.44, which is one-third of the total income shown by these expenditures.

[Living Expenses]

For the years 1942 through 1948, inclusive, there will be added the sum of $1,000.00 per year as income expended for living expenses, and for the years 1949 through 1951, inclusive, there will be added the sum of $1,500.00 as income expended for living expenses, in accordance with the findings here made. Thus, the Court finds that the taxable income of Claude Ridley for each of the years from 1942 through 1951, inclusive, is as follows:

1942 ....         $ 9,549.56

1943 ....           9,549.56

1944 ....           9,549.56

1945 ....           9,549.56

1946 ....           9,549.56

1947 ....           9,549.56

1948 ....           9,549.56

1949 ....          10,049.56

1950 ....          10,049.56

1951 ....          10,049.56

 

During the years 1937 through 1951, inclusive, the defendant, Claude Ridley, was engaged in the business of farming, operating a country store and filling station, and of manufacturing and selling illicit whiskey. In each of these endeavors he was aided and assisted by his wife, Dimple Ridley, and he derived income from each of these sources.

Claude Ridley made purchases with the aforesaid income of the following series "E," "F," and "G" Savings Bonds issued in the names of the respective payees and beneficiaries on the dates and in the face amounts, as follows:

Mr. Claude Ridley, P. O. D., Mrs.

Dimple Ridley Bought February,

1944 "E" Bonds ..........................         $ 5,000.00

Claude Ridley, P. O. D., to Mrs.

Dimple Gray Ridley Bought August,

1944 "F" Bonds ..........................         $10,000.00

To Mrs. Dimple Ridley or Claude Ridley

Bought 
January 4, 1945
 "E"

Bonds .....................................         $ 5,000.00

To Claude Ridley or Mrs. Dimple G.

Ridley Bought 
January 4, 1945
 "E"

Bonds .....................................         $ 5,000.00

Claude Ridley Bought May, 1945 "F"

Bonds .....................................         $10,000.00

To Claude Ridley or Mrs. Dimple Pidley

Bought 
January 14, 1946
 "E"

Bonds .....................................         $ 5,000.00

To Mrs. Dimple Ridley or Claude

Ridley Bought 
January 14, 1946
 "E"

Bonds .....................................         $ 5,000.00

Mrs. Dimple Ridley or Mrs. Claude

Ridley Bought April, 1946 "G"

Bonds .....................................         $ 5,000.00

Mr. Claude Ridley or Mrs. Dimple

Ridley Bought April, 1946 "G"

Bonds .....................................         $ 5,000.00

Mrs. Dimple Gray Ridley or Mr.

Claude Ridley 
January 2, 1947
 "E"

Bonds .....................................         $ 5,000.00

Mr. Claude Ridley or Mrs. Dimple

Gray Ridley 
January 2, 1947
 "E"

Bonds .....................................         $ 5,000.00

Mrs. Dimple Gray Ridley or Claude

Ridley Bought February, 1947 "G"

Bonds .....................................         $ 5,000.00

Claude Ridley or Mrs. Dimple Gray

Ridley Bought 1947 "G" Bonds ............         $ 5,000.00

To Claude Ridley or Mrs. Dimple G.

Ridley Bought September, 1947 "G"

Bonds .....................................         $ 5,000.00

Mrs. Dimple G. Ridley or Claude Ridley

Bought September, 1947 "G"

Bonds .....................................         $ 5,000.00

Claude Ridley or Mrs. Dimple G. Ridley

Bought April, 1949 "G" Bonds ............         $10,000.00

Claude E. Ridley or Mrs. Dimple G.

Ridley Bought February, 1950 "G"

Bonds .....................................         $10,000.00

[Contract Vague]

On the 6th day of April, 1951, Claude Ridley purchased from Waco Byers, Hattie Byers and John Byers 199 acres of land in Murray County, Georgia, paying therefor the sum of $10,557.00, and shortly thereafter, Claude Ridley agreed with his brother, W. A. Ridley, and his nephew, L. B. Ridley, that if the said W. A. Ridley and L. B. Ridley would go in there and "clean up" the farm that he would give them a half interest in the same. W. A. Ridley and L. B. Ridley agreed to this but didn't do much on it during the year 1951, but during the years 1952 and 1953 they spent some two to three hundred man hours working on the farm and cleaning it up; they have a bulldozer there that would normally rent for about $14.00 an hour and have used the bulldozer to clear up about fifty acres of land and to clean up around the edges of fields already cleared; they have not completed their cleaning up but intend to do so in the future. The agreement between Claude Ridley and W. A. Ridley and L. B. Ridley with respect to this was an oral agreement; there was no definite agreement as to just what the cleaning up would consist of; how much work was to be done, or when it was to be done, nor does it appear how much has been completed or how much remains to be completed in the future. The Government's claim of lien was recorded in Murray County on November 24, 1952 .

On the 2nd day of October, 1950, Claude Ridley purchased 46 lots of land in what is known as the Albert Rogers Subdivision in Whitfield County, Georgia for $4,963.50 and thereafter L. B. Ridley and W. A. Ridley furnished materials and performed labor in erecting two houses on said lots under an agreement with Claude Ridley that they were to be paid when the houses were sold; the said Claude Ridley now owes L. B. Ridley and W. A. Ridley approximately $700.00 for such labor and materials. The contract of employment for the building of the houses was not in writing, nor does the evidence show when the buildings were completed. Claude Ridley received during the period from January 1, 1942 through and including the year 1951, taxable income in the amount of $98,550.00; never filed any tax returns; kept no records of income; refused to cooperate with the agents of the Internal Revenue Department when they undertook to investigate his income.

The taxpayer offers no reasonable explanation of his failure to file returns, and the Court finds as a matter of fact that the defendant is guilty of fraud with the intent to evade the payment of income taxes due. The Court further finds that the said Claude Ridley failed to file any declaration of estimated taxes and failed to pay the taxes due.

Conclusions of Law

The authority granted to the Commissioner of Internal Revenue, where records are not kept by the taxpayer to use such method of computing his taxable income as would clearly reflect his income (26 U. S. C. A. Sec. 41), is nothing more than the grant of authority to the Commissioner to use indirect or circumstantial evidence where direct evidence such as records can not be obtained. The net worth and expenditures method adopted by the Commissioner through the agent in this case is simply the exercise of the authority to use circumstantial evidence in computing the taxpayer's taxable income.

The determination of the Commissioner, as evidenced by the assessment of the tax, is not conclusive but only furnishes prima facie evidence of its correctness, ¹ and where, as here, the United States files its complaint in equity seeking to foreclose its lien for taxes, and asking this Court to direct all persons having liens or claiming interests in the property be brought into Court, and that the merits of their claims be determined, seeking a receiver and injunctive relief, and where the defendant taxpayer denies that he owes the taxes so assessed and avers that the tax assessments are erroneous, and introduces evidence both direct and circumstantial, which if fully credited would require the Court to determine that the deficiency tax assessments made by the Commissioner of Internal Revenue are incorrect, and to determine anew the taxpayer's tax liability, the Court is free to determine for itself from all of the evidence in the case just what the taxpayer's liability is, and where, as here, the only circumstantial evidence before the Commissioner was the fact that the taxpayer made certain expenditures, mostly in the nature of investments, and where those facts are likewise before the Court, with other evidence in addition thereto, this Court is free to weigh all of the evidence and to reach a conclusion different from that of the Commissioner.

In this case the taxpayer, Claude Ridley, failed to keep records as required by law, ² and the Commissioner of Internal Revenue had the right to use such method of computing his taxable income as in his opinion would clearly reflect the income, ³ and the Commissioner chose the net worth method of computing income. This method at best is subject to the criticism that when heedlessly resorted to and loosely applied, it is dangerous and inexorable. In all cases, civil and criminal, it should be used with the utmost caution to avoid injustice to honest taxpayers which might otherwise result. This, however, does not incapacitate it as an instrument of evidential value in cases where it may be properly applied. When a taxpayer violates the mandate of the statute which requires him to keep proper records of his income, and conditions are otherwise such that his taxable income may be determined in retrospect only by resort to circumstantial evidence of this character, he will not be permitted to rely upon his ability to conceal the distorted facts of income and his fraudulent conduct to avoid the imposition of taxes which the collection authorities may show to be lawfully due. ⁴

[Use of Net Worth Method Justified]

This Court is of the opinion that under the facts of this case that the use of the net worth and expenditures method of determining the income is justified. However, the Court is of the further opinion that this method has been "too loosely applied" in the following particulars:

1. The circumstances show that the opening net worth as of December 31, 1941 should have been at least $42,414.44, the amount of that portion of the total income received prior to January 1, 1942 .

2. That the higher estimate of the agent as to the amount of expenditures for living expenses must yield to the evidence and strong corroborating circumstances, and such expenditures should be fixed as set forth in the Court's findings.

3. That the allocation of income by the agent as being in the years that the investment expenditures took place is a loose application of the net worth-expenditures method of determining income and is not supported by any other fact or circumstance, while the oral testimony, as well as other circumstances, indicate that such investment purchases were made from accumulated savings rather than from current income, and there is no other evidence to indicate great income in one year and little income in another. The income should be distributed evenly over the years 1937 through 1951, inclusive, in accordance with the foregoing findings of fact.

W. A. Ridley and L. B. Ridley claim an interest in the 199-acre farm bought by Claude Ridley from the Byers. The basis of this claim is an oral contract that they were to have a one-half interest in the farm if they would "clean it up." They claim that they have done much work on it during 1952 and 1953, but that the work has not been completed. In order for this promise, for the sale of an interest in lands, to be binding upon the obligor, it must be in writing. ⁵ Although the Georgia Code provides that this requirement shall not extend to cases where there has been such part performance of the contract as would render it a fraud of the party refusing to comply if the Court did not compel a performance, ⁶ the contract here is too vague and uncertain to be capable of enforcement. ⁷ The contract has not yet been completed, and though W. A. Ridley and L. B. Ridley may have a valid claim against Claude Ridley for the value of the work done, they have not acquired any interest in the land, equitable or otherwise.

W. A. Ridley and L. B. Ridley also claim an interest in two certain houses and lots in the Albert Rogers Subdivision, the basis of this claim being an alleged oral agreement with Claude Ridley that they would furnish the labor and material and construct upon the described two lots two houses, Claude Ridley agreeing to reimburse them when the property was sold. A balance of approximately $700.00 is now due them.

[No Lien or Interest]

Under the facts as contended for by said claimants, they have neither a lien upon nor an interest in the described property.

While the Georgia law provides that a laborer, ⁸ or a materialman,/9/ may acquire a lien where labor is performed and material is furnished in improving real estate, by complying with the requirements of the statutes as to the filing and recording of the notices of claim of lien within the time prescribed, there is no evidence here that such liens have been obtained. The claim of lien or interest in the property of W. A. Ridley and L. B. Ridley for the construction of the two houses is denied.

The defendants contend that to subject the interest of Claude Ridley in the joint ownership bonds would affect the right of survivorship. This has been decided contrary to the contentions of the defendants.

"The incidence of the bonds here in question as governed by the regulations in respect to their issue is that while there is preserved the right of survivorship, that right is preserved only when co-ownership is not otherwise terminated under the circumstances recognized by the regulations. The present bonds within certain limitations may be reached by creditors for the debts of a co-owner. . . . When subjected to process by creditors there is recognition of the extent of interest therein of each of the respective co-owners." Guldager v. United States , 204 Fed. (2d) 487, 489.

The Court finds that the bonds, as detailed in the findings of fact, purchased in May, 1945 and registered in the name of Claude Ridley only, as prescribed by Title 31, Code of Federal Regulations, Sec. 315.4, are the sole property of Claude Ridley in accordance with section 315.2 of said regulations.

In the list of bonds as set out in the findings of fact, the Court finds that where the bonds were registered in co-ownership as prescribed by Title 31 of the Code of Federal Regulations, Section 315.4 (2), the Court finds that pursuant to Section 315.13(c), that Mrs. Dimple Ridley is the owner of a one-half interest in such bonds and the taxpayer, Claude Ridley, owns a one-half interest in such bonds.

In the list of bonds as set out in the findings of fact, where the bonds are registered in the beneficiary form--Claude Ridley, P. O. D., Mrs. Dimple Ridley, or, Claude Ridley, P. O. D., Mrs. Dimple Gray Ridley, the Court finds in accordance with Title 31, of the Code of Federal Regulations, Sec. 315.13(c), that Claude Ridley is the owner of such bonds as set forth in sections 315.4(3) and 315.46 of said regulations.

Among the penalties or additions to the tax made by the Commissioner, are the following:

10% of the tax for failure to file a declaration or pay the installment of estimated tax as provided by section 294(d)(1) of Title 26, U. S. C. A.

6% of the amount by which the tax exceeds estimate (total tax here) for substantial understimate of estimated tax as provided by Sec. 294(d)(2) of Title 26, U. S. C. A.

The addition of 10% of the tax for failure to file the declaration or to pay the installment of the estimated tax is proper to be added in the applicable years. However, the addition of 6% for substantial underestimate of estimated tax is improper for the very obvious reason that the tax was not underestimated, indeed, the taxpayer filed no declaration of estimated tax at all the suffers the greater sanction of 10% addition to the tax for the failure, and the failure to pay the tax.

The argument of the Government that the failure to file the declaration of estimated tax is in effect a declaration of no tax, thus subjecting the taxpayer to this penalty, is rejected as contrary to a proper construction of the statutes.

The tax will be computed in accordance with the findings here made. Interest and additions to tax as computed will be made in the manner applied by the agent, except the addition of 6% for substantial underestimate shall not be added.

No evidence showing the necessity for a receiver or injunction was offered, and no necessity therefor appears.

The lien of the United States for taxes here found to be due attaches to all of the property of Claude Ridley and the prayer of the United States for foreclosure is granted.

A judgment for the taxes, penalties and interest, computed in accordance with these findings and conclusions, may be prepared and presented.

¹ U. S. v. Anderson, 269 U. S. 422 [1 USTC ¶155]; McCarl v. U. S., 42 Fed. (2d) 346 (and cases cited).

² 26 U. S. C. A. Sec. 54(a).

³ 26 U. S. C. A. Sec. 41.

⁴ Bryan J. Baker v. C. I. R., No. 14385, decided by U. S. Court of Appeals for the Fifth Circuit, January 29, 1954.

⁵ Ga. Code, 20-401.

⁶ Ga. Code, 20-402.

⁷ Prior v. Hilton & Dodge Lumber Co., 141 Ga. 117, 119.

⁸ Ga. Code, 67-1801, et seq. (Laborer's Liens).

⁹ Ga. Code, 67-2002, et seq. (Materialmen's Liens).

 

 

[54-1 USTC ¶9141]Allen McCain, et al. v. The Liberty National Bank, et al.

In the United States District Court for the Northern District of Georgia, Rome Division, Civil Action No. 738, September 29, 1953

Lien for taxes: Priority over state taxes: Priority of creditors.--The husband and wife were fatally injured in an automobile accident and the wife died shortly before the husband. Claims which had priority over the U. S. tax were: a compromise amount in lieu of a year's support for the decedent's minor daughter, fees and expenses of the minor daughter's guardian, court costs, and receiver's fees and expenses including counsel fees. After paying these claims, the remainder of the estate was less than the U. S. tax, leaving no funds for payment of State taxes, the wife's doctor bills and funeral expenses, claims for damages to persons riding with the deceased at the time of the accident, or support claims.

Henry Stewart (Stewart and York) and E. L. Gammage, Jr., all of Cedartown , Ga. , for plaintiffs.

J. Ellis Mundy and James W. Dorsey, United States Attorneys, Lee S. Radford, Department of Revenue, Income Tax Unit, Atlanta, Ga., James K. Rankin and Malcolm A. Brenner, Atlanta, Ga., W. W. Mundy, Jr., C. C. Bunn, Jr., and Brantley Edwards, Cedartown, Ga., Marshall, Greene, Baird and Neely, and Powell, Goldstein, Frazer and Murphy, Atlanta, Ga., Chester A. Austin, Birmingham, Ala., J. M. Grubbs, Jr., Cedartown, Ga., John P. Stewart, Atlanta, Ga., John W. Maddox (Matthews and Maddox) and Maddox and Maddox, Rome, Ga., Glenn T. York, Jr., Forrest C. Oates, Jr., and James I. Parker, Cedartown, Ga., Covington and Andrews, Rome, Ga., and Murphy and Murphy, Bremen, Ga., for defendants.

Statement of the Case

HOOPER, District Judge:

This action was removed from the Superior Court of Polk County, Georgia, where Allen McCain, as Administrator of the Estate of J. H. Harvell, deceased (also alleging himself equitable owner of the assets of Harvell Motor Company, Inc.) began an action against Marion H. Allen, Collector of Internal Revenue for Georgia, and others. Mr. Allen having died Charles H. Dunn was substituted as party defendant and on his motion the action was removed to this court pursuant to 28 United States Code, Sec. 1442(a)(1). A large number of defendants were named and various other parties at interest intervened, their individual claims being hereinafter discussed or disposed of in groups. A great many hearings were had in this court but almost without exception the questions involved were those of law, there being practically no dispute in the evidence. Assets of defendant Harvell Motor Company, Inc. and of the Harvell estate were sold. A great many claims were settled by agreement, by stipulation of all parties in open court at one of the hearings, at which hearing all parties at interest were notified to appear. No Findings of Fact will be necessary in cases where the amounts and priorities of the claims were stipulated. As to other claims where priority was in dispute, Findings of Fact and Conclusions of Law will be given below in connection with each claim. Attached hereto and marked "Exhibit A" is a statement showing all amounts received by Allen McCain as Executor of the Estate of J. H. Harvell and also as Receiver for Harvell Motor Company, also disbursements heretofore made pursuant to written orders or directions of this Court, or stipulation of parties, and then a list of payments to be made pursuant to this order and judgment of the court, this being a Final Judgment and Decree in said case.

Findings of Fact and Conclusions of Law

Claims Against the Estate of J. H. Harvell, Deceased

1. Claim of the United States . This claim while originally made in a much larger sum was by stipulation of parties to the case, made in open court and without objection, agreed to be in the sum of $14,000.00. Although the priority as between this claim and claims of the State of Georgia , and others hereinafter referred to, remained in dispute.

As a conclusion of law this Court finds that the claim of the United States of America against said estate on account of taxes due and owing to the United States at the time of the death of the said J. H. Harvell, are superior to the claims of the State of Georgia for taxes against the deceased. This ruling is predicated upon the provisions of 31 United States Code, Section 191, which provides that "whenever the estate of any deceased debtor, in the hands of executors or admin istrators is insufficient to pay all the debts due from the deceased, the debts due to the United States shall be first satisfied." The situation referred to in that statute exists in this case, and that statute, rather than state statutes, must control. See Michigan v. United States, 317 U. S. 338 [43-1 USTC ¶9225]; United States v. Gilbert Associates, 345 U. S. 361, decided April 6, 1953, reported in 21 Law Week, 4275 [53-1 USTC ¶9291].

The payment of the claim of the United States will exhaust all funds remaining in the hands of the Receiver after payment of various sums having priority thereto as listed on the attached "Exhibit A."

The United States made no objection to the allowance of a year's support to the minor daughter of J. H. Harvell, deceased, as shown on said Exhibit, nor the funeral expenses of J. H. Harvell, the doctors' bills during his last illness, the costs of admin istration of said estate, and the expenses of this litigation. The United States did object, however, to the allowance of claim in behalf of Dr. W. P. Downey who attended upon the wife of J. H. Harvell during her last illness, and Miller Funeral Home for funeral expenses of said Mrs. Harvell, as to which the Court will make Findings of Fact and Conclusions of Law as follows:

[Wife's Medical and Funeral Expenses]

2. The Court finds that Mr. and Mrs. J. H. Harvell were injured in an automobile accident, Mrs. Harvell dying as a result thereof a short time before Mr. Harvell died, and that medical expenses were incurred in favor of Dr. W. P. Downey and funeral expenses in behalf of Miller Funeral Home.

The Court finds, however, that as a Conclusion of Law that the above claims do not have priority as claims against the estate of J. H. Harvell to the same extent as doctors' bills and funeral expenses in connection with the last illness and burial of J. H. Harvell would have. Counsel for said creditors in a comprehensive brief very ably insist to the contrary, citing as authority for such contention, the provisions of Georgia Code Section 113-1508, providing in part as follows:

"Claims against the estate of a decedent shall rank in the following order: (1) year's support for the family, (2) funeral expenses, to correspond with circumstances of the deceased in life, including physician's bills and expense of the last sickness."

It is insisted that the expression "funeral expenses" covers funeral expenses incurred by the estate of the deceased not only for burial of the deceased, but for his next of kin. While the Court can readily appreciate the fact that the statute in question, if construed as this claimant contends, would be a wise and salutory statute, tending to expedite the burial of a wife when killed in a common disaster with her husband, this Court is not of the opinion that the statute, when enacted, was intended to so provide.

Whether taxes due the United States would not have priority over all the claims enumerated in Georgia Code Section 113-1508, need not be decided for the reason that the United States in this case has conceded that expenses of the last illness and burial of Mr. Harvell take priority over taxes due the United States. Such a concession by the Government is certainly in accord with the dictates of wisdom and humanity, for it would be unfortunate indeed if a man in his last illness could not be attended by a physician, and in his death not be interred, without any assurance that the doctor and the undertaker would be paid.

[Other Claims Against Estate]

3. Annie Pearl Daniel filed a claim in the sum of $8,400.00 based upon a contract made with her by J. H. Harvell during his lifetime in which he recognized the paternity of her two minor children and agreed to support them. The Court rules that Annie Pearl Daniel under such circumstances has no priority of payment out of such estate but ranks only with ordinary creditors and therefore, is not entitled to participate in the distribution of his estate.

4. Rob ert McCain and Mrs. Ruby McCain, riding with J. H. Harvell at the time of his fatal accident, filed a claim for damages including $409.00 medical bills. The Court rules that these claimants would rank as ordinary creditors and cannot participate in the distribution.

5. Mrs. Mavis Harvell Austin expended the sum of $105.00 for the benefit of the estate and is awarded a refund of that amount without objection.

6. The Receiver is directed to pay to T. L. Williams for reporting evidence, the sum of $30.00 and to the Clerk of this Court, for court costs, the sum of $15.00.

7. The Receiver is directed to pay the following sums incurred in connection with this case covering fees and expenses:

To E. L. Gammage, Jr., Guardian ad litem for Mrs. Mavis Harvell Austin, a minor, for a compromise of her claim for year's support, the sum of $1,500.00.

To E. L. Gammage, Jr., fees and expenses as Guardian ad litem for Mrs. Mavis Harvell Austin, a minor, $548.30.

To Malcolm A. Brenner, Jr., fees and expenses as court appointed certified public accountant for the Receiver, $1765.00.

To Allen McCain, Receiver, for fees and expenses, $3,751.15.

To Henry A. Stewart, Sr., fees and expenses as court appointed counsel for Receiver, $4,585.20.

8. The above leaves on hand the sum of $4,628.05, which Receiver is directed to pay to the United States of America upon account of its tax lien stipulated to be in the sum of $14,000.00. This leaves unpaid the claim of the State of Georgia for taxes in the sum of $2,889.94 and interest thereon.

The Receiver, when the time for appeal from this Judgment and Decree is over, may pay out the aforesaid sums.

It is further ordered and decreed that Harvell Motor Company, Inc., a corporation of the State of Georgia , be, and it is hereby adjudicated as dissolved as of this date.