In U.S. v. Adent, 117 AFTR 2d 2016-1505 (7th Cir. 5/10/16), Leonard and Joyce Advent owned a commercial property as joint tenants with their son, Derek. Leonard and Joyce owed tax to the federal government. The Internal Revenue Service placed a lien on the property for the amount owed by Leonard and Joyce.
The IRS then sought to foreclose and force a sale of the property and Leonard and Joyce objected to the sale, claiming it would prejudice Derek who was not a party to the tax liability owed by his parents. Internal Revenue Code § 7403 gives the IRS the authority to file suit to enforce a tax lien and force the sale of a property. The Code does not provide for an exception to the ability of the IRS to force a sale of the property where the property is co-owned by an innocent third party who does not owe tax to the IRS.
In United States v. Rogers, 461 U.S. (1983), the United States Supreme Court confirmed the right of the Internal Revenue Service to force a sale of the whole property, even when there is an innocent co-owner. However, the Supreme Court acknowledged that while it should be exercised sparingly, the District Court has the discretion not to approve a forced sale. The factors the District Court should consider when considering a forced sale are:
- The prejudice to the government’s interest as the result of a partial, rather than a total, sale;
- Whether the third party with a non-liable separate interest in the property normally would have a legally-recognized expectation that the separate property would not be subject to forced sale by the delinquent taxpayer or his or her creditors;
- The prejudice to the third party as a result of a total sale; and
- The relative character and value of the non-liable and liable interests held in the property.
With regard to the Adent case, the Court of Appeals held that the sale of the commercial property could proceed because the government would be unduly prejudiced because a partial sale is not possible; the prejudice to Derek is minimal since he doesn’t live in the commercial building, he would receive 50% of the sale proceeds, and could buy the property himself; and because the property was owned 50 / 50, the relative ownership considerations weighed in favor of neither party.
In United States v. Kimball, Jr., 117 AFTR.2d 2016-2234 (DC ME 6/24/2016), John H. Kimball, Jr. owed $1,090,700.05 in taxes and penalties. In 1989, John created a gift trust to purchase a ski condo for his children. John had the power to revoke the trust, but upon such revocation the trust assets would be distributed to John’s children instead of himself. In that sense, the trust was more like an irrevocable trust than a traditional revocable trust. In 1993, John resigned as trustee in favor of his sister. The trust by its terms then became irrevocable.
Since 1989, John rarely used the ski condo. The court ruled that the expenses he personally paid for the maintenance of the condo would be more than enough to cover any rent that he should have paid for those few times he made use of the condo without his children being present.
In 2010, the IRS filed tax liens against the ski condo. The IRS argued the gift trust was holding the condo as John’s nominee and that it should be able to enforce its tax liens against the property. The District Court used the analysis in United States v. Craft, 535 U.S. 274, (2002) to determine whether the IRS had a valid tax lien against the ski condominium. The Craft case holds that it is a question of federal law as to whether the taxpayer owns or has rights in property, but that state law must be analyzed in order to determine what rights the taxpayer has. As such, the District Court looked to the property law of Maine to determine what rights John had in the condo.
The District Court denied the United States’ Motion for Summary Judgment, finding that John had no state law rights in the ski condominium under the gift trust, that the beneficiaries under the trust were all adults, that the trust was irrevocable, and that John had made minimal use of the condo. As such, the tax lien could not be enforced against the condo.
One of the simplest planning strategies to provide protection against creditors, including taxing authorities, is to transfer assets to an irrevocable trust for beneficiaries other than the transferor. Unless the creditor can show that the trust is somehow the alter-ego of the transferor (this is usually accomplished by showing that the transferor continued to enjoy the use of the property after transfer) or that there was a fraudulent transfer, this planning strategy is one of the most effective strategies to protect against claims from future creditors.
This type of planning can also be used to assist an elderly person in obtaining eligibility for long-term care Medicaid benefits to help pay for the cost of an extended stay in a skilled nursing facility. For seniors who served in the military during a time of war, this type of planning can also assist in qualifying for Veteran’s Aid and Attendance enhanced pension benefits that can be used to help pay for in-home caregivers or for the cost of an assisted living facility.