IRS Lien on Trust Assets

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Irs Lien On Trust Assets, Houston Tax Attorney

As long as the government tries to collect taxes, there will be taxpayers who try to find ways to not pay the taxes.

These tax payment avoidance options often involve co-ownership of property or, in many cases, trusts.

The recent United States v. Simones, No. 1:20-cv-00795-PJK-SCY (D.N.M. 2021) case shows how the IRS is able to sidestep certain trusts to enforce its Federal tax lien against the trust assets.

Facts & Procedural History

The taxpayer was an individual who owed over $200,000 in back taxes to the IRS.

The taxpayer formed a trust and transferred real estate into the trust. The trust listed the taxpayer and two of his friends as the trustees.

The taxpayer transferred one of the properties to his friend in 2004 and his friend transferred the property to the trust in 2005. Another property was transferred to the trust in 2004 and another property was transferred in 2008.

Starting in November of 2011, the IRS filed lien notices for the taxpayer and for the trust for the taxpayer’s back taxes.

On August 2020, the IRS filed suit against the taxpayer and the two trustees. The IRS was asking the court to enforce its Federal tax lien against the three properties.

The Federal Tax Lien

Section 6321 provides that the Federal government has a Federal tax lien on any property owned by a taxpayer who owes back taxes.

This Federal tax lien is not self-enforcing. The IRS has to take some action to collect the lien. The IRS does this in two ways.

First, the IRS files its notice of federal tax lien. The lien notice puts the public on notice that the IRS has a lien on the taxpayer’s property. This helps ensure that third parties are not able to acquire legal title to the property. This is important as Section 6323 provides that a purchaser and others can acquire legal title to the property if a valid lien notice is not filed. The Federal tax lien notice does usually impact the taxpayer’s credit. This alone is sometimes enough to encourage the taxpayer to either pay the tax or work with the IRS to remove the IRS lien notice. If the taxpayer does not act, the IRS may opt to wait and see if the property sells. Usually, when the property sells, the title company will pay a portion of the sales proceeds to pay off the IRS back taxes. The IRS can wait for the 10-year tax collection statute (and it can even extend the statute by 10 additional years in some cases).

Second, if the IRS does not want to wait, it may bring suit to foreclose on its lien. That is what it did in this case. There are very few defenses that can be raised in these cases. This case involves one defense, i.e., whether the taxpayer actually owns the property. Recall that the properties in question were owned by a trust and not by the taxpayer.

The Taxpayer’s Nominee

The Federal tax lien attaches to property the taxpayer owns. This includes property that the taxpayer owns that is held by third parties.

In cases like this, the IRS argues that the trust was a nominee for the taxpayer. The IRS asked the court to disregard the trust on this basis. The court summarized the law as follows:

In assessing the nominee question, courts will first look to state law to determine whether the taxpayer has rights in the property. Id. After that, courts may consider other factors including whether consideration was paid, the relationship between the parties, and whether the transferor acts like the owner. 

The court noted that New Mexico state law allows the courts to treat the trust beneficiary as the owner of the property. Thus, the taxpayer had rights to the properties.

The court then considered whether the taxpayer actually retained some or all of the benefits of true ownership of the properties. For this point, it noted that the taxpayer continued to pay the utilities for the properties. This suggests that the taxpayer acted as if he was the owner. The court did not explain whether the taxpayer received the rental income from the properties (if any) or used the properties for his own benefit or claimed tax benefits from the real estate, such as depreciation deductions. This evidence may not have been before the court. Based on the utility payments, the court concluded that the taxpayer owned the properties.

Fraudulent Transfers

The court then considered the IRS’s arguments that the transfers to the trusts were fraudulent transfers. The court again considered state law. Like Texas and most other states, New Mexico law includes fraudulent transfer laws.

In applying New Mexico law, the court concluded that the taxpayer made the transfers to the trusts to hinder or delay the collection of his taxes. This was based on the fact that at least some of the taxes had been assessed when the first property was transferred to the trust. It was also based on the taxpayer having submitted a collection due process hearing request around that same time. According to the court, this knowledge of the tax balance was sufficient evidence under the state fraudulent transfer act.

The court addressed the “intent” requirement in state law by noting that the taxpayer seemed to act in concert with the other two trustees. The court did not explain this concept. It is equally likely that the parties contributed the properties to the trust for legitimate reasons. This is plausible. There was evidence suggesting that one of the properties was legitimately owned by one of the trustees and that that trustee contributed the property to the trust.

As an aside, while the IRS can use nominee and fraudulent transfer laws to subject property to its lien, taxpayers can also strategically use state law to avoid the lien. The intentionally defective deed is one example.

The Takeaway

This case shows the result when the taxpayer does not use a non-self-settled spendthrift trust or a self-settled domestic asset protection trust.

These types of trusts should be set up long before back taxes or other debts are owed. There are numerous examples where these types of trusts avoided the IRS’s lien.

Absent these or other types of trusts being set up in advance, this case helps explain why holding property in the trust is not sufficient to avoid a Federal tax lien.

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