In United States v. Spangler, the Eleventh Circuit Court of Appeals upheld a lower court order requiring a taxpayer to transfer a promissory note to the government so that the note payments would be credited towards the amount of the taxpayer’s court ordered tax restitution.

Given that the IRS has a poor track record in collecting taxes from taxpayers via the traditional avenues, this scenario raises the question as to whether the IRS would be able to collect tax payments from third parties via a promissory note.

Generally an individual – be it a taxpayer or the government – steps into the shoes of the person who holds a promissory note and it acquires the rights of that person. If the individual is a taxpayer whose promissory note is seized by the government or turned over to the government via a court proceeding, the analysis then focuses on what rights the individual taxpayer had in the note.

Is The Taxpayer Who Held The Note a “Hold In Due Course” ?

 A “holder in due course” is any person that acquires a negotiable promissory note without knowledge of any claims or defenses associated with the note. The individual who makes payments on a note that is held by a “holder in due course” is generally not justified in refusing to pay the third party due to defenses or claims that he or she may have against the original note holder.

Qualifying If Committed Fraud  ?

A taxpayer who committed fraud related to the note would probably not qualify as a “holder in due course,” because their fraud would create a claim and defense to payment of the note. Similarly, taxpayers could structure the promissory note so that it is non-negotiable and/or only acquire non-negotiable notes – which would ensure that the government or other parties who might obtain the note would never qualify as a “holder in due course.”

If the taxpayer were not a “holder in due course,” a third party who was subject to the note could raise the defense of fraud, duress or illegality of the transaction in an effort to rescind the note and to recover the instrument or its proceeds. If the note were held by the government, the person making the payments could raise these defenses in order to recover the note proceeds from the government and to rescind the note.

It would be even more interesting if the third party raised a fraud defense, as the government would have to argue that the taxpayer – the same taxpayer that it convicted of tax fraud – did not commit fraud in order for the government to collect on the promissory note. This could create a conflict of interest for the government – one that tax criminals could conceivably, given the right facts, use to overturn their criminal tax fraud sentences.

Does this mean that taxpayers who are facing criminal tax fraud charges can simply transfer assets to a third party in exchange for a promissory note, with the aim of having the third party rescind or void the note and reclaim the note proceeds once the government obtains possession of the note?

The answer is probably not, as the government would likely pursue the third party for fraud as well and/or impose transferee liability upon the third party. The risk is simply too great. Although, this type of case would raise some very interesting issues and the government may find itself running into more of these cases due to the rising number of mortgage foreclosures and the recent increase in private investors purchasing promissory notes.

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