To determine whether the IRS can levy or take property, one has to consider what property the taxpayer owns. State law dictates what property the taxpayer owns.
The property laws in most states are similar, which makes applying Federal tax collection law relatively easy. But then there is Louisiana law. Louisiana law differs in many ways from the laws of other U.S. states.
This can raise some interesting questions in applying Louisiana law to identify property rights to determine how the Federal tax collection laws apply to those property rights. The recent Goodrich v. United States, No. 17-cv-0610 (W.D. La. 2020) case provides an example involving the state law concept of a “usufruct.”
Facts & Procedural History
The taxpayer owed back taxes to the IRS. He was a resident of Louisiana. He died having not paid his tax debts.
The taxpayer’s wife had died several years prior. Her will left her assets to her children, but granted the taxpayer-husband the ability to use the assets during his lifetime.
At the time of his death, he owned oil and gas interests, some common stock, and personal property. This was owned 50% by the taxpayer outright. The taxpayer also had a 50% via the right to use the property left to him by his spouse’s will, but this property did not pass to the taxpayer until after his death. This came about as the probate for the wife’s estate was started but wasn’t completed until after the taxpayer’s death.
Before the taxpayer’s probate estate was closed, the IRS levied on the estate’s bank accounts. It also levied on the oil and gas royalties belonging to the taxpayer’s estate. The tax dispute ended up in court.
State Property Law & Federal Tax Law
The question for the court was whether the IRS levy was lawful. The court looked to state law to determine what rights the taxpayer had in the property.
Federal law looks to state law to determine what property rights a person owns. Then Federal tax collection laws say how those property rights are to be collected.
Louisiana law applied in this case given that the taxpayer and his wife resided in Louisiana at the time of their deaths. Suffice it to say that Louisiana law differs in many respects from the law you find in just about every other state in the U.S.
Louisiana Usufruct Law
As relevant here and as explained by the court, Louisiana law has a concept of usufruct. The term “usufruct” refers to the right to use or consume property during lifetime. While the person gains the right to use or consume the property, the property belongs to the person(s) named as the “naked owners” upon the death of the usufruct holder.
The rules for a usufruct differ based on whether the property is considered a consumable or a nonconsumable. Consumable property includes money or cash, for example. Nonconsumable property includes real estate, for example.
With consumable property the usufructuary can sell or consume during his lifetime, but he is obligated to (1) either pay the value of the property he received to the naked owners at death or (2) delivery the property of the same quantity or quality to the naked owners at death.
The usufructuary cannot sell nonconsumable property. The usufructuary can use this property during his lifetime, but has to transfer it to the naked owners at death.
This Louisiana usufruct law seems comparable to the concept of a life estate that is found in other states, such as Texas. Specifically, the nonconsumable usufruct seems similar to a life estate. With a life estate the life tenant has the right to use and enjoy the property during his lifetime. The remaining property passes to the other owner upon the death of the life tenant.
Louisiana’s usufruct can also be compared to the contractual right to receive royalties in the future too. Here is an article covering a wrongful IRS levy on contractual rights to receive royalties.
The consumable property under a usufruct differs from a life estate (or the contractual right to future royalties), as the property can be sold and then the value of the property paid to the naked owners.
An Immediate Transfer vs. a Debt Owed
What exactly is his property interest? Is it more akin to an immediate transfer as to the other party for a life estate or is it merely a debt owed to the naked owners?
This case shows why this question matters. If the consumable property usufruct is an immediate transfer, the IRS lien may not attach to the property. This would be the case as the taxpayer-husband did not receive the property during his lifetime. At the time the IRS tax lien arose, the property would belong to the naked owners, i.e., the children.
But if the consumable property usufruct is a debt owed to the naked owners, that would mean that the usufruct holder, the taxpayer-husband here, owned the property immediately upon the death of his wife and, as such, the IRS tax lien attached to the property immediately upon the wife’s death.
The IRS’s Wrongful Levy & Valid Levy
The court found that the IRS had wrongfully levied on the proceeds from the sale of nonconsumable property usufruct. This property belonged to the naked holders immediately, not by the taxpayer-husband.
For the consumable property usufruct, the court found that it belonged to the taxpayer-husband as he had the right to sell the property. The court found that the obligation to pay the same amount or provide the property to the naked owners was a just a debt. Thus, the court upheld the IRS levy for this property.
Those whose loved ones ow the IRS back taxes and live in Louisiana should consider these rules. The tax attorneys will be thinking of the interesting tax planning possibilities that this division of property rights may allow.
Those owning back taxes, may have a more immediate focus. For them, a usufruct for consumable property will not protect against an IRS levy or lien. But apparently a usufruct for nonconsumable property might. To take full advantage of this, the probate estate for the first spouse to die may have to be held open for several years until after the second spouse dies, as in this case.