Imagine you live in a community property state, like Texas, and jointly own a home with your spouse. You owe back taxes to the IRS and want to protect your share of the home if the IRS tries to seize your assets.
You divorce your spouse and transfer your interest in your home to your spouse. Since your spouse owns their half and now your half, it seems you have successfully placed the entire value beyond IRS reach. A recent ruling shows why this common strategy can fail. The court case is particularly insightful as the transfers were made long before the tax balances were due and long before the IRS showed up and were not made to avoid paying taxes per se–and the IRS still prevailed.
The court case is United States v. Le Beau, 17cv1046-LL-AHG (S.D. Cal. Jan. 30, 2024). The Le Beau case provides an opportunity to consider this fact pattern.
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Facts & Procedural History
This case involved a lawyer who failed to file tax returns or pay payroll taxes for his law firm for multiple years in the 1990s. The tax balances totaled more than $1.7 million for unpaid income taxes and payroll taxes from 1992-1999. The IRS filed tax liens for the balances.
In 2010, the IRS sued the lawyer and obtained a $1.15 million judgment against him for the income taxes and a separate $371 thousand judgment for the payroll taxes. As of the recent court opinion, the lawyer still owes more than $1.7 million, which includes penalties and interest.
This case focuses on the lawyer’s interest in his home in California, which is a community property state like Texas. The lawyer and his wife required the home in 1980. Shortly thereafter the lawyer transferred the home to his wife. Sometime after that, but before the IRS showed up, the lawyer and his spouse divorced. They still live together even though they are divorced.
After the IRS filed suit in district court against the lawyer and his wife for unpaid taxes, the couple divorced and the wife filed an innocent spouse claim with the U.S. Tax Court and subsequently appealed that to the Ninth Circuit Court of Appeals.
For this case in the district court against the couple, the district court allowed the IRS to proceed against the lawyer. This included pursuing the home that was held by the spouse which was transferred to her by the lawyer. The IRS sought to enforce its liens against the lawyers’ marital share of the home.
About IRS Liens
A federal tax lien arises automatically by operation of law. This is set out in Section 6321 of the tax code. The tax lien relates back to the date the taxes were originally due.
The tax lien attaches to all of the taxpayer’s property and rights to property. This is a broad provision. It can even include property held in trust, depending on how the trust is structured.
To perfect the lien against third parties, under Section 6323(f), the IRS can file a public Notice of Federal Tax Lien. This gives constructive notice to creditors of the tax balance and IRS lien. This can prevent buyers of the property or subsequent transferees from getting clear title even if they pay full fair market value for the property.
The IRS then has powers under Section 7403 to bring a civil action against the taxpayer to enforce the lien. This allows the IRS to petition the court for a forced sale of the taxpayer’s property to satisfy the tax debt. Even state law homestead rights won’t protect a home from this type of forced sale.
Liens on Marital Property
This case involved a taxpayer in California, which is a community property state. Under California Family Code § 760, community property is all real or personal property acquired during the marriage by a married person while domiciled in California. Each spouse owns a one-half, undivided interest in all community property. This is similar to other states that have community property laws, such as Texas.
But what about the half-interest that the non-debtor spouse owns? Section 6321 of the tax code provides that the IRS lien attaches to “all property and rights to property” of the taxpayer. If the taxpayer spouse transfers his or her one-half interest to the non-debtor spouse, can the IRS still recover that transferred half-interest to satisfy an unpaid tax balance?
About the Nominee Rules
The answer is, sometimes, yes. The IRS can pursue the transferred property interest under the nominee rules.
Courts have interpreted Section 6321 to apply the federal tax lien to property held by a third party as the taxpayer’s “nominee or alter ego.” A nominee is one who holds bare legal title to property for the benefit of another.
To determine nominee status, courts examine factors like whether consideration was paid, if the transfer was intended to avoid creditors, the relationship between parties, possession/control of property, and if benefits were retained.
If the property is held by a nominee, the IRS can foreclose on the lien against that property interest to satisfy the taxpayer’s unpaid tax debt.
In examining these factors in this case, the district court found that the lawyer’s husband retained sufficient interest in the property. It noted that the personal belongings of the lawyer are located at the property. The lawyer has a key and uses the property address for mailing correspondence. The utility bills for the property are addressed solely to the lawyer. The lawyer has made improvements to the property, including installing a new roof and heated pool. The lawyer has always been listed as the borrower on the mortgage because they “made the money.” The lawyer executed a mortgage modification agreement with the bank for the property. The lawyer claims the mortgage interest deduction on their tax returns. The lawyer is also the named insured on the homeowner’s insurance policy for the property.
This was more than sufficient interest to allow the IRS to reach the home using its nominee powers. These are the exact opposite of the facts that one would need to show to be able to potentially avoid the IRS’s nominee powers.
What About the Wife’s Half?
But what about the wife’s one-half interest? Can the IRS fees and sell the house even though the wife owned one half? Section 7403 provides the answer.
Section 7403 explicitly allows a lien creditor like the IRS to sell not only a debtor’s interest in a property, but the entire property held as a tenancy by the entirety by the debtor and his non-debtor wife. As noted by the district court in this case, this has been upheld in several other court cases.
This effectively allowed the IRS to proceed against the lawyer husband and take the spouse’s property to pay the taxes, even though the spouse may have been granted innocent spouse relief. If the spouse had been granted innocent spouse relief, which the opinion does not indicate the outcome for, the IRS’s nominee powers effectively circumvented the innocent spouse relief provisions provided by Congress.
The Takeaway
While asset protection planning can be legitimate, the courts often afford the IRS great leeway to collect taxes even if the parties are not trying to hide assets. The IRS has tools to enforce collections, including tax liens that can’t be avoided easily by transferring properties out of one spouse’s name. This is one area where it can help to talk to a tax attorney. This type of situation requires careful planning, to ensure that the IRS only gets its fair share under the law.
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