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Issue  82  Article  156
Published:  5/1/2002

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IRS Tax Liens Attach to Entireties Interest
Chris Burti, Vice President and Legal Counsel

The United States Supreme Court has ruled in a 6 to 3 majority decision that an IRS lien against one spouse attaches to the interest of that spouse in entireties property. The case is United States v. Craft, 535 US ____ (2002) and it was argued January 14, 2002, decided April 17, 2002. The decision leaves many substantial issues unanswered in its practical application.

When the husband failed to pay federal income tax liabilities in the sum of $482,446 assessed against him, a federal tax lien was filed. After the notice of the lien was filed, the couple executed a quitclaim deed conveying his interest in a parcel of entireties property to the wife for $1.00 as consideration. Subsequently, she attempted to sell the property and the title examination revealed the lien. For reasons that were not set out in the opinion, the IRS was contacted concerning the lien. The IRS agreed to release the lien and allow her to sell the property if half the net proceeds were held in escrow until the Government’s interest in the property was determined.

Craft brought this action to determine her rights to the escrowed proceeds. The Government’s position was that its lien had attached to the husband’s interest in the property held in the tenancy by the entirety. It further asserted that the transfer of the property to her was invalid as a fraud on creditors. The District Court granted summary judgment in favor of the Government. On appeal, the Sixth Circuit held that no lien attached because the husband had no separate interest in the entireties property under Michigan law. It remanded the case to the District Court to consider the Government’s alternative claim that the conveyance should be set aside as fraudulent. On remand, the District Court concluded that where state law makes property exempt from the claims of creditors, no fraudulent conveyance can occur. It also found that the husband’s use of nonexempt funds to pay the mortgage on the entireties property placed the funds beyond the reach of creditors. The District Court ruled that this constituted a fraudulent act under state law, and awarded the IRS a share of the proceeds of the sale of the property equal to that amount.

Both parties appealed the District Court’s decision. The Government claimed again that its lien attached to the husband’s interest in the entireties property. In affirming the District Court’s decision after remand, the Sixth Circuit held that the prior opinion on the issue of whether the lien attached to the husband’s entireties property was res judicata. It also affirmed the District Court’s determination that the husband’s mortgage payments were fraudulent.

The Supreme Court granted certiorari to consider the Government’s claim that respondent’s husband had a separate interest in the entireties property to which the federal tax lien attached. The opinion starts out with the following premise. "Whether the interests of respondent’s husband in the property he held as a tenant by the entirety constitutes “property and rights to property” for the purposes of the federal tax lien statute, 26 U. S. C. 6321, is ultimately a question of federal law. The answer to this federal question, however, largely depends upon state law. The federal tax lien statute itself ‘creates no property rights but merely attaches consequences, federally defined, to rights created under state law.’ United States v. Bess, 357 U. S. 51, 55 (1958); see also United States v. National Bank of Commerce, 472 U. S. 713, 722 (1985). Accordingly, ‘[w]e look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer’s state-delineated rights qualify as "property" or "rights to property" within the compass of the federal tax lien legislation.’ Drye v. United States, 528 U. S. 49, 58 (1999)."

We do not argue with this statement of the law. It is the conclusions that the majority has drawn based upon the statement that baffles so many knowledgeable real estate attorneys.

The Court reviewed Michigan tenancy by the entirety law, which is substantially similar to North Carolina’s laws. The Court points out that under "Michigan law, respondent’s husband had, among other rights, the following rights with respect to the entireties property: the right to use the property, the right to exclude third parties from it, the right to a share of income produced from it, the right of survivorship, the right to become a tenant in common with equal shares upon divorce, the right to sell the property with the respondent’s consent and to receive half the proceeds from such a sale, the right to place an encumbrance on the property with the respondent’s consent, and the right to block respondent from selling or encumbering the property unilaterally." Again, few would dispute that these rights characterize the typical tenancy by the entirety. Nevertheless, as in a bad novel, we have been provided foreshadowing as the court states: "A common idiom describes property as a “bundle of sticks” a collection of individual rights which, in certain combinations, constitute property. See B. Cardozo, Paradoxes of Legal Science 129 (1928) (reprint 2000); see also Dickman v. Commissioner, 465 U. S. 330, 336 (1984).

State law determines only which sticks are in a person’s bundle. Whether those sticks qualify as “property” for purposes of the federal tax lien statute is a question of federal law. In looking to state law, we must be careful to consider the substance of the rights state law provides, not merely the labels the State gives these rights or the conclusions it draws from them. Such state law labels are irrelevant to the federal question of which bundles of rights constitute property that may be attached by a federal tax lien."

Here we have a curious and, perhaps, novel legal theory. Fairly stated, it could be summarized as follows: The state will decide what rights people have in property. The Federal government can over-rule such determinations in order enforce tax liens by declaring that there is a property right that the state has determined does not exist. That is exactly what the Supreme Court majority did in this opinion. "We turn now to the federal question of whether the rights Michigan law granted to respondent’s husband as a tenant by the entirety qualify as ‘property’ or ‘rights to property’ under 6321. The statutory language authorizing the tax lien ‘is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have.’ United States v. National Bank of Commerce, 472 U. S., at 719–720. ‘Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes.’ Glass City Bank v. United States, 326 U. S. 265, 267 (1945). We conclude that the husband’s rights in the entireties property fall within this broad statutory language. Michigan law grants a tenant by the entirety some of the most essential property rights: the right to use the property, to receive income produced by it, and to exclude others from it. See Dolan v. City of Tigard, 512 U. S. 374, 384 (1994) ( [T]he right to exclude others’ is ‘“ ‘one of the most essential sticks in the bundle of rights that are commonly characterized as property’ ”’) (quoting Kaiser Aetna v. United States, 444 U. S. 164, 176 (1979)); Loretto v. Teleprompter Manhattan CATV Corp., 458 U. S. 419, 435 Cite as: 535 U. S. ____ (2002) 9 (1982) (including ‘use’ as one of the ‘[p]roperty rights in a physical thing’). These rights alone may be sufficient to subject the husband’s interest in the entireties property to the federal tax lien. They gave him a substantial degree of control over the entireties property, and, as we noted in Drye, ‘in determining whether a federal taxpayer’s statelaw rights constitute ‘property’ or ‘rights to property,’ [t]he important consideration is the breadth of the control the [taxpayer] could exercise over the property.’ 528 U. S., at 61 (internal quotation marks omitted). The husband’s rights in the estate, however, went beyond use, exclusion, and income. He also possessed the right to alienate (or otherwise encumber) the property with the consent of respondent, his wife. Loretto, supra, at 435 (the right to ‘dispose’ of an item is a property right). It is true, as respondent notes, that he lacked the right to unilaterally alienate the property, a right that is often in the bundle of property rights. … There is no reason to believe, however, that this one stick—the right of unilateral alienation—is essential to the category of ‘property.’”

We feel that here is where the majority strayed from traditional doctrine and "dropped the ball" in their analysis. They overlooked, or chose to ignore, an essential ‘stick’ in the ‘bundle’. That is, as the Court acknowledges, one spouse’s "right to block the (other spouse) from selling or encumbering the property unilaterally." (emphasis added). This is the primary right that prevents liens from attaching. Prior to this decision, it was almost universally accepted that it prevented any lien from attaching to conventional entireties property. Instead, the Court mistakenly focused on the spouse’s lack of a right of unilateral alienation of the property. The majority seemed to have difficulty with the concept of a marital entity having title to the property when they supposed that; "the entireties property would belong to no one for the purposes of 6321." They then queried; "Respondent had no more interest in the property than her husband; if neither of them had a property interest in the entireties property, who did?" The Court ruled that the lien attached to all of the husband’s property and rights to property pursuant to US Code Sec. 26 U. S. C. 6321 including the entireties interest.

The dissenting opinion of Justice Thomas deals succinctly with the majority’s reliance on Drye v. United States, 528 U. S. 49, 59 (1999), where he points out that "the Court suggests that Michigan’s definition of the tenancy by the entirety estate should be overlooked because federal tax law is not controlled by state legal fictions concerning property ownership. … But the Court misapprehends the application of Drye to this case. Drye, like Irvine and Mitchell before it, was concerned not with whether state law recognized ‘property’ as belonging to the taxpayer in the first place, but rather with whether state laws could disclaim or exempt such property from federal tax liability after the property interest was created."

It seems clear, that prior to this opinion becoming the ‘Law of the Land’, that if these five Justices had faced this issue as the determining question of their Bar examination, they may never have reached their elevated position. Justice Thomas accurately presents the opinion shared by most commentators who have ventured to voice their view, "This amorphous construct ignores the primacy of state law in defining property interests, eviscerates the statutory distinction between ‘property’ and ‘rights to property’ drawn by 6321, and conflicts with an unbroken line of authority from this Court, the lower courts, and the IRS. Its application is all the more unsupportable in this case because, in my view, it is highly unlikely that the limited individual ‘rights to property’ recognized in a tenancy by the entirety under Michigan law are themselves subject to lien." It is interesting to note Justice Thomas’ observation that "(b)efore today, no one disputed that the IRS, by operation of 6321, “steps into the taxpayer’s shoes,” and has the same rights as the taxpayer in property or rights to property subject to the lien."

Several commentators have queried if the decision is retroactive. The opinion is set out as an interpretation of existing law. It is not voiced by the majority as a change. It seems likely that it should be viewed as retroactive in the sense that it would apply to all unexpired tax liens. The case was remanded to the trial court to "value" this "property right" for federal tax lien purposes. While the Court gave little guidance on how to value the lien, it stated that "We express no view as to the proper valuation of respondent’s husband’s interest in the entireties property, leaving this for the Sixth Circuit to determine on remand. We note, however, that insofar as the amount is dependent upon whether the 1989 conveyance was fraudulent, see post, at 1, n. 1 (THOMAS, J., dissenting), this case is somewhat anomalous. The Sixth Circuit affirmed the District Court’s judgment that this conveyance was not fraudulent, and the Government has not sought certiorari review of that determination." We have difficulty in understanding how labeling the transfer fraudulent will affect the value as that issue only goes to the effectiveness of a transfer.

The case has already given rise to much discussion and will continue to do so until the practical application of the decision is worked out. In this regard, the opinion leaves many questions unanswered. How will the inchoate property right be valued? How will this new lien right affect the priority of other judgments, deeds of trust or liens that do not attach under state law? What effect, if any, does this decision have in states that have previously adopted the Uniformed Federal Tax Lien Registration Act? If the lien attaches to this "property right", can it be levied upon? This will be a core issue in determining value. If there can be no levy until the tenancy is terminated, it is an expectancy and is not worth as much as a present interest.

Some commentators have expressed the view that the traditional inability to unilaterally encumber entireties property is an archaic notion that should no longer have relevance. Others, including Justice Stevens in his concurring dissent, have argued in support of its continuation. This protection might be analogized to the protection offered by Homestead exemptions. In any event, we are likely to see Craft again as the valuation issue will assuredly be disputed. If the valuation issue is not appealed or does not answer most of the practical questions, corrective legislation will be necessary.

The slip opinion may be viewed online at the following URL;

http://a257.g.akamaitech.net/7/257/2422/17apr20021140/www.supremecourtus.gov/opinions/01pdf/00-1831.pdf


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