We are vary familiar with the ability of the IRS to take aggressive collection action against an individual or business with unpaid tax balances. Most commonly, it will levy a bank account or receivable, or garnish wages. Recently, however, we have experienced more aggressive actions by IRS collectors in their efforts to secure payment on tax debts. We would like to briefly discuss two lesser-known actions which may be imposed by the IRS to take a client’s assets, of which you should be aware.
The Nominee Lien
Under IRC §6321, “If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.” A federal tax lien may only attach to property in which a delinquent taxpayer has rights.
To determine whether a taxpayer has rights to property under the federal tax lien statute, courts must look to state law.1 The federal tax lien statute does not create property rights, but may attach consequences to those rights.2 The consequences in most cases are the rights to equity interests up to the amount of the lien or balance due against the property.
Under a “nominee” theory, the nominee must hold legal title to property for the benefit of someone else. The facts and circumstances of each case are carefully reviewed to determine if a nominee situation exists, including: (1) a close personal relationship between the nominee and the transferor; (2) the nominee paid little or no consideration for the property; (3) the parties placed the property in the name of the nominee in anticipation of collection activity; (4) the parties did not record the conveyance; and (5) the transferor continues to exercise dominion and control over property.3 The IRS is looking closely at real property (most commonly) held by a relative of a tax debtor to determine if it can assert a nominee claim.
One mechanism carefully scrutinized in these situations is the use of a quitclaim deed. The effect of a quitclaim deed is governed by state law, but in many states, a quitclaim deed has the effect of conveying to the grantee all the then existing legal or equitable rights of the grantor in the property described.4 The IRS has challenged such quitclaim transfers under its theory of nominee liens. The Internal Revenue Manual states: “A nominee situation generally involves a fraudulent conveyance or transfer of a taxpayer’s property to avoid legal obligations.”5 There must be adequate consideration (or payment) for any transfer to overcome such a challenge, or the IRS may proceed to collect against a third party’s assets. In such a case, the third party does not have the same rights as a taxpayer to due process under the Internal Revenue Code. The third party must take the costly action of suing the government in federal court to protect his or her property.
For example, real estate was transferred to a spouse by quitclaim deed. The spouse/transferee handled all expenses for the home, except the mortgage. She also handled a significant portion of family expenses. Some years later, the spouse/transferor incurred tax debts. The IRS imposed a nominee lien upon the transferee, whose only recourse was to sue to quiet title in federal court.
Adding a nuance to its arsenal, the IRS has attempted to bolster its nominee lien theory by adding a novel “lien tracing” component based on a very narrow finding in one case, Municipal Trust and Savings Bank v. U.S.6 The facts in that case involved an Estate taxpayer and a complex series of land transfers. Estate property was distributed when tax debts were due and owing, thus the U.S. was able to recover funds from the distributed assets. The limited case law in connection with the government’s lien tracing theory deals mainly with nominee situations, or fraudulent transfers to avoid tax debts. Although lien tracing seems like a stretch to reach assets, a cautious approach is warranted in these types of situations.
Jeopardy and Termination Assessments
Another extraordinary power of the IRS whereby it may take an individual’s property or money, based on suspicion and assumptions, is its ability to make “termination”7 and “jeopardy” assessments. If the IRS chooses to take this action, and it withstands any appeal, the tax is immediately due and payable.8 These procedures can be used to freeze bank accounts, take funds from the taxpayer, and file liens against a taxpayer’s property. All of these procedures may irreparably damage a taxpayer, as we have seen.
For example, a bank may note suspicious activity in an account, as evidenced by large deposits from overseas. Such activity may be investigated by internal bank specialists, who may then report the activity to the FBI or Homeland Security, and the IRS. If the IRS deems any of the activity suspicious, it may freeze the account, assert all deposits are income to a taxpayer, assess tax, and levy the account immediately. Even if an individual claims a business purpose for the deposits, the IRS may take this action if it meets a very low standard of “reasonableness.”
The code provision that allows this action9 focuses on the reasonableness of the IRS assessment. The standards to be employed by the reviewing court in determining whether the government has met its burden of proof, and that the making of a termination assessment is reasonable are:
1. Whether taxpayer is or appears to be planning to quickly depart from United States to conceal himself.
2. Whether taxpayer is or appears to be designing to place his property beyond the reach of the government either by removing it from the United States or by concealing it, or by transferring it to another person, or by dissipating it.
3. Whether taxpayer’s financial solvency appears to be imperiled.
Further, under IRC §7429, a court must consider whether the amount of assessed tax was appropriate, under the circumstances. The method for calculating the tax must not be irrational, arbitrary and completely unsupported. The government need only establish that the taxpayer’s circumstances appear to be jeopardizing collection of a tax, not that they definitely do so.10
Straying from the Federal Rules of Evidence, a challenge in court is a “summary” proceeding, and the court may consider hearsay.11 In broadening the reach of this statute, a federal judge determined “Plaintiff also argues that the IRS, in making the jeopardy assessment, considered evidence that could be inadmissible hearsay at trial and that therefore no value should have been given to that evidence. We find no merit in this argument. In reaching administrative decisions the government can consider hearsay evidence.”12
The reality in these cases is the IRS has a very low burden to meet in order to have a termination assessment sustained. It only has to be a “reasonable suspicion.” There are cases, however, when the “suspicions” are false, and even when the IRS knows they are false, a court may let the assessment and collection stand, and force a taxpayer to challenge the assessment in a refund or Tax Court proceeding, another costly endeavor, by which time a taxpayer may be out of resources to fight the government.
In Summary
The IRS has powerful tools at its disposal as it seeks to collect taxes. Tax professionals should be aware of these tactics, and resources to defend third parties and unsuspecting individuals when faced with such actions.
1. U.S. v. Towne, 406 F. Supp.2d 928, 932 (N.D. Ill., 2005)
2. Id.
3. IRM 5.17.2.5.7.2 (03-27-2012)
4. In re Blair, 330 B.R. 206, 211 (Bankr.N.D.Ill. 2005)
5. IRM 5.17.2.5.7.2 (03-27-2012)
6. 114 F.3d 99, 101 (7th Cir. 1997)
7. IRC §6851
8. Laing v. U.S., 1976-1 C.B. 388, 423 U.S. 161, 96 S. Ct. 473, 46 L. Ed. 2d 416, 76-1 U.S. Tax Cas. (CCH) P 9164, 37 A.F.T.R.2d 76-530 (1976).
9. IRC §7429
10. Cantillo v. Coleman, 559 F. Supp. 205, 83-1 U.S. Tax Cas. (CCH) P 9268, 51 A.F.T.R.2d 83-684 (D.N.J. 1983); Hecht v. U.S., 609 F. Supp. 264, 88-1 U.S. Tax Cas. (CCH) P 9160, 56 A.F.T.R.2d 85-5580 (S.D. N.Y. 1985).
11. Balaguer v. US, 656 F.Sup. 383 (United States District Court, D. Puerto Rico, 1987)
12. 5 U.S.C. § 556(d); Richardson v. Perales, 402 U.S. 389, 407–08, 91 S.Ct. 1420, 1430, 28 L.Ed.2d 842 (1971); Sears v. Department of the Navy, 680 F.2d 863, 866 (1st Cir.1982)
Kathleen M. Lach is a Partner in the Tax and Litigation Departments of Arnstein & Lehr LLP. She represents clients before a variety of different tax authorities, including the Internal Revenue Service, the Illinois Department of Revenue, and the Illinois Department of Employment Security.
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