Posting for

Wednesday, August 5, 1998

by: Bert Rush

brush@firstam.com

FEDERAL ESTATE TAX LIENS/BANKRUPTCY/MARSHALING

A recent decision of the Bankruptcy Appellate Panel of the Ninth Circuit serves up a combination plate of issues concerning federal estate tax liens. The case is In re Decker (B.A.P. 9th Cir. 1996) 199 B.R. 684.

Chester Decker died on July 3, 1985. In his will, Chester devised real property in Hawthorne, NJ, to his son, Steven Decker. Other assets went to other heirs.

Three executors were appointed pursuant to Chester's will. In October 1986 the executors moved for a determination of federal estate tax liability (under 26 U.S.C. sec. 2204), and for an extension of time within which to pay (26 U.S.C. sec. 6166). The IRS agreed to the extension--permitting the estate to pay taxes due over fifteen years.

In June 1987 the original executors were released by the probate court, and Steven was substituted as executor.

In September 1987 Steven mortgaged the property to Valley National Bank for $250,000. The mortgage doc noted that Steven acquired the property from the estate of Chester.

The estate defaulted on its payments to the IRS in October 1992. The IRS threatened to levy against the property--but it failed to do so and, in December 1994, Steven filed Chapter 11 bankruptcy. This filing triggered the automatic stay--so the IRS would now need a order lifting the automatic stay to proceed with its levy. The IRS was listed as an unsecured creditor of Steven's, with a disputed claim in the amount of $331,000.

In May 1995 Steven (as debtor-in-possession) filed a "Motion for Order Authorizing Debtor and Debtor-in-Possession to Sell Real Property and Pay Off Pre- and Post-Petition Secured Debt Thereon and to Pay Costs Attendant to the Sale." This motion proposed to sell the PIQ for $555,000 and pay certain secured creditors, including Valley National Bank--but not including the IRS.

On June 30, 1995, the IRS filed opposition to the motion, claiming the PIQ was subject to a lien in favor of the IRS to secure payment of the estate tax due (under 26 U.S.C. sec. 6324)--and that this lien was senior to the mortgage held by Valley National Bank. Including penalties and interest, the IRS claimed $1,035,524 to be due.

On July 3, 1995, both Steven and Valley National Bank filed responses to the IRS opposition, claiming that the federal estate tax lien expired that very day because the IRS had failed to enforce its lien rights within ten years of the death of the taxpayer, as required by 26 U.S.C. sec. 6324. Valley National Bank also argued that: (1) the priority dispute between it and the IRS should be decided in an adversary proceeding; (2) the doctrine of marshaling should be applied against the IRS, because there were other assets which could be seized to pay its debt; (3) the IRS had forfeited its lien under sec. 6324 in favor of a lien under sec. 6324A (providing for creation of a special lien for estate taxes subject to a sec. 6166 arrangement for extension of payment), which lien under sec. 6324A would not be effective against Valley National Bank; and (4) even if the IRS held a sec. 6324 lien, it would not be effective against Valley National Bank.

After a hearing the bankruptcy court ruled that an adversary proceeding was not necessary--the priority dispute could be resolved as a summary judgment motion involving only legal issues. It then ruled that (1) the sec. 6324A lien would not be enforceable against Valley National Bank (as the holder of a security interest); (2) likewise the sec. 6324 lien would not be enforceable against Valley National Bank (as holder of a security interest); (3) the ten-year limitation on sec. 6324 liens was "durational, not a statute of limitations"--so it was not stayed during bankruptcy and it expired July 3, 1995--and the IRS lien was (as we say in the title biz) "out by time"; and (4) the IRS was subject to the doctrine of marshaling--it would be required to exhaust efforts to enforce against other assets before it could seek enforcement against the PIQ (the sole asset available to Valley National Bank) ???!

The Bankruptcy Appellate Panel ("BAP") agreed to review the issues as an appeal from a summary judgment--holding that failure to require an adversary proceeding was harmless error.

The BAP next ruled that the ten-year limitation period under sec. 6324 was stayed by Steven's bankruptcy. Although it was not presented as an issue for decision, the BAP noted that a federal estate tax lien need not be recorded to be valid (as this was not, apparently), even against a subsequent purchaser for value with no actual knowledge of the lien. (Citing U.S. v. Vohland [9th Cir. 1982] 675 F.2d 1071, 1074-76.) Saying that it didn't need to decide whether the ten-year period was limitational or durational, the BAP held the period was stayed by the bankruptcy under Bankruptcy Code (11 U.S.C.) sec. 108(c)--which provides in pertinent part:

In so holding, the BAP said any other result would unfairly permit debtors to "unilaterally shorten limitations periods by the strategic filing of a bankruptcy petition."

Likewise, the BAP reversed the bankruptcy court on the marshaling issue, saying that the Ninth Circuit has previously rejected the application of marshaling to the enforcement of federal tax liens. To hold otherwise would create an unreasonable burden, unauthorized by statute, on collection of taxes.

But the BAP affirmed the bankruptcy court's ultimate result--without commenting on sec. 6324A, the BAP held that Valley National Bank's mortgage would not be subject to the IRS lien under 26 U.S.C. sec.6324(a)(3), which provides:

In other words, the original executors requested a discharge from personal liability under 26 U.S.C. sec. 2204 in October 1986. The IRS had nine months within which to dispute the discharge--which they did not do--so the original executors were discharged in June 1987. Sec. 6324(a)(3) says that such a discharge of fiduciaries does not operate to release the lien unless (and to the extent that) assets of the estate have been transferred to bona fide purchasers or bona fide encumbrancers (in this case Valley National Bank), in which case the lien is released from the transferred asset--to re-attach to the consideration received by the heirs from the BFP or BFE.

So the ultimate result of the bankruptcy court ruling was affirmed, and the Valley National Bank mortgage is not subject to the IRS lien.

This is an important decision because it reminds us, once again, of the "silent lien" permitted for federal estate tax collection under sec. 6324. This topic was treated in Claims Chronicles III, in the story from Baltimore (Hebb Estate). Recent changes in the tax code raised the value of the gross estate from $600,000 to $1,000,000--triggering liability for federal estate taxes--but with the dramatic run-up of stock prices and rebounding real estate values we shouldn't expect fewer estates to have this liability. Title and escrow/closing people should always consider the possibility of a silent federal estate tax lien where a former owner of property died within ten years of a pending transaction, and where the property was probated. (The federal estate tax lien is easily avoided as against non-probated real property--such as that passing to a joint tenant or through a trust). And remember the ten-year period under sec. 6324 may be stayed by the bankruptcy of an heir and/or executor or administrator--as happened in Decker--and also may be tolled by off-record enforcement actions of the IRS.

And, when such a death is detected--and the possibility of a lien arises, what should we do? The BAP in Decker gives this advice (quoting from In re Vohland [9th Cir. 1982] 675 F.2d 1071, at 1076):

This is an important topic--it needs to be included in our training of employees and agents.

Questions, comment, argument? Just press "reply" and send your thoughts to LandSakes.

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  Following Wednesday's posting Jay Dobson (Portland) writes:

In the last couple of years, we've had a couple of near brushes with estate tax lien claims by the IRS. In the messier of the two, we insured the sale of a house(@ $200,000) from The-Good-Son. He had acquired title from a trust. The trust was set up by mom and dad, and after their deaths, the assets were to be distributed to The-Good-Son. He duly got the house from the trust and we insured the sale from him. The title person was aware of estate tax issues (surprisingly) and found the probate for mom (she died several years after dad). The total assets in the estate amounted to less than $200,000, so the issue was dropped. It seems, however, that mom and dad were not only successful doctors, but also wise real estate investors, and that there was over $1,000,000 in real estate in the trust, which the IRS considered part of the estate for tax purposes. The IRS argued they had a lien for $300,000 and it had attached to our insure's property. They kindly gave us a short period of time to pay them before they levied against our insured's home. After a brief moment of panic, we wrote back, pointing to the same statute the court referred to above saying (with a straight face) that the lien attached to the proceeds of the sale and not our insure's property, and that our outside counsel was prepared to fight until doomsday over the issue (maybe a bluff, but we had spoken to them) - and also pointing out what other property was still owned by The-Good-Son acquired through the trust (being a title company with ready access to tax records has some benefits). So far, (it's now been a couple of years) the IRS has left our insured alone, most likely pursuing the path of least resistance.

Reply to Jay: Actually I think you're on the right side of that one, since the PIQ passed to The-Good-Son through a trust outside of probate. The lien divestiture language of sec. 6324(a)(2) reads:

Sections 2034 to 2042 (26 U.S.C.) are contained in that part of the Internal Revenue Code which defines the "gross estate" for purposes of determining whether estate tax is due--but sections 2034 to 2042 refer only to nonprobate property. On the other hand, section 2033 (26 U.S.C.) refers to property subject to probate. It follows that property for probate is not entitled to the lien divestiture protection afforded by section 6324(a)(2)--so the only way to release the estate tax lien from probate property is as described by the BAP in Decker (which, again, was decided on other lien divestiture protections contained in sec. 6324[a][3]).

The only other case I know of on this is one cited to us by the IRS in connection with the Hebb Estate claim (CC III): U.S. v. Estate of Young (E.D. Pa. 1984) 84-2 U.S.T.C. par. 13,594, 592 F.Supp. 1478. The Young decision contains a good discussion of these issues.