This week, guest blogger Anna Gooch of the Center for Taxpayer Rights returns with a post about a fascinating 6th Circuit case dealing with the seizure powers of states and the Constitution’s Takings Clause. Anna has been coordinating the Center’s nationwide survey of state taxpayer rights as well as the Center’s current workshop series, Reimagining Tax Administration: State Tax Practices & Taxpayer Rights. All of us tax folks who only focus on federal tax controversies should especially read on – state tax practice is fascinating! — Nina Olson
Federal tax practitioners are frequently reminded of the awesome powers the United States is given as a super-creditor – federal tax liens apply to all of a taxpayer’s interest in present and future property, and the reach of levies is much more expansive than that of private creditors. With the strength of the federal government a seemingly ever-present concern for taxpayers (exacerbated by politicians and the media), the ability of state and local governments to wreak havoc on taxpayers’ lives can easily slip through the cracks. Perhaps due to balanced budget requirements and limited scrutiny from practitioners and oversight groups, state governments are free to exercise their power with impunity – usually. In one recent case, the Sixth Circuit held that a Michigan law allowing strict foreclosure in the case of overdue property taxes oversteps not only the U.S. Constitution, but also the limitations established by over 800 years of legal precedent.
The four plaintiffs in Hall et al. v. Meisner et al. each owned property in the city of Southfield, Oakland County, Michigan. When each owner failed to pay the property tax due, the county initiated foreclosure proceedings pursuant to the Michigan General Property Tax Act. The county then conveyed the properties to the city for the amount of the overdue tax (plus penalties and interest). In turn, the city transferred the properties to a for-profit entity for a nominal amount. This entity then sold the properties at fair market value. At no point during any of these transactions did any of the plaintiffs receive a refund of the equity they had in their property. The General Property Tax Act permits this. When a Michigan government entity is the creditor, as it is in the case of property tax, the government can pursue “strict foreclosure,” where the government receives absolute title to the property without a sale. The plaintiffs then sued, claiming that this practice violates the Takings Clause of the 5th Amendment.
Before I discuss the court’s explanation of why Michigan’s actions here violated the Takings Clause, an explanation of the Michigan General Property Tax Act is warranted. I found that the process set out in the act is best understood with a timeline.
- March 1, Year 1: Overdue property tax assessed in Year 0 becomes “delinquent.”
- March 1, Year 2: The county may begin foreclosure proceedings. If the county chooses not to, the state may initiate the foreclosure instead.
- June 15, Year 2: The county (or the state) must file a petition for foreclosure. The property owner is notified of their right of redemption.
- March 31, Year 3: A judgment for foreclosure is entered, giving the county (or the state) absolute title to the property.
Assuming the county is the foreclosing entity, the state has right of first refusal to purchase the property at either fair market value or the value of the tax due, whichever is greater. If the state declined this right, the city or locality in which the property is located could purchase the property for the amount of the tax due. The entity that ends up owning the party, whether the state, county, or city, is then permitted to conduct a public sale of the property. The original property owner is never entitled to receive a refund of their equity in the property.
The court found that Michigan violated the Takings Clause by writing the General Property Tax Act by “defining away” the property interest that the plaintiffs had as equitable title. By ipse dixit (shoutout to my high school Latin teacher), Michigan wrote the law in such a way that ensures that the Takings Clause does not apply. According to the state and the district court, “The foreclosing governmental unit – the County – had not obtained any surplus at all from its disposition of the plaintiffs’ homes, because it conveyed them (to the City of Southfield) for merely the amounts of their tax deficiencies.” Because the General Property Tax Act allows strict foreclosures when the government is the party that initiates the foreclosure, the equitable title to the property is transferred with the legal title when the county (or state) receives absolute title to the property. Thus, there is no remaining property interest to take. Citing the U.S. Supreme Court, the Sixth Circuit finds that “a State may not sidestep the Takings Clause by disavowing traditional property interests long recognized under the law.”
So, which traditional property interests did Michigan disavow? The court readily found the practice of strict foreclosure afforded to government entities violates hundreds of years of British and American legal principles. Beginning with the 12th century introduction of mortgages into European law, the court emphasized that throughout history, the unilateral elimination of equitable title was considered “an intolerably harsh sanction.” Before the practice of foreclosure by sale became the standard, courts (and the drafters of the Magna Carta) recognized the importance of reimbursing a defaulting property owner for the loss of the value of the property to the extent the value exceeded the debt. One solution to this was (and remains) the right of redemption given to property owners. For European courts, a mortgage was just a mortgage, just as a debt is just a debt – there is no inherent right to additional equity that accompanies either.
American courts agreed with their European predecessors. Describing the history, the Hall court writes that “American courts were uniformly hostile to strict foreclosure” where absolute title was awarded to the creditor, citing cases that found the practice “unconscionable” and with “no appropriate place” in a legal system where a default on a mortgage or debt does not convey legal title to the creditor. To satisfy the competing interests of the creditor’s interest in its security and the landowner’s equitable interest, American courts – including those in Michigan — almost uniformly adopted foreclosure by sale, which was generally required to be public. The practice of foreclosure by sale extended not only to mortgages, but also to tax debts. The U.S. Supreme Court firmly agreed with this position. Holding that a creditor is entitled only to the value of the debt owed, “a tax collector had ‘unquestionably exceeded his authority’ when he had sold more land than ‘necessary to pay the tax in arrear.’” Put bluntly, “According to the long-settled rules of law and equity in all the states whose jurisprudence has been modelled upon the common law, legal title to the premises in question vested in the creditor upon the debtor’s default, yet the landowner still held ‘equitable title’ to the property.”
Though the Hall court does not discuss federal foreclosure procedures, it is important to note the difference between the government foreclosure process in the Michigan Property Tax Act and that in federal law. The law governing IRS foreclosures and the proceeds from those foreclosures conforms with the centuries of European and American law discussed in this case because it requires that the IRS return any remaining equity to the taxpayer-owner. Moreover, it mandates that the IRS take additional steps before allowing seizure and sale. Both the Internal Revenue Code and the IRM provide that in the event that there are excess proceeds from the sale, those proceeds should either be returned to the property owner or given to junior creditors, whoever is entitled to them under the applicable state law. This is the key difference, and one that protects taxpayer rights in a way that the Michigan law does not. Regardless of whether the IRS chooses to pursue an administrative foreclosure or a judicial foreclosure, there are several steps that must be taken before the action can begin. Indeed, foreclosure must be a last resort for the IRS where other collection mechanisms have failed. Christine discusses what proving this involves here. Additionally, the IRS must give notice not only to the property owner, but also to those who occupy the property. The IRS’ procedures for initiating and conducting a foreclosure sale are not perfect, as discussed by the Taxpayer Advocate here, but they are in line with centuries of law designed to protect property owners and their equitable interest in their property.
Equitable title arises before a sale or other transfer; in not holding a public sale, Michigan ignores rather than extinguishes equitable title when the government initiates foreclosure proceedings in response to unpaid tax debt. Internationally, there is a rich history in this area, with near unanimity in the conclusion that strict foreclosure improperly discards the owner’s equity in their land. Michigan’s General Property Tax Act and the lawsuit that followed are just one example of the power that state governments have when collecting tax debts and the importance of advocacy to keep this power in control and to protect taxpayer rights at the state and local levels.