On September 10, 2014, the IRS issued SBSE 05-0913-0077 announcing a change in its policy regarding the attachment of the federal tax lien to unrecorded conveyances. This post will seek to explain what this change means and does not mean for those battling the federal tax lien.
The federal tax lien exists whenever the IRS makes an assessment, the IRS sends notice and demand and the taxpayer neglects or refuses to pay. The federal tax lien does not require the filing of a notice in the public records in order to exist although such notice does protect the IRS vis a vis the competing creditors listed in IRC 6323(a) – purchasers, holders of a security interest, mechanics lienholders and judgment creditors. The Supreme Court has said that Congress could not have expressed intent to create a broader lien than the federal tax lien.
The federal tax lien attaches to after acquired property as well as to property in existence at the moment it arises. The issue in this notice concerns whether property of the taxpayer existed at the time the lien arose and involves a very sad situation for a third party if the federal tax lien attaches. Mr. and Mrs. Filicetti got divorced in 2005 in Idaho. The divorce court awarded Mrs. Filicetti the principal residence with a contingent contractual right for her former husband to get half the proceeds if she sold the house within three years of the divorce. In Idaho the divorce decree itself is effective to convey title. Mrs. Filicetti did not record the divorce decree. She continued living in the house for more than three years.
Meanwhile, Mr. Filicetti did not pay his 2005 taxes reported on his return. His failure to pay the 2005 taxes continued after the IRS assessed the taxes and sent a notice and demand letter. The federal tax lien arose as a result in 2006. In September 2008 the IRS filed the notice of federal tax lien. That notice tells the world that Mr. Filicetti owes the IRS and that its lien attaches to all of his property and rights to property.
After filing the notice of federal tax lien, the IRS looked around to see what it could collect from Mr. Filicetti and noticed that he had an interest in jointly owned property – the principal residence during his marriage. The IRS brought a suit to foreclose its lien interest in the property when Mr. Filicetti did not work with it to pay the tax. I imagine discussions occurred prior to the initiation of the suit. Just like Bre’r Rabbit, Mr. Filicetti probably said to the IRS “please don’t throw me in the briar patch” by bringing a foreclosure suit against this property. Of course, Mr. Filicetti did not mind if his tax debt was paid from the proceeds of the home he lost in the division of property pursuant to the divorce.
On the other hand, Mrs. Filicetti did mind. Her problem, however, stemmed from the fact that she never recorded the divorce decree awarding her the property and the decree left with Mr. Filicetti the contingent right to obtain half the property had she sold it within three years of the transfer pursuant to the divorce.
The case plays out very much like an innocent spouse case but without the innocent spouse provisions to come to Mrs. Filicetti’s rescue since this is not a situation with a joint return. In 2012 the district court in Idaho determined that Mr. Filicetti did not have a continuing interest in the property to which the federal tax lien could attach and, therefore, entered a decision for Mrs. Filicetti. In the SBSE memo published last month, the IRS announced that it agrees with the court’s decision on this point and it will change the Internal Revenue Manual so that it does not sue to foreclose against similar parties in the future. This concession may be extremely narrow since Idaho’s recordation laws do not appear mainstream. For Mrs. Filicetti, the concession also comes after she had to expend funds and, no doubt, a fair amount of sleepless nights.
The Notice reaches this conclusion through two steps. First, it views the state law which does not require recordation of the divorce decree to create a valid transfer of property. Because the decree created a valid transfer, when the federal tax lien arose it did not attach to the real property itself. The result stems from an acknowledgment that state law creates property rights and the federal tax lien attaches or does not attach to property based on the rights created under state law. In most instances state recording statutes require recordation of a deed or other instrument passing title in order to perfect title in the acquiring party. Here, state law vested all rights to the real property in Mrs. Filicetti with the issuance of the divorce decree settling property rights between the spouses. So, Mr. Filicetti had no interest in the real property left to which the federal tax lien could attach at the time it arose. This part of the concession by the IRS is totally dependent on the law of Idaho. If you practice in a state that requires record notice in order for good title to pass, the result would differ. Without doing a survey of the states on this issue, I suspect Idaho’s provision reflects that of a distinct minority.
Having determined that Mr. Filicetti did not have an interest in the real property, the IRS moved onto the second issue – that of the contingent interest in the event of a sale within three years of the decree. The IRS viewed Mr. Filicetti’s interest in one half of the proceeds of the sale of the principal residence within three years as a personal property interest giving him a contingent right to monetary proceeds – a right that expired in three years. The federal tax lien attached to the right since it attaches to all property and rights to property but once the three year period ran the right ceased to exist and the lien interest did as well. The federal tax lien did not act to extend the three year right but merely attached to the taxpayer’s right which had a time limitation.
Based on Idaho law and the contingent right owned by the taxpayer the SBSE memo reaches the right conclusion but the case serves as a cautionary tale for those divorcing or separating from their spouses. If you are parting company with a spouse, that spouse’s tax problems can continue to be your problems if you retain joint property interests. To protect yourself, you must eliminate joint property holdings. Nothing you write in the decree can protect you from the federal tax lien if the former or separated spouse incurs and does not pay a federal tax liability.
I think the IRS is sensitive to the difficult situations in which former spouses can find themselves, but in collection matters it does not have the innocent spouse provisions to point to as a clear basis for granting relief. We had a case in our clinic a few years ago in which a wife owned property prior to marriage, placed her spouse on the title for purposes of obtaining a loan, separated from her husband after abuse but never divorced him or retitled the property. While living apart, he ran up federal tax liabilities. When she wanted to sell the property to move to a better part of the city with the child, she learned that the IRS wanted all of the equity in the house to satisfy the federal tax debts of the husband. Ultimately, the IRS consented to granting a discharge in that case with the intervention of the local taxpayer advocate and the kindness of the collection territory manager but the IRS did not need to do so.
The Rodgers factors would almost certainly have prevented an attempt by the IRS to foreclose its lien had it shown any inclination to do so, which it did not, but she would have had to wait out the statute of limitations on collection of her former husband’s debt prior to selling the property had the IRS not consented to the discharge. Legally, the parties were stuck in a position in which the IRS probably could not move forward to affirmatively collect but neither did the law require it to give up its lien interest in the property. The discharge acknowledged the fact that by holding onto its right the IRS essentially barred her from selling without getting any benefit for itself. Its concession provided her with welcome relief she could not have obtained through litigation. The four factors that the Supreme Court set out in its Rodgers decision for district courts to weigh when the IRS seeks foreclosure were preventing the IRS from bringing, or succeeding, had it sought to resolve the problem through litigation because the harm to her outweighed the government’s interest in the property.
Let your client know that as long as a joint interest is property exists, the unpaid taxes (and other debts) of the former spouse continue as a specter hanging over property your client may think is free from the problems of the former spouse.