In United States v. Scherer, No. 2:19-cv-03634 (S.D. Ohio 2020) the district court reversed its earlier decision denying the IRS summary judgment on the issue of the attachment of its federal tax lien to stock transfer by the taxpayer to a trust. It reversed its earlier opinion because the court found that the trust lacked valid ownership of the stock against a subsequent purchaser. The opinion provides a rare glimpse at IRC 6323(b)(1) and a less rare, but still uncommon, situation of a district court judge reversing a decision on a motion for reconsideration, giving heart to everyone who files these types of motions.
When I teach 6323, I try to convey the goals of the drafters of the 1966 Federal Tax Lien Act and the efforts of William T. Plumb, Jr., together with other leaders in the ABA Tax Section, to guide Congress to create a statute that caused the federal tax lien to operate smoothly with commercial interests. Senator Long of Louisiana, who headed the Senate Finance Committee at the time of passage of the bill provides an eloquent explanation of the reason for and the goals of the legislation in the preamble available through the link above. This legislation has withstood the test of time. Relatively few changes to the provisions of the act and essentially no structural changes have occurred since its passage. For those interested in a deeper understanding of the Act, an article in the Harvard Journal on Legislation provides insight drawn from the time of its creation.
IRC section 6321 and 6322 create the federal tax lien which the Supreme Court has observed was broadly meant “to reach every interest in property that a taxpayer might have.” The trouble with the lien created by these two sections is that for all of its power and breadth, no one knows about it except for the IRS and the taxpayer (only the rare taxpayer will actually know about it, but the taxpayer does or should know that an unpaid liability to the IRS exists.) Congress did not want to cripple commerce with a secretive but all powerful lien. To temper the power of the lien and allow commerce to flow smoothly, Congress created IRC 6323, explaining the situations in which the IRS must make the lien public in order to defeat other creditors and purchasers and times when making it public would still not allow the federal tax lien to defeat the competing party. IRC 6323 provides the masterpiece of the 1966 legislation, integrating the federal tax lien with commercial activity in a way that both makes sense and works well.
In subparagraph (a) Congress lists four parties that can defeat the federal tax lien until the IRS files public notice of the lien in the right place. With these four parties, holders of security interests (think mortgage holders and UCC competitors), judgment lien creditors, purchasers and mechanic’s lien holders (think builders not auto mechanics), the IRS must win the race to the courthouse or lose its lien interest in specific property. Most cases involving the federal tax lien involve IRC 6323(a). The Supreme Court decision in McDermott v. United States provides a good example.
The Scherer case involves IRC 6323(b) where Congress lists 10 situations in which the party can defeat the federal tax lien even if the IRS had already gone to the courthouse and publicly recorded its lien. The first of the 10, IRC 6323(b)(1), rarely ends up in litigation but that happens here. This subparagraph provides:
With respect to a security (as defined in subsection (h)(4))—
(A) as against a purchaser of such security who at the time of purchase did not have actual notice or knowledge of the existence of such lien; and
(B) as against a holder of a security interest in such security who, at the time such interest came into existence, did not have actual notice or knowledge of the existence of such lien.
Before going further, understanding the meaning of security in (h)(4) becomes necessary and understanding the meaning of purchaser in (h)(6) will also become necessary. IRC 6323(h)(4) provides:
The term “security” means any bond, debenture, note, or certificate or other evidence of indebtedness, issued by a corporation or a government or political subdivision thereof, with interest coupons or in registered form, share of stock, voting trust certificate, or any certificate of interest or participation in, certificate of deposit or receipt for, temporary or interim certificate for, or warrant or right to subscribe to or purchase, any of the foregoing; negotiable instrument; or money.
IRC 6323(h)(6) provides:
The term “purchaser” means a person who, for adequate and full consideration in money or money’s worth, acquires an interest (other than a lien or security interest) in property which is valid under local law against subsequent purchasers without actual notice. In applying the preceding sentence for purposes of subsection (a) of this section, and for purposes of section 6324—
(A) a lease of property,
(B) a written executory contract to purchase or lease property,
(C) an option to purchase or lease property or any interest therein, or
(D) an option to renew or extend a lease of property,
which is not a lien or security interest shall be treated as an interest in property.
Lots of definitions to apply to the fact pattern at issue in the case. Notice that securities include money. This provision allows individuals against whom a federal tax lien has been recorded to go around buying things in grocery stores or other places of business without being stopped, because to stop them from purchasing items because of the recording of the lien would stop commerce.
Here the property at issue is not money but stocks. The delinquent taxpayer transfers his interest in stock to a trust. The stock clearly meets the definition of security just like the cash. In general, we don’t want to hold up the transfer of stock any more than we want the federal tax lien to hold up the purchase of bread at the grocery store. Even though the stock at issue meets the test of security, the statute requires a purchaser who did not know about the lien.
Here, the trust fails at this step of the test. In reevaluating the case the court found the following:
… the Government is correct that, even if there was an equitable change in ownership, this does not suffice to make the Trust a protected “purchaser” of the WVHI stock under §§ 6323(b)(1)(A) and (h)(6). Section 6323(b)(1)(A) provides that a lien shall not be valid as against a “purchaser” of a security who at the time of purchase did not have actual notice or knowledge of the existence of such lien. 26 U.S.C. § 6323(b)(1)(A). Section 6323(h)(6), in turn, defines a “purchaser” as a person who, for adequate and full consideration in money or money’s worth, acquires an interest in property “which is valid under local law against subsequent purchasers without actual notice [of the acquisition].” 26 U.S.C. § 6323(h)(6). It follows that, if the Trust’s equitable ownership interest in the WVHI stock would not be valid under Ohio law against a subsequent purchaser who had no notice of the agreement between Defendant Scherer and the Trust, then the Trust cannot be a protected purchaser under §§ 6323(b)(1)(A) and (h)(6), and the Government’s lien would attach to the WVHI stock.
The court found that the trust’s equitable ownership interest in the stock would be invalid against a hypothetical subsequent purchaser without notice. The problem with the protection the trust sought stemmed from the casual way in which the taxpayer tried to pass ownership. The court further stated:
Defendant Scherer, however, never signed and physically delivered the WVHI stock certificate to the Trust. Consequently, because the Trust does not have an ownership interest in the WVHI stock that would be valid against a subsequent purchaser without notice under Ohio law, the Trust cannot be a protected purchaser of the WVHI stock within the meaning of §§ 6323(b)(1)(A) and (h)(6). …The Court, therefore, finds that the Government’s federal tax liens against Defendant Scherer for tax years 1990, 1991, and 1992 attach to the WVHI stock.
The rules defining purchaser exist to thwart efforts to pass stock to related parties. Here, the casual nature of the attempt to pass the stock speaks to the relationship of the parties. Even though Congress gave strong protection to securities, allowing them generally to pass back and forth in commerce unimpeded by the existence of a filed federal tax lien against one of the owners in a stream of stock ownership, limits to that ability to divest the federal tax lien from securities do exist.The Scherer case provides a situation in which the reach of the statutory protection did not reach far enough to protect this transfer.
If you have never taken the time to look through the ten provisions of 6323(b), it’s worth the effort. In doing so notice the provisions that put limitations based on knowledge and other factors and those that do not. The drafters tried to carefully describe the situations deserving protection.