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Quiet the Title before You Sell

Posted on Aug. 27, 2015

The recent decision in Little Italy Oceanside Investments, LLC (Little Italy) provides a lesson in when not to bring a quiet title action as well as highlighting the changes to the code regarding the application for discharge as a substitute for the remedy fashioned by the Supreme Court in the Williams case.  The case raises a number of lien issues brought on when a taxpayer holds property in another name and this post will seek to peel through those issues.  In the case itself, the taxpayer, Mr. Poiselli, ended up paying his substantial tax liability, totaling over ¾ of a million dollars.  The payment occurred when the property was sold by the third party, the alleged alter ego, and payment resulted because of the power of the federal tax lien when filed against an alleged alter ego of a taxpayer.

Mr. Poiselli incurred a federal tax liability which by September, 2008 had reached the amount of $555,749.06 including penalties and interest.  The case does not provide details on how he acquired the liability and it does not matter for the resolution.  Though Mr. Poiselli hails from Michigan, since 2005 he was the sole member of an LLC that purchased property in Florida and held it under the name Little Italy.  At the dollar level of half a million owed, the IRS generally will assign an account to a revenue officer to provide personal assistance to the taxpayer to satisfy the debt.  Though the court describes Linda Stamey as a revenue agent, I am almost certain she must be a revenue officer.  While this is not important to the outcome or to the court, tax practitioners benefit from knowing what title relates to specific duties of the person at the IRS.

The revenue officer assigned to the case learned of the property and determined that Little Italy was the alter ego of Mr. Poiselli.  As a consequence, she filed the notice of federal tax lien in the county in Florida in which the property was located.  Although the opinion does not mention it, I imagine that she also filed a “regular” notice of federal tax lien in the place where Mr. Poiselli lives in Michigan and she would have filed a notice of lien in any additional locations in which she identified that he owned real property.  In order to file the alter ego lien in Florida, she needed the permission of Chief Counsel attorneys (see IRM I expect that the collection file would contain a written request from her seeking authorization and a written response analyzing the situation and giving approval.

Prior to the time she filed the alter ego lien in Florida, the revenue officer should have notified Mr. Poiselli.  The Court found that she sent notices to him and to his attorney.  He alleged in the suit that he never received notice of the filing of the alter ego lien personally or through his attorney.  He did, however, at some point become aware of the lien because Little Italy decided to sell the property and as the sole member of the LLC he would have come into this information.  The purchaser of the property required the removal of the federal tax lien.  That could have occurred in several ways.  The easiest way to remove the lien in these circumstances is to satisfy the underlying liability and have the IRS release the lien.  This happened.  When a taxpayer satisfies the liability, the IRS happily releases the lien.  Ms. Stamey would have closed her case with a feeling of a job well done.  Both she and the federal tax the lien had done their work.  The easy path to lien removal, however, does not always lead to the best result if you actually do not want to pay the IRS.  Mr. Poiselli and Little Italy learned this the hard way.

After selling the property and paying off the tax liability with the proceeds of sale, Mr. Poiselli, or rather Little Italy if you do not see the two as alter egos, brought suit seeking return of the money paid to the IRS that allowed the sale to go through with clear title.  The IRS, understandably, did not see this as the preferable outcome and refused to return the money.  A pause here to briefly discuss the concept of alter ego may provide a benefit to those who have not encountered this argument.

The concept of alter ego does not come from the Internal Revenue Code but rather from common law.  Alter ego applies when two or more individuals or entities bind their financial relationships in such a way that distinguishing one from the other becomes virtually impossible.  The case does not get into the relationship of the parties in such a way that allows a view of why the IRS thought alter ego appropriate here.  Something about the way in which Mr. Poiselli and Little Italy bound their finances together must had led the IRS to this conclusion.  On the available facts, Little Italy looks more like a nominee than an alter ego to me although the same result could have attached with either approach.  In both instances, the IRS takes the position that its lien attaches to the property interest the taxpayer has in property nominally titled to another party.  Filing the lien in the name of the third party under the theory of alter ego or nominee simply ties up that property daring the taxpayer to bring suit to set the matter straight or waiting for the IRS to do the same thing.  In this case, however, the timing of the suit controls the arguments available to the taxpayer seeking to set the alter ego lien aside and, from the taxpayer’s perspective, the timing here proved fatal to the available arguments.

Instead of bring suit to quiet title and resolve the true ownership of the property and whether Little Italy did serve as the alter ego of Mr. Poiselli, the presence of the purchaser moved the parties in a different direction.  Once the buyer materialized, Little Italy would have needed some time – maybe a couple of years, to bring suit to quiet title and get the property ready to sell without encumbrance.  The buyer did not want to wait that long apparently and Little Italy did not want to lose what must have looked like a great sales price.  So, it sold the property and used the proceeds to pay off the lien interest in the property.  It looks like the sale generated enough proceeds to fully satisfy the tax liability of Mr. Poicelli meaning that the IRS released the federal tax lien.  If the proceeds had only partially paid Mr. Poicelli’s liability, the IRS would have instead granted a discharge of the property allowing the buyer to take clean title but leaving Mr. Poicelli with some portion of the tax liability still due.

At the conclusion of the sale of Little Italy’s property in Florida the buyer is happy because the buyer now owns the property it wanted and the property is free of liens, the IRS is happy because it has not received full payment on a debt it was having trouble collecting, Mr. Poicelli might have been happy if he was not, in fact, the alter ego of Little Italy since his large federal tax debt has now been satisfied but Little Italy, and possibly Mr. Poicelli, was not happy because it received $750,000 less than it hoped for in the sale of the property.  So, Little Italy brought suit in Michigan against the IRS seeking return of the money paid to the IRS at the closing to cause the IRS to release the lien.  In the suit, it had three theories: 1) quiet title; 2) deprivation of due process; and 3) refund of money paid for the taxes of another based on the Supreme Court’s decision in Williams.  I will discuss each in turn.

The United States has waived sovereign immunity to allow suit against it to quiet title.  To bring such a suit you must have an interest in the property.  By the time Little Italy brought this suit, however, it no longer had an interest in the property.  It had sold the property to a third party.  The court found “Little Italy may not bring its Quiet Title Claim pursuant to section 2410 because at the time it filed this action, Little Italy did not claim to have any interest in the Florida Property.  Indeed, it is well settled that a ‘section 2410 plaintiff must be able to claim some presently held property interest of its own to bring a section 2410 quiet title action.’”  In its pleadings Little Italy specifically alleged that it had completed the sale.  The court properly dismissed the suit for lack of jurisdiction on this count because of the “small” procedural defect.

The second prong of Little Italy’s suit for return of the money rested on due process.  Little Italy claimed that it never had a sufficient statutory remedy to address either the alter ego determination or the alter ego lien filing; however, the court found it did.  The court said that due process does not “always require the state to provide a hearing prior to the initial deprivation of property.”  Little Italy had two post-deprivation remedies: (1) quiet title and (2) discharge.  Furthermore, it had five years after the filing of the notice of federal tax lien and before the sale in which it could have pursued those remedies (five years in which Florida real estate was not moving very quickly.)  Little Italy countered that it could not avail itself of those remedies because it did not know about the lien; however, the court found the notices were properly sent and that met the requirements.

Now, everything rested on the Williams argument.  Timing again was key.  The Williams case sought to fix a catch 22 for parties caught in the situation that Little Italy portrayed itself.  A federal tax lien encumbered its property, the need to sell the property and the lack of recourse to address the problem since only the taxpayer could sue for refund after paying the tax.  So, in Williams the Supreme Court fashioned a remedy to allow third parties to bring suit to recover funds paid to allow the sale of property where the federal tax lien of a third party otherwise encumbered the property and would have stopped the sale.

The timing problem Little Italy faced was that Congress actually addressed the problem raised in Williams and fashioned a statutory remedy that eliminated the judicial one.  The statutory remedy allows the third party to seek a discharge under 6325(b)(4).  Congress changed the discharge provisions and 7426(a) specifically to “enable an individual like Williams… to challenge a lien placed upon a plaintiff’s property as a result of a tax liability incurred by another party.”  Portsmouth Ambulance, Inc. v. United States, 756 F.3d 494, 499 (6th Cir 2014).  Section 6325(b)(4) requires the IRS to issue a certificate of discharge as a matter of right to third parties under the circumstances specified in the statute.  The third party must furnish cash or post a bond.  If the third party does this the IRS must refund the amount deposited or release the bod,  “to the extent that the Secretary determines that the taxpayer’s unsatisfied liability giving rise to the lien can be satisfied from a source other than property owned by the third party, or the value of the interest of the United States in the property is less than the Secretary’s prior determination of its value.”

Unfortunately, Little Italy chose not to seek a discharge under that provision and just sold the property and paid off the lien.  Its effort to use the Williams case came too late.  Its theoretical remedy of discharge like the remedy of quiet title needed to come at a different point in the process.  These new statutory remedies enacted in response to Williams, “preclude a third party in Little Italy’s position from maintaining a refund claim against the United States pursuant to section 1346(a)(1).”

By waiting and seeking a post-sale remedy, Little Italy lost some possible arguments.  These arguments would have run into the alter ego response from the IRS that caused the filing of the lien in the first place.  The court here did not need to address whether such a relationship existed because it did not matter.  If the IRS position that Little Italy did serve as the alter ego of Mr. Poicelli proved correct, Little Italy would not have prevailed in its quiet title action or received a discharge based on 6325(b)(4) (unless substantial other property of Mr. Poicelli’s existed.)  It may have sought the post-sale path to avoid having to face the argument about the relationship of the parties.  This case shows that waiting does not work.  If the IRS asserts that a relationship such as alter ego or nominee exists and ties up property with a notice of lien asserting that position, the taxpayer needs to tackle the issue head on and show the incorrectness of the IRS determination regarding the relationship.  Waiting and seeking a post-sale remedy only leads to a sure loss without putting the IRS to its proof on the underlying merits of its determination.

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