Federal Tax Liens and the Unrecorded Divorce Decree

• Publication year: 2021

91 Nebraska L. Rev. 214. Federal Tax Liens and the Unrecorded Divorce Decree

Federal Tax Liens and the Unrecorded Divorce Decree

Note (fn*)

TABLE OF CONTENTS

I. Introduction..........................................214

II. Background...........................................216
A. The Fifth Circuit Approach........................216
B. The Majority Approach............................219

C. IRS General Counsel Memorandum 24,039 (June 18, 2010).......................................... 222

III. Analysis .............................................. 223
A. The Taxpayer or the Taxpayer's Creditors?......... 224
B. Incorporation of State Recording Acts .............. 226
C. The IRS as a Creditor Without Notice ............. 228
1. Protecting the IRS as a Creditor............... 229
2. Notice to the IRS .............................. 231
D. Judicial and Legislative Solutions ................. 235

IV. Conclusion............................................ 236

I. INTRODUCTION

If all your "ex's (ex-spouses) live in Texas," current Fifth Circuit law warns that any property transferred, but not yet recorded, pursuant to a divorce decree while in Texas may be used to satisfy your ex-spouse's tax debt.(fn1) In addition, by "hang[ing your] hat in Tennessee" your property may soon be subject to similar treatment by the Internal Revenue Service (IRS).(fn2)

Section 6321 of the Internal Revenue Code states:

If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.(fn3)

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In addition:

If any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary to collect such tax (and such further sum as shall be sufficient to cover the expenses of the levy) by levy upon all property and rights to property (except such property as is exempt under section 6334) belonging to such person or on which there is a lien provided in this chapter for the payment of such tax.(fn4)

Courts are to begin their analysis by looking to state law to determine the rights a taxpayer has in the property, then to federal law in deciding whether the "property" or "rights to property" are within the legislative scope of the federal tax lien.(fn5)

For most § 6321 tax liens, the property that the government has placed a lien on will clearly belong to the delinquent taxpayer. However, in situations where 1) a couple divorces, 2) a couple transfers real property due to divorce proceedings, 3) the designated party fails to adequately record the conveying instrument, and 4) the transferor incurs a tax deficiency, the determination of what interest remained in the transferor can become a hotly contested dispute.

Currently, the federal circuits are split on this issue. The Fifth Circuit, arguing in the present minority, holds that a federal tax lien has priority over a docketed divorce decree that has not yet been re-corded.(fn6) The majority of circuits, however, hold that the delinquent taxpayer has no remaining interest in said property after such conveyance, recorded or not, to which the tax lien could attach.(fn7) Recently, the IRS has reaffirmed its position that there is an interest remaining in the taxpayer and seems set to litigate if necessary-this time in the Sixth Circuit.(fn8)

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The following cases demonstrate the need for standardized treatment of the IRS in relation to a state's recording requirements, especially when dealing with an unrecorded divorce decree. While state law defines what interest a taxpayer retains after such conveyance, this Note suggests that future courts should adopt the majority approach when determining what interest the IRS acquires after issuance of a § 6321 tax lien on a taxpayer's real property. This Note begins, in Part II, by discussing the major cases in the circuit courts that have led to this dispute, along with the recent IRS General Counsel Memorandum which has reignited the conflict. Then in section III.A, this Note demonstrates that a § 6321 tax lien should only attach to the interests of the taxpayer and not to the interests of the taxpayer's creditors. In section III.B, this Note analyzes the application and purpose of state recording acts when integrated with a federal tax lien. Next, in section III.C, this Note argues against a court's treatment of the IRS as a creditor without notice. That section further discusses a possible undeveloped argument that a docketed divorce decree dividing interest in property should qualify as constructive or inquiry notice upon the IRS when a tax lien arises. The Note concludes, in section III.D, with suggestions of judicial and legislative solutions to standardize the treatment of the IRS in tax lien proceedings with regards to conveyances contained in unrecorded divorce decrees.

II. BACKGROUND

A. The Fifth Circuit Approach

The first case in this line of litigation was United States v. Creamer Industries, Inc.,(fn9) decided under Texas state law in the Fifth Circuit. While not a divorce case, Creamer's reasoning with regard to unrecorded conveyances and federal tax liens have been the basis for subsequent divorce-related rulings.(fn10) On January 21, 1959, Creamer Industries, Inc. (Creamer) and the Maxwell Steel Company, Inc. (Maxwell) entered into a contract to transfer and convey all of Maxwell's assets to Creamer. The contract failed to list six lots, five of which the IRS subsequently levied, on March 24, 1959, to enforce a tax lien against Maxwell. On April 1, 1959, the corrected deed was delivered and backdated to January 21, 1959, but it was not recorded until April 28, 1959.(fn11) The court, without explanation, proclaimed that, "[a]s to the taxes owed to it, the United States was a 'creditor' within the

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Texas recording statute,"(fn12) and was, thus, "protected by the statute."(fn13)

However, the dissent proclaimed this was "a startling result."(fn14) Judge Brown added, "Congress has not said that this Nation has a tax lien against any and all property once owned by a delinquent taxpayer to the same extent as some innocent purchaser or judgment creditor might have under local recordation statutes."(fn15) Furthermore, the "[t]axpayer [Maxwell] here had no right in or to the property," and there were no cases supporting "the faintest hope that Maxwell, . . . had any rights, legal or equitable, against anyone . . . to get the property back or assert any interest in it."(fn16)

Twenty-one years later, in Prewitt v. United States,(fn17) the Fifth Circuit encountered a similar case, this time involving an unrecorded conveyance in the context of divorce proceedings. The pertinent facts of Prewitt are as follows: Prior to September 9, 1982, James and Johanna Damon were married and owned the property at dispute in the case. They divorced on that date and property was awarded to Johanna. The decree was entered but not recorded until after a tax levy was imposed on James, due to various illegal activities he had committed. Later, Robert Prewitt purchased the property from Johanna without knowledge of the tax lien against James. Subsequently, on

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about August 10, 1983, the IRS seized the property, prompting Prewitt to sue to attack the levy.(fn18)

The Prewitt court affirmed the decision of the district court in favor of the IRS, holding that the IRS "filed a federal tax lien against [James] after the divorce decree became final but before it was properly recorded."(fn19) The court additionally affirmed that the "IRS was a creditor without notice of the property division, notwithstanding the filing of the divorce decree in state court or the discussion between Johanna and the [IRS] special agents."(fn20)

Interestingly enough, the Prewitt court found that James' property interest was not enforceable since the divorce decree had become final two months prior to the date the tax lien arose.(fn21) The court then proceeded to call it a "somewhat appealing[] . . . argument" but eventually discarded this finding because the majority in Creamer had rejected an identical argument.(fn22) In doing so the court said the "IRS may take advantage of state recording statutes, and the right of certain of James' creditors to reach property he formerly owned until the disposition is properly recorded is sufficient to support a tax lien on the property."(fn23)

Prewitt was not without its disagreement about the interest left in the conveying delinquent taxpayer. In his concurrence, Judge Jolly stated that he "concur[red] because, and only because [the court was] bound by [its] own precedent," referring to the court's previous Creamer decision.(fn24) He stated that he fully agreed with the reasoning in the dissenting opinion in Creamer.(fn25) "Whatever the lien attached to," Judge Jolly added, "it did not attach to this property because it in no way, shape or form belonged to the taxpayer."(fn26) Even though Judge Jolly's arguments only made it to the level of a concurring opinion, the majority of circuits have supported his reasoning.

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B. The Majority Approach

The first notable case in the...