Valuing interest in tenancies by the entirety under craft.

• Author: Bhandari, Jagdeep S.

In United States v. Craft, 535 U.S. 274 (2002), Mr. and Mrs. Craft owned Michigan real property as tenants by the entireties. During the marriage, Mr. Craft failed to pay federal income taxes for tax years 1979 through 1986 and in 1988, the Internal Revenue Service assessed the husband $482,446 of income tax, penalties, and interest. The IRS recorded a notice of federal tax lien (1) and after the lien notice was filed, Mr. Craft transferred his interest in the property to his wife for $1 by quit-claim deed.

In 1992, Mrs. Craft sold the property. She reached an agreement with the IRS whereby the property was sold free of the tax lien, if Mrs. Craft placed half of the net proceeds in an escrow account pending a judicial determination of the government's interest in the property. In an unusual ruling, the district court allowed the IRS to seize an interest in one half of the proceeds from the sale of tenancy by the entireties property. The district court stated that Mr. Craft enjoyed present "rights to the property" that the IRS lien attached to. On appeal to the Sixth Circuit, the court followed the majority of jurisdictions and held that no lien attached to the proceeds since the property was owned jointly, with each party owning an undivided interest in the whole. Since the joint owner possessed no individual and separate interest in the entireties property, the Sixth Circuit concluded that there was no individual property for the tax lien to attach to. (2)

On certiorari, the Supreme Court held that the state law recognized Mr. Craft had present rights to property, even though he owned it as a tenant by the entireties, and that federal law allowed the government to maintain a lien on the husband's rights to property. (3)

Tenancy by the Entireties Ownership

Like Michigan and Florida, approximately 25 states recognize tenancy by the entireties ownership, and historically do not allow a creditor with a judgment against an individual owner to seize or encumber property that belongs to the individual as tenants by the entireties. (4) In said jurisdictions, property owned as tenants by the entirety belongs to neither spouse individually, but to a separate fictional economic unity created by their marriage. (5) Florida, like Michigan, characterizes tenancy by the entirety ownership as creating no individual rights whatsoever, but each owner "is vested with an entire title." (6) Accordingly, property held as tenants by the entirety can only be reached to satisfy a husband and wife's joint debts and cannot be reached to satisfy the obligations of only one spouse. (7)

Despite the inability to separate the husband's interest from that of the wife's interest in jointly owned property, the Craft court noted that property ownership has been defined as a "bundle of sticks," and includes both present and future interests. Despite the fact that under state law neither of the owners had the right to unilaterally alienate the other owner from the property, and that each party had to survive the other party to obtain total ownership, the court ignored that portion of the state law and found one party had present interests in the property. The present interests provided the husband with "a substantial degree of control over the entireties property" as found by the court and therefore were subject to the federal tax lien.

Once the court determined that each tenant individually possessed present rights under state law, the court held that under federal law, the federal tax lien attached to said property rights within the meaning of 26 U.S.C. [section] 6321. The court selectively chose which part of the state law it applied to the federal law. It recognized the individual's "present rights" under state law, but it ignored the state law's finding that neither tenant owns a severable interest in the property.

Typically, Mr. Craft's right of survivorship is considered a future interest and would be merely an expectancy. Expectancy interests are not vested rights which can be conveyed or transferred. The court said in Drye v. United States, 528 U.S. 49, 60, n.7 (1999), that an expectancy would not constitute "property" for the purposes of a federal tax lien. But Drye's discussion of an "expectancy" did not decide the issue for the Craft court. The Craft court did not decide how many "sticks" were required for a tax lien, but it decided that it did not have to reach the issue of "expectancies" or whether survivorship alone would qualify as "property" or "rights to property" under [section] 6321 since sufficient present possessory sticks existed for the tax lien to attach. (8)

The court expressed its concern that if it did not identify present "sticks" for the tax lien to attach to, that entireties property would belong to no one for [section] 6321 purposes. Hence, if "the wife had no more interest in the property than her husband; if neither of them had a property interest in the entireties property, who did?" (9) If neither the wife nor the husband had attachable lien rights in the present property, the decision would produce an absurd result that would allow spouses to shield their property from federal taxation by classifying it as entireties property.

Yet, this conclusion has been relied upon by attorneys for several decades and has assisted them in creating asset protection plans. Maybe it is time, in this court's opinion, to change that planning option. Even though the fiction of owning the property as one economic unit has been used for several years by clients to avoid creditors, the court felt that such a position facilitated abuse of the federal tax system, and...