Daily Development for Friday, April 19, 2002

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

TENANCY BY THE ENTIRETIES; FEDERAL TAX LIENS: Federal tax lien against one spouse attaches to entireties property.

United States v. Craft, __ U.S. __ (April 17, 2002).

Don Croft and his wife, Sandra, owned a piece of real estate in Michigan as tenants by the entirety. After Don failed to file his federal income tax returns for seven years, the IRS assessed a $482,446 lien against him under the federal tax lien statute, 26 U.S.C. § 6321.

After the lien hit, Don and Sandra jointly conveyed the property to Sandra for $1.00. When Sandra tried to sell the property a few years later, a title search revealed the lien. To allow the sale, the IRS released the lien under an agreement that one-half of the sales proceeds would be held in escrow pending determination of the Government's interest in the property.

The United States District Court awarded the escrow funds to IRS, ruling that the tax lien attached upon the transfer of the property to Sandra. The Sixth Circuit reversed, holding that the lien did not attach to entireties property. The Sixth Circuit, however, remanded the case to the District Court for consideration of whether Don's use of non-exempt funds to pay down a mortgage on the property after the lien attached constituted a fraudulent conveyance.

On remand, the District Court held that the tax lien did not attach to the property but that Don's mortgage payments with non-exempt funds were fraudulent transfers. The Sixth Circuit affirmed, and both sides appealed.

The Supreme Court reversed and held that the lien would attach to Don’s interest. It held that despite "the state law fiction that a tenant by the entireties has no separate interest in entireties property," each tenant possessed "individual rights in the estate sufficient to constitute 'property' or 'rights to property'" for purposes of the federal tax lien statute. It remanded for a determination of the value of the value of Don’s interest (as to which it made no comment) and for accounting of the fraudulent transfers.

The decision was based on the broad sweep of the federal tax lien statute and the majority's view that federal law controls the question what rights constitute property under the statute. Justice O'Connor's majority opinion explained the holding with a metaphor:

        "A common idiom describes property as a "bundle of sticks" a collection of individual rights which, in certain combinations, constitute property. . . . State law determines only which sticks are in a person's bundle. Whether those sticks qualify as property for purposes of the federal tax lien statute is a question of federal law."

Under Michigan law, Don had a lot of sticks in the entireties property: a right of use, a right to exclude third parties, a right to share any income from the property, a right of survivorship, a right to become a tenant in common if he got divorced, a right to sell the property with Sandra's consent, and a right to block Sandra from selling property unilaterally. Because Don had so many sticks, the federal tax lien attached. To rule otherwise would enable spouses to shield property from federal taxation.

The Court noted that the decision here parallels the treatment of other interests protected from judgment liens by state law, such as homesteads, that were subject nevertheless to IRS liens.

Justices Thomas and Scaglia dissented. The principle thrust of the dissent was that the majority’s approach here was inconsistent with the treatment of attachment of liens to partnership interests that had been restricted as to transfer.

Reporter’s Comment: A fallacy in the ruling is that it takes away a big stick from the spouse who did not incur the tax lien - the right to block the other spouse from encumbering entireties property unilaterally. Thus, the IRS actually gets to lien more sticks than state law puts in the delinquent taxpayer's bundle.

Editor’s Comment 1: As a practical matter, the Editor is not disturbed the opinion. Anyone who practices in a jurisdiction that uses the highly protective version of the tenancy by the entireties knows that they commonly are used to shield investments from creditors. Any property can be held in tenancy by entirety, not just those properties specially related to a domestic relationship. Although it may be state policy to shield certain investment vehicles from creditors, the editor sees no reason why that policy ought to bind the federal government.

Edtitor’s Comment 2: Some have argued that the case has to do with the fundamental notion of the state’s recognition of property. Note, however, that the Supreme Court here is dealing with division of proceeds by stipulation following voluntary sale of the asset by its owners. The Court did not reach the point of determining what will happen if, indeed, the property interest to which the tax lien attaches is still held by a married couple.

In some jurisdictions, it would be possible for the lien to attach to one spouses interest but to lay dormant until death, divorce, or voluntary division of the property makes it possible to separate out the bound spouse’s interest. The editor sees nothing in the Court’s opinion that expressly clarifies whether this treatment would be have been appropriate in the case at hand. Such treatment certainly would maximize the protection given to the non-debtor spouse’s property expectations.

On the other hand, it is possible that the court is authorizing the foreclosure sale of the property, with division of the proceeds. As the Reporter argues, this does expressly overrule the innocent spouse’s interest in controlling the disposition of the property. Other federal law permits such intervention for valid federal policies, however, such as the forced sale of a cotenant’s together with that of bankrupt cotenant.

The Court says that the fact that the husband lacked the power to control the disposition of his interest is not a big enough "stick" to prevent characterization of his interest as "property" subject to lien under the federal tax laws. Of course, the Court’s decision as to the size of the stick clearly is a federal intervention in the state law concept. The Court essentially is saying: "OK, but no big deal." Right?

Comment 3: On a whimsical note, we should acknowledge dissenting Justice Scaglia’s memorable rant on the impact of this decision on the interests of women in America:

        "I write separately to observe that the Court nullifies (insofar as federal taxes are concerned, at least) a form of property ownership that was of particular benefit to the stay-at-home spouse or mother. She is overwhelmingly likely to be the survivor that obtains title to the unencumbered property; and she (as opposed to her business-world husband) is overwhelmingly unlikely to be the source of the individual indebtedness against which a tenancy by the entirety protects. It is regrettable that the Court has eliminated a large part of this traditional protection retained by many States."

Many of the editor’s feminist friends will be surprised that Justice Scaglia has come out as such an ardent advocate of the interests of women, particularly in a situation in which the law itself is gender neutral - a fact the "old" Justice Scaglia would be likely to point out in other contexts. Perhaps he is gleefully poking fun at his good friend and colleague on the Court, Justice Ginsberg, or perhaps - on the road to Damascus . . .

The Reporter for this case was Bruce Davis of the Arlington, Virginia, bar.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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