Posts tagged with "delinquent taxes"

Trustees May Be Liable in their Own Person and Estate for Failure to Comply with IRS Notices of Levy Issued against Trust Beneficiaries

Trustees May Be Liable in their Own Person and Estate for Failure to Comply with IRS Notices of Levy Issued against Trust Beneficiaries

United States v. Michel, 08 CV 1313 DRH WDW, 2012 WL 3011124 (E.D.N.Y. July 23, 2012)

In a recent case before the United States District Court for the Eastern District of New York, the United States government commenced an action against a trustee in order to collect unpaid federal taxes owed by the trust beneficiary. The District Court granted the government’s summary judgment motion and found the trustee liable for unpaid federal taxes plus interest.

In 1995, the beneficiary’s mother died. Pursuant to her will, the majority of her estate was left to be held in trust, and administered, managed, invested and reinvested by the trustee as set forth in the will. The relevant provision of the will directed the trustee to pay her son, the sole beneficiary of the trust, at least $1,000 per month, but not more than 60-percent of the net income of the trust. The same provision also provided the trustee with sole discretion to pay trust principal to her son as necessary for the comfortable “maintenance, support, health, education and well being” of her son, and his two sons. In February 1996, the trustee was issued letters of trusteeship for the trust created by the will.

In April 1996, the trustee was informed by his attorney by letter that the son owed the federal government for various taxes totaling $246,579. The attorney additionally informed the trustee that whatever income was going to the son, regardless of the source, must go first to the creditor. In June 1996, the trustee was served with an Internal Revenue Service (IRS) Notice of Levy and Notice of Federal Tax Lien. The Notice of Levy listed federal income tax liabilities and civil penalties that the son owed to the IRS for tax years 1979 through 1989. The notice further stated that the levy required the trustee to turn over to the IRS “this person’s property and rights to property (such as money, credits and bank deposits) that you have or which you are already obligated to pay this person.” In either 2000 or 2001, the trustee was directed by his new attorney to make distributions from the trust to the son because the IRS had been satisfied. The trustee did not see the paperwork documenting satisfaction of the IRS levy and signed blank checks to permit the attorney to draw on the trust account for the son. The government then commenced action against the trustee to collect the son’s delinquent tax liability through the judicial enforcement of the IRS levy.

The IRS has two principal tools to collect delinquent taxes. The first is a lien foreclosure suit, brought pursuant to 26 U.S.C. § 7403(a). The other is the issuance of a levy upon all property and rights to property belonging to the delinquent taxpayer, pursuant to 26 U.S.C. § 6331(a). Where the taxpayer’s property is being held by another, the notice of levy is customarily served upon the custodian of the property pursuant to 26 U.S.C. § 6332(a). Serving the notice on the custodian creates a custodial relationship between the person holding the property and the IRS so that the property comes into constructive possession of the government. If the custodian fails or refuses to surrender the property or rights to property subject to the levy, the custodian becomes liable in his own person and estate to the government in the sum equal to the value of what he failed to surrender. 26 U.S.C. § 6332(d)(1).

Pursuant to New York law, the plain language of the trust instrument must be analyzed in order to determine a trust beneficiary’s property rights in trust income or principal. The Second Circuit has held that a beneficiary has a property interest in trust income when the trust instrument sets out the trustee’s duty to pay income in mandatory terms. Magavern v. United States, 550 F.2d 797, 801 (2d Cir.1977). Therefore, when the trustee is required to make a payment of trust income to a beneficiary, even when the amount and timing of the mandatory income distribution are left to the trustee’s discretion, the trust beneficiary has a property right in trust income that is subject to a tax levy.

In the instant case, because the trustee’s duty pay out a certain amount of trust income was set forth in mandatory terms, the beneficiary had a right to property in the trust income, and the government tax levy could attach to this right. However, the will did not require the trustee to pay trust principal to the beneficiary. The terms of the trust left decisions with respect to the trust principal entirely to the trustee’s discretion. Therefore, the beneficiary had no attachable right to property in the trust principal until the trustee decided to make a distribution of such principal to him. The District Court concluded that the beneficiary had some property rights to both the trust income and that portion of the trust principal, if any, that was distributed to him. These rights to property were in the possession of the trustee, and it was undisputed under the facts of the case that the trustee did not surrender any levied property to the IRS in compliance with 26 U.S.C. § 6332(a). Therefore, the trustee could be liable in his own person and estate to the government under 26 U.S.C. § 6332(d)(1).

A custodian of property or rights to property that are subject to an IRS levy has only two defenses to avoid liability in his own person and estate. The first available defense is that the trustee is neither in possession of nor obligated with respect to the property or rights to property belonging to the delinquent taxpayer. 26 U.S.C. § 6332(a). The second available defense is that the taxpayer’s property or rights to property at issue are subject to attachment or execution under a judicial process. Id. In the instant case, the first defense was not applicable because, pursuant to the terms of the will, the trustee was both obligated to pay the beneficiary certain amounts of trust income at given intervals and empowered to make discretionary distributions. The trustee made no suggestion that the second defense was applicable. The absence of intentional or negligent conduct is not relevant as to whether an enforcement action may be maintained against the custodian; therefore, good faith could not absolve the trustee of liability for his failure to comply with his statutory obligations to surrender property pursuant to a valid IRS Notice of Levy. Therefore, the District Court found that the trustee could not avoid liability for his actions under either of the two statutorily available defenses.

The District Court determined that the government established as a matter of law that the trustee failed to honor the Notice of Levy served on the trust beneficiary in June 1996 by improperly distributing estate assets to the trust beneficiary after the date of the levy. However, the court also held that the trustee was liable for less than the judgment amount requested by the government, but the court permitted the government to submit a supplemental briefing as to its entitlement to additional estate money to which the trust beneficiary had a property right.

Should you have any questions relating to trusts or other personal asset protection issues, please do not hesitate to contact Attorney Susan Maya, at SMaya@Mayalaw.com or 203-221-3100, and Attorney Russell Sweeting, at RSweeting@Mayalaw.com or 203-221-3100, in the Maya Murphy office in Westport, Fairfield County, Connecticut.

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Several Different Legal Theories May Allow Creditors To Reach a Debtor’s Assets Held in Trust

Several Different Legal Theories May Allow Creditors To Reach a Debtor’s Assets Held in Trust

United States v. Evseroff, 00-CV-06029 KAM, 2012 WL 1514860 (E.D.N.Y. Apr. 30, 2012)

In a recent case before the United States District Court for the Eastern District of New York, the United States government sought to collect delinquent taxes by accessing assets held in a trust established for the benefit of the taxpayer’s children. The current case was remanded to the District Court by the United States Court of Appeals for the Second Circuit after the Second Circuit reversed an earlier District Court ruling on the same matter. On remand, the District Court ruled that the government may collect against all assets held by the trust.

Between 1978 and 1982, the taxpayer invested in a series of tax shelters that generated deductions that were later disallowed by the Internal Revenue Service (IRS). In December 1990, after being audited, the taxpayer received notification that he owed over $227,000 in taxes and penalties. This amount was later corrected. In January 1992, the taxpayer received a notice of deficiency indicating that he had accrued more than $700,000 in tax liability. The taxpayer challenged the IRS calculation of his tax liability in a petition to the United States Tax Court. In November 1992, the Tax Court entered judgment against the taxpayer in the amount of $209,113 in taxes and penalties, and $560,000 in interest.

In June 1992, the taxpayer established a trust, naming a series of family friend and business associates as the trustees and naming his two sons as the beneficiaries. In the same month, he transferred approximately $220,000 to the trust and in October 1992 he transferred his primary residence, valued at $515,000, to the trust. The taxpayer received no consideration and there was no evidence the trust assumed the individual taxpayer’s mortgage obligations. Pursuant to the transfer agreement, the taxpayer was allowed to live in the residence and was responsible for the expenses of the residence, including the mortgage and property taxes. At the time of the transfer, the mortgage was scheduled to be paid off in five years; however, the transfer agreement did not specify an end date for the taxpayer’s occupancy.

At the bench trial held in 2005, the government advanced several theories for recovering assets from the trust, all of which were rejected by the District Court. The government appealed. In 2008, the United States Court of Appeals for the Second Circuit reversed the judgment and remanded the case. In its remand order, the Second Circuit directed the District Court to reconsider its findings with respect to whether the conveyances by the taxpayer to the trust were actually fraudulent, whether the trust held property as the taxpayer’s nominee and whether the trust was the taxpayer’s alter ego.

According to New York law, every conveyance made with “actual intent, as distinguished from intent presumed in law, to hinder, delay or defraud” one’s creditors is fraudulent as to both present and future creditors. N.Y. Debtor and Creditor Law § 276. The primary issue is the intent of the debtor in making the conveyance, not the actual financial status of the debtor at the time of the conveyance. The requisite intent required by this section does not need to be proven by direct evidence; it may be inferred from circumstances surrounding the allegedly fraudulent transfer. Factors, known as “badges of fraud,” that a court may consider in determining fraudulent intent include: lack or inadequacy of consideration; close relationship between the transferor and the transferee; debtor’s retaining possession, benefit or use of the property; series of transactions after incurring the debt; the transferor’s knowledge of the creditor’s claim and the inability to pay it; the financial condition of the debtor before and after the transfer; and the shifting of assets to a corporation wholly owned by the debtor. See Steinberg v. Levine, 6 A.D.3d 620 (N.Y. 2004); In re Kaiser, 722 F.2d 1574, 1582–83 (2d Cir.1983) (citations omitted). To support a fraudulent conveyance finding, the creditor must have suffered some actual harm; however, actual harm may be found if the debtor depletes or diminishes the value of the assets of the debtor’s estate available to the creditors. Lippe v. Bairnco Corp., 249 F.Supp.2d 357, 375 (S.D.N.Y. 2003)

The District Court found that the taxpayer was well aware of his tax liabilities and other potential demands on his assets when he transferred his residence and $220,000 to the trust in 1992. Evidence of the taxpayer’s conduct at the time of the transfers supported the court’s finding that the taxpayer acted with the intention to hinder or delay collection of his assets. The taxpayer retained the benefits of ownership of the residence after it was transferred to the trust for no consideration. His payments of mortgage and other property-related expenses, in lieu of rent, were the type of payments that would be made by a property owner, not a renter. Much of the taxpayer’s net worth consisted of cash, which he was continually transferring among bank accounts held by family and close associates, as well as withdrawing to hold in an office safe. These transfers and withdrawals made it difficult for the IRS to locate and value the taxpayer’s assets. The District Court also found that the transfers of cash and real estate to the trust unambiguously caused the requisite actual harm to his creditors by reducing the assets that the taxpayer had available to satisfy his tax debt and reducing the value of his readily accessible assets well below the amount of his tax debt. After the transfers, the IRS would have had to collect between fifty and ninety percent of his remaining assets to satisfy his tax debt. As a result of this analysis, the District Court found that the taxpayer’s intent to evade the IRS collection efforts was substantial and sufficient on its own; therefore, the court concluded that the taxpayer’s transfer of the residence and $220,000 to the trusts was actually fraudulent within the definition of New York law. The remedy for fraudulent conveyance is that the creditor may collect upon the fraudulently conveyed property. Therefore, the District Court held that the government may collect against the assets in the trust on this basis.

The nominee theory focuses on the relationship between the taxpayer and the property to determine whether a taxpayer has engaged in a legal fiction, for federal tax purposes, by placing legal title to property in the hands of another while, in actuality, retaining all or some of the benefits of being the property’s true owner. Richards v. United States, 231 B.R. 571, 578 (E.D.Pa.1999). The overall objective of the nominee analysis is to determine whether the debor retained the practical benefits of ownership while transferring legal title. Id. The critical consideration is whether the taxpayer exercised active or substantial control over the property. Factors examined by the court include: (1) whether inadequate or no consideration was paid by the nominee; (2) whether the property was placed in the nominee’s name in anticipation of a liability while the transferor remains in control of the property; (3) where there is a close relationship between the nominee and the transferor; (4) whether they failed to record the conveyance; (5) whether the transferor retains possession; and (6) whether the transferor continues to enjoy the benefits of the transferred property. Giardino v. United States, No. 96–CV–6348T, 1997 WL 1038197, at *2 (W.D.N.Y. Oct.29, 1997). A nominee finding can be made even where there is no intent to defraud creditors or hinder collection efforts. Where a nominee relationship is found, the government may access only the property held on the taxpayer’s behalf by the nominee and not all the property of the nominee.

The District Court found that the trust was the taxpayer’s nominee with respect to the residence only, and not with respect to the $220,000. The taxpayer had a close relationship with the trustees and the trust paid no consideration for the transfer of the residence. There was no evidence in the transfer agreement that the trust prevented the taxpayer from benefitting from the use and occupancy of the residence as much as when he held legal title to it. The District Court found the evidence that the taxpayer made some payments relating to the property to be insufficient evidence to rebut the inference that he was the de facto owner of the property. The payments that the taxpayer made in exchange for his occupancy were precisely those that an owner would make. Once the mortgage was paid off, the taxpayer was only responsible for upkeep and expenses for the property; therefore, the trust received no net return from this asset. The District Court considered that, were the trust acting as the owner of the property, it would have sought market rental rates that would have exceeded the taxpayer’s payments. Therefore, the District Court found that the trust held the residence as the taxpayer’s nominee and that the government could recover the taxpayer’s debts against the residence under a nominee theory.

The alter ego theory differs from the nominee theory because the nominee theory focuses on the taxpayer’s control over and benefit from the actual property, while the alter ego theory emphasizes the taxpayer’s control over the entity that holds the property. The alter ego doctrine arose from the law of corporations and allows the creditor to disregard the corporate form (also known as “piercing the corporate veil”) by either using an individual owner’s assets to satisfy a corporation’s debts or using the corporation’s assets to satisfy the individual owner’s debts. Although the New York Court of Appeals has never held that the alter ego theory may be applied to reach assets held in trust, the District Court found no policy reason not to extend the application of veil piercing to trusts. The policy behind piercing the corporate veil is to prevent a debtor from using the corporate form to unjustly avoid liability, which applies equally to trusts. Therefore, the District Court held that the alter ego theory could be applied to the trust in the instant case.

To pierce the corporate veil in New York, a plaintiff must show that “(1) the owner exercised such control that the corporation has become a mere instrumentality of the owner, who is the real actor; (2) the owner used this control to commit a fraud or ‘other wrong’; and (3) the fraud or wrong results in an unjust loss or injury to the plaintiff.” Babitt v. Vebeliunas,332 F.3d 85, 91–92 (2d Cir.2003) (citations omitted); see also Wm. Passalacqua Builders, Inc. v. Resnick Developers S. Inc., 933 F.2d 131, 138 (2d Cir.1991). With respect to analyzing the taxpayer’s control over the trust, the relevant factors can be drawn by analogy from the corporate context. In analyzing the alter ego question as it relates to a corporation, courts consider factors such as the absence of formalities, the amount of business discretion displayed by the allegedly dominated corporation, whether the related corporations deal with the dominated corporation at arm’s length and whether the corporation in question had property that was used by other of the corporations as if it were its own. Vebeliunas,332 F.3d at 91 n.3 (citation omitted).

The District Court that the trust was an alter ego of the taxpayer. The trust formalities were so poorly observed as to give rise to the inference that the trust was not a bona fide independent entity. Between 1992 and 1998, the trust did not record the taxpayer’s payment of expenses for the residence as income and, during this period, the trust did not claim the mortgage interest deduction for the residence. The individual taxpayer remained as the named beneficiary of the flood and fire insurance policies of the residence. The accounting work for the trust was performed by a business associate of the taxpayer as a professional courtesy. The trust tax statements were sent directly to the taxpayer instead of to the trustees. The District Court also found that the manner in which the trust was managed also demonstrate that it was an extension of the taxpayer because there was little evidence that the trustees were actively involved in managing the trust or its assets. Having trustees play an active role in managing the trust is an important factor in deciding whether to respect the form of a trust because active involvement of trustees would support the separate existence of a trust. Dean v. United States, 987 F.Supp. 1160, 1165 (W.D.Mo.1997). Finally, the taxpayer demonstrated his domination of the trust by controlling its property to a high degree.

Once the District Court found that the taxpayer controlled the trust, the next steps were to determine whether he used that control to commit a fraud or a wrong against the government, in its capacity as a creditor, and whether that wrong resulted in an unjust loss. The court found these elements to be plainly satisfied by the facts and its previous findings with respect to actual fraudulent conveyance and the nominee doctrine. Therefore, the District Court concluded that the existence of the trust as a separate entity was a legal fiction. Under the alter ego theory, the government may collect against all assets held by the trust as if they were held by the taxpayer himself.

Therefore, the District Court held that the government may proceed to collect against all the assets held by the trust that the taxpayer established for benefit of his sons in order to satisfy his delinquent tax liabilities.

Should you have any questions relating to trusts and other personal asset protection issues, please do not hesitate to contact Attorney Susan Maya, at SMaya@Mayalaw.com or 203-221-3100, and Attorney Russell Sweeting, at RSweeting@Mayalaw.com or 203-221-3100, in the Maya Murphy office in Westport, Fairfield County, Connecticut.

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