The Internal Revenue Service (IRS) has enhanced tools to collect income taxes from delinquent taxpayers. Federal law imposes a federal tax lien on all of a debtor taxpayer’s assets, and the tax lien tax takes precedence over any exemptions from execution that would protect assets from normal civil judgment creditors. Asset protection against the IRS’s collection of tax debt is very difficult.
Tax law provides that the amount of any income taxes owed, plus interest and penalties, shall be a lien upon all the taxpayer’s property or rights to property. The federal tax lien continues until the tax liability is paid or until the expiration of the IRS’s maximum collection period, which is ten years from the date of the tax assessment. A tax lien arises automatically upon the non-payment of tax liability after the IRS has sent the taxpayer a timely notice and demand for payment. The tax lien is retroactive to the date the IRS assesses tax liability even through the lien does not exist until after proper notice to the taxpayer with demand for payment.
The IRS lien does not defeat prior recorded security interests in the taxpayer’s property such as a mortgage on real property. The IRS may file a Notice of Federal Tax Lien (“NFTL”) to perfect the lien against subsequent security interests filed by competing secured creditors. It is important to understand that the tax lien exists without the NFTL and attaches to the taxpayer’s property at the time the IRS assessed tax liability. It is already too late to transfer assets when the IRS reveals its tax lien through the NFTL.
The strength of the federal tax lien is its scope covering “property and rights to property.” Not only does the lien attach to property titled in whole or in part in the name of the taxpayer, but the tax lien enables the IRS to “step in to the shoes” of the taxpayer and enforce any property rights the taxpayer may have under state law. As one example, when a delinquent taxpayer tried to disclaim an inheritance to the benefit of his children in order to avoid taking property in his name the Supreme Court said that a federal tax lien had attached to his right to disclaim created by his parents’ will so that the taxpayer no longer had the unencumbered power to disclaim the money.
Tax liens supersede property exemptions created by state law. Florida law, for instance, exempts tenants by entireties property from judgments against a married debtor. A civil creditor of one spouse may not attack assets held as tenants by entireties with a non-debtor spouse. However, the Supreme Court ruled that a federal tax lien attaches to the single-filing taxpayer’s interests in tenants by entireties assets because the taxpayer has the legal right to exercise substantial control over entireties property.
Any property the taxpayer may control now, or in the future, is captured by a tax lien. A common example is a jointly owned bank account (other than an entireties account) owned by the taxpayer and other joint depositors. If the taxpayer has the right to withdraw money from the account the tax lien applies even if most of the money in the account was deposited by other persons. The tax lien is provisional: the IRS can seize the account and other people with an interest in jointly owned property must come forward to assert their claim in federal court.
Property the taxpayer does not presently have or control may still be subject to the lien. A contingent future property right is subject to a tax lien such as a debtor’s rights to receive future payments from a trust established by a parent for the taxpayer’s benefit.
There have been several cases dealing with the tax liens attachment to a taxpayer’s beneficial interest in a spendthrift or discretionary trust established by a third party for the taxpayer’s benefit. Most states, including Florida, protect a debtor’s interest in a trust where the trust agreement contains a “spendthrift provision” that expressly prohibits the assignment of a beneficial interest. Spendthrift provisions are ineffective against a federal tax lien. Because tax liens apply to property rights as well as property title, the tax lien can be enforced against a taxpayer’s rights to receive trust distributions from a spendthrift trust. The lien attaches to a beneficiary’s present rights to distributions at some future time even though distributions may be contingent upon a future event. The IRS may levy upon the beneficiary’s trust interest and order the trustee to make all future distributions to the IRS instead of the taxpayer.
A beneficiary’s trust interest may be protected from IRS liens if trust distributions are entirely in the discretion of a third party trustee. The trustee must have absolute and unconditional control over trust distributions to the taxpayer. If the taxpayer has any legal basis to compel a trustee to distribute money then the IRS could assert its tax lien against the beneficiary’s legal right and power to get trust money. A discretionary trust will be subject to tax liens if the trust agreement inadvertently vests the beneficiary with enforceable rights to receive trust property at any time under any condition.
One way a taxpayer may protect his inheritance against tax debt is including customized provision in the will or trust that shifts all the taxpayer’s interest and rights to his children, spouse, or other non-taxpayer in the event of unpaid IRS taxes. The taxpayer can be provided rights to reacquire the inheritance after tax debts are paid or the 10 year collection period expires.