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6321 - Property Rights of 3rd Parties p3
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6321 - Property rights of a nondeclared spouse p1
6321 - Property rights of a nondeclared spouse p2
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6321 - Stolen Property
6321 - Rent
6321 - Stock Certificates
6321-Unperfected interests p1
6321-Unperfected interests p2
6321-Unperfected interests p3
6321-Unperfected interests p4
6321-Unperfected interests p5
6321-Tangible property in the taxpayer's possession
6321-Trusts for third parties p1
6321-Trusts for third parties p2
6321-Trusts p1
6321-Trusts p2
6321-Trusts p3
6321-Trusts p4
6321-Trusts p5
6321-Trusts p6
6321-Trusts p7
6321-Property transferred during divorce (2) p1
6321-Property transferred during divorce (2) p2
6321-Real property p1
6321-Real property p2
6321-Real property p3
6321-Real property p4
6321-Real property p5
6321-Real property p6
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6321-Relinquishments and disclaimers
6332 - Annotations- Exclusiveness of Remedy
6332 - Annotations- Evidence of Debts
6332 - Annotations- Garnishment
6332 - Annotations- Levy and Demand
6332 - Annotations- Insurance Policy 1 p1
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6332 - Annotations- Insurance Policy 1 p3
6332 - Annotations- Insurance Policy 2
6332 - Annotations- Interest and Penalties
6332 - Annotations- Leasehold Interest
Taxpayer's Property in Possession of Thrid Party p1
Taxpayer's Property in Possession of Thrid Party p2
Taxpayer's Property in Possession of Thrid Party p3
6322-Constitutionality
6322-Limitations p1
6322-Limitations p2
6322-Prior law
6322-Relation-back doctrine
6322-Release of liens
6322-State law
6322-Waiver
6322 - Nevada

 

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2. That Decker Farms Number 2, a co-partnership, of Jack R. Decker, H. Wayne Decker, and Ashby S. Decker entered a voluntary appearance in this matter and disclaimed any and all interest to or claim upon the real property in issue here; and that Harold W. Brereton and Nica W. Brereton, his wife, and Wayne Decker and Evelyn S. Decker, his wife, having been regularly served, and failing to appear and answer have been declared in default. That there is no indication in the record of service by publication upon "all other persons unknown, claiming any right, title, estate, lien or interest in the real property described in the complaint adverse to plaintiff's ownership or clouding plaintiff's title thereto."

3. That Salt Lake County assessed drainage district taxes against the real property described as follows:

Commencing 165.48 feet South from the center of Section 34, Township 3 South, Range 1 West, Salt Lake Base and Meridian ; thence South 150 feet; thence West 186.5 feet; thence North 150 feet; thence East 186.5 feet to beginning.

in the amount of $3.62 for the year 1951.

4. That defendant, Wayne Decker, under a warranty deed dated December, 1953, from Jack R. Decker, H. Wayne Decker, and Ashby S. Decker and recorded December 31, 1953, in Book 1057, page 261, of the official records of the Salt Lake County Recorder, acquired title to that portion of the subject property described as follows:

Commencing 165.48 feet South from the Northeast corner of the Southwest 1/4 of Section 34, Township 3 South, Range 1 West, Salt Lake Base and Meridian , and running thence South 82.74 feet; thence West 170 feet; thence North 82.74 feet; thence East 170 feet to the place of beginning.

5. That on August 16, 1954, in the office of the Salk Lake County Recorder, notice of a federal income tax lien against defendant Wayne Decker dated August 16, 1954, for the years 1942, 1943, 1944, 1945, 1946, and 1947 in the total amount of $158,064.95 was duly filed for record against defendant Wayne Decker.

6. That defendant Wayne Decker is the father of Jack R. Decker, H. Wayne Decker, and Ashby S. Decker. That Jack R. Decker is the husband of LeJeune Decker and that Wayne Decker is the father-in-law of LeJeune Decker. That Jack R. Decker is an attorney licensed to practice in the State of Utah and that as such he acted for his father in connection with his father's tax and other legal matters. That Wayne Decker had health problems which had led him to turn all his business affairs over to Jack R. Decker and to rely upon his son's professional and personal assistance concerning property and tax matters. That by virtue of the above relationship through a blood relationship, a professional relationship, and a business relationship Jack R. Decker was intimately aware of Wayne Decker's financial and tax status, and that Jack R. Decker stood in a fiduciary capacity with his father.

7. That sometime prior to May 22, 1956 Jack R. Decker, having theretofore been informed by the defendant that he saw no way to avoid letting his property go to the government received a telephone call from his father telling him that the property the father, Wayne Decker, owned which is described in Finding 4, was to be sold by Salt Lake County for delinquent drainage district taxes. The evidence does not disclose what beyond this was said on that occasion, but the Court believes that probably something further was said on this or other occasions between Wayne Decker and Jack R. Decker concerning a plan that might permit retention of the property in the family but free of the income tax lien. Jack R. Decker testified in his deposition, on the contrary, that the purpose of having the property bid in as far as he was concerned was to induce the government to "execute" upon it. It seems probable that whatever the real reasons were, it was not believed likely that the property could be cleared of the tax lien without a substantial payment, but that the absence of other bidders at the sale due perhaps to the record tax lien, the failure of the government to check and follow up the status and its lien in view of the tax sale, and the long period of time which elapsed before the matter was brought to a head, crystalized the determination of plaintiff and her husband to retain the property free of the lien. Notwithstanding uncertainty in the record in the latter respects, it admits of no doubt that Jack R. Decker and his wife, LeJeune Decker, discussed the matter and determined between them upon a plan of action with respect to said property, and that Jack R. Decker was the dominant factor in the formulation and the execution of this plan.

8. That on May 22, 1956, the real propinvolved herein was conveyed to the plaintiff LeJeune Decker by tax deed from Salt Lake County, Utah, dated May 22, 1956, and recorded June 4, 1956, in Book 1315, page 374, of the Official Records of the Salt Lake County Recorder. Consideration for the conveyance was $4.44 delinquent drainage district taxes, penalties, interest, and costs. That said property is of the reasonable value of in excess of $4,000.

9. That LeJeune Decker did not buy as an independent purchaser at a tax sale but, being unsophisticated in business affairs and land transactions, her actions in bidding and buying at Salt Lake County tax sale were directed by her husband and perhaps others in the hope, or for the express purpose of defeating the income tax lien of the United States, which hope or purpose also motivated the failure of Wayne Decker and Jack R. Decker to pay said drainage district taxes.

10. That Jack Decker was present with LeJeune Decker at the tax sale when she purchased the land in question, and it is a reasonable inference that he directed her actions in respect to such sale. That the plaintiff, LeJeune Decker, in buying the property was agent for her husband Jack R. Decker.

11. That the said Wayne Decker, and his agent and attorney Jack R. Decker, under the circumstances had the duty to pay said drainage district taxes. That if the purchase of said property by LeJeune Decker was not with Wayne Decker's knowledge, express direction and collusion, it was in substance and reality the act of Jack R. Decker in breach of the fiduciary duty owed by him to represent his father and to perform his legal duties in the premises.

12. That neither the defendant, Wayne Decker, nor the defendant United States of America redeemed from the tax sale.

13. That since May 22, 1956 , plaintiff or persons claiming under her, having paid all the general and other state taxes on the property described in Finding of Fact 1 since 1956.

14. That the defendant, Wayne Decker, had stipulated with the government on January 16, 1956, and on a subsequent occasion on August 16, 1957, which stipulation replaced the previous one and which remained in force until about the time of the commencement of this action that:

The proponent expressly waived; "The benefit of any statute of limitations applicable to the assessment and/or collection of the liability sought to be compromised, and agrees to the suspension of the running of the statutory period of limitations on assessment and/or collection for the period during which this offer is pending, or the period during which any installment remains unpaid, and for 1 year thereafter."

From the foregoing Findings of Fact the Court makes the following:

Conclusions of Law

1. That this Court has jurisdiction of this quiet title action by virtue of 28 U. S. C. 2410, and that the Court has jurisdiction of the parties.

2. That the plaintiff, LeJeune Decker, in buying the property was acting under the direction of and as agent for ther husband Jack R. Decker. That the said Wayne Decker and his agent and attorney Jack R. Decker, under the circumstances, had the duty to pay said drainage district taxes; and that if the purchase of said property by LeJeune Decker was not with Wayne Decker's knowledge, express direction, and collusion it was the act of Jack R. Decker in breach of the fiduciary duty owed by him to represent his father and to perform his legal duties in the premises. That in any event the property in question is held in trust by LeJeune Decker for the father-in-law Wayne Decker. See Hadlock v. Benjamin Drainage District, 89 Utah 94, 53 P. 2d 1156 (1936), 106 A. L. R. 876; and Free v. Farnsworth, 105 Utah 583, 144 P. 2d 532 (1943); see also Paxton v. Paxton, 80 Utah 240, 15 P. 2d 1051 (1932).

3. That the acquisition of said property by the plaintiff, either in collusion or as an act in breach of a fiduciary duty, was an act which would not cut off the preexisting federal income tax lien. Hadlock v. Benjamin Drainage District, supra; Free v. Farnsworth, supra.

4. That no statute of limitations has run against the lien of the United States. Mertins, Law of Federal Income Taxation, Vol. 10, 57.41, pp. 80-81. Phillips v. Commissioner of Internal Revenue [2 USTC 743], 283 U. S. 589, 51 S. Ct. 608, 75 L. Ed. 1289 (1931).

5. That the lien of the defendant, United States of America , against the property described therein continues in full force and effect.

6. That except for the property covered by the lien of the United States the title of plaintiff should be quieted as against all named defendants.

7. That judgment should be entered declaring that the lien of the United States against the land described hereunder be determined prior to and superior to the claims of plaintiff, with the exception of a first lien in favor of the plaintiff for the $4.44 which was the amount of her expense at the County tax sale and interest on that amount at the rate of 6% to date. That the decree herein should further provide in the absence of other agreement between the parties for foreclosure of said liens by sale of the following described real property pursuant to 28 U. S. C. 2410 and other provisions of law:

Commencing 165.48 feet South from the Northeast corner of the Southwest 1/4 of Section 34, Township 3 South, Range 1 West, Salt Lake Base and Meridian ; and running thence South 82.74 feet; thence West 170 feet; thence North 82.74 feet; thence East 170 feet to the place of the beginning.

That a distribution of the proceeds of said sale shall be made by the United States Marshal giving first preference to the $4.44 expense of the plaintiff, LeJeune Decker, together with 6% interest, and the remainder of the sale price shall be paid to the Secretary of the Treasury or his delegate to be applied in partial satisfaction of the lien against Wayne Decker.

That costs of suit should be awarded to the United States as against LeJeune Decker.

Counsel for the United States of America shall within fifteen days prepare, serve and lodge with the Court a proposed form of decree consistent herewith, for settlement by the Court after notice to the plaintiff, unless counsel can stipulate for approval as to form.

 

 

 

United States of America , Plaintiff-Appellant v. United Banks of Denver , as Trustee of the Trust Created by the Last Will of Carl J. Martinson, and William Arthur Martinson, Defendants-Appellees

(CA-10), U. S. Court of Appeals, 10th Circuit, No. 75-1273, 542 F2d 819, 10/6/76, Reversing and remanding District Court decision, 75-1 USTC 9218

[Code Sec. 6321]

Lien for taxes: Trust assets: Vested interest: "Property" subject to lien.--Under state law, the taxpayer's interest in a trust was a vested interest subject to complete defeasance. Accordingly, the case had to be reconsidered by the District Court, which had held that the interest was contingent and thus did not qualify as "property" or a "right to property" belonging to the taxpayer at the time of attachment.

James F. Shepherd, James L. Treece, United States Attorney, Denver, Colo., Scott P. Crampton, Assistant Attorney General, Gilbert E. Andrews, Crombie J. D. Garrett, Karl Schmeidler, John G. Manning, Department of Justice, Washington, D. C. 20530, for plaintiff-appellant. Gene W. Reardon, Reardon, Reardon and Reardon, 2150 First Nat'l Bank Bldg., Denver, Colo., for defendants-appellees.

Before LEWIS, Chief Judge, and BREITENSTEIN and MCWILLIAMS, Circuit Judges.

MCWILLIAMS, Circuit Judge:

The issue as posed by the parties is whether the taxpayer's interest in a trust fund established by his father's will constitutes "property" or "rights to property" to which a federal tax lien may attach under Section 6321 of the Internal Revenue Code of 1964. As will be developed, we view the issue before us to be much narrower. In any event, the trial court held that the taxpayer's interest under his father's will did not constitute either "property" or "rights to property" under Section 6321, and accordingly granted the trustee's motion for summary judgment. The Opinion and Order of the trial court is reported as P-H 1975 FED. TAXES (35 Am. Fed. Tax R. 2d) 75-449 (D. Colo. Jan. 17, 1975). The United States now appeals the dismissal of its action.

This is a civil action instituted by the United States against the United Banks of Denver, as trustee of the several trusts created under the last will of Carl J. Martinson, to foreclose an Internal Revenue tax lien of $142,540.81, plus interest, upon all property and rights to property belonging to the taxpayer, William Arthur Martinson, Carl's son. The section of the Code under which the United States brought this proceeding appears at 26 U. S. C. 6321 and reads as follows:

6321. Lien for taxes

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. Aug. 16, 1954 , c. 736, 68A Stat. 779. (Emphasis added.)

The tax deficiency which formed the basis of the present action arose out of unpaid income tax by the taxpayer, William Arthur Martinson, for the years of 1950 and 1951. The taxpayer was later indicted for willful tax evasion in 1959. By that time the taxpayer had disappeared, sometime during 1957, and has not been seen since. Whether he was dead or alive at the date this proceeding was instituted was not known. However, for the purposes of the summary judgment hearing before the trial court, it was assumed that the taxpayer was still alive. In other words the basis for the trial court's ruling was that, even assuming that the taxpayer be still alive, his interest under his father's will was not "property" or a "right to property" under 26 U. S. C. 6321, and hence was not subject to a tax lien foreclosure proceeding. The underlying facts are not in dispute.

The taxpayer's father, Carl J. Martinson, died in 1969 leaving a will which had been executed in 1959. In his will the father, after making two minor bequests of $1,000 each, devised and bequeathed his home and furnishings to his widow, Mabel Martinson, and then devised and bequeathed the remainder of his estate to the United Banks of Denver, as trustee, to be held under the terms of several trusts established by the will. Three-eighths of the residue of the estate was to be held in the Mabel Martinson Fund for the use of Mabel, who, incidentally, is the taxpayer's stepmother.

Carl's will further provided that should Mabel predecease her husband, two-thirds of the property which would have gone into the Mabel Martinson Fund should go into a trust to be known as the William Arthur Martinson (the taxpayer) Fund. Alternatively, the will provided that should Mabel survive her husband, on her (Mabel's) death three fourths of the balance then held in the Mabel Martinson Fund should go to the William Arthur Martinson Fund. In this latter connection the provision relating to the William Arthur Martinson Fund reads as follows:

2. Three-fourths (3/4ths) to my Trustee herein named, IN TRUST, NEVERTHELESS, which Trust shall be known as the "WILLIAM ARTHUR MARTINSON FUND", it to pay to my son, WILLIAM ARTHUR MARTINSON, from the income and from so much of the principal as may be necessary, the sum of One Thousand Dollars ($1,000.00) a month for so long as he lives or until said fund is fully paid to him; provided, however, in event my son, WILLIAM ARTHUR MARTINSON, does not survive me, or surviving me, dies before receiving the balance of the distribution of principal and income, then one-third (1/3rd) thereof shall be and become a part of the "CARL DAVID MARTINSON FUND" hereinabove provided, one-third (1/3rd) thereof shall be and become a part of the "CHARLES MARTINSON FUND" hereinafter provided, and one-third (1/3rd) thereof shall be and become a part of the "ANTHONY MARTINSON FUND" hereinafter provided.

As indicated, Carl, the taxpayer's father, died in 1969, and Mabel, Carl's wife, survived him. Mabel, under applicable Colorado law, renounced the will and elected to take the share allowed her by Colorado law as the surviving widow. COLO. REV. STATS. 153-5-4 (1963). In connection therewith the state probate court attempted to "equally compensate" the several trust funds created under Carl's will for the "losses" caused by Mabel's election. At the time the state probate court refused to accelerate William's interest under his father's will. In this latter regard the state probate court decreed as follows:

* * *

[T]he dominant intent of the Testator was to postpone the enjoyment of the William Arthur Martinson Fund . . . until the death of Mabel Martinson, and therefore, the gift . . . should be distributed to the Trustee named herein.

* * *

With respect to the three-eighths (3/8) of the income derived from the property held in the trust . . . and belonging to the William Arthur Martinson Fund, the Court finds that it should not be distributed but shall be accumulated until the death of Mabel Martinson, and further finds that there shall be no acceleration of the enjoyment of the principal and no payments made from the principal or income of the William Arthur Martinson Fund except as above provided until the death of Mabel Martinson.

As above indicated, Mabel Martinson was living and residing in Denver , Colorado as of the commencement of the present proceeding, and apparently remains alive as of the present time. It was in this general setting that the trial court concluded that William's (the taxpayer's) interest in the trust created in his name under his father's will did not constitute "property" or a "right to property" under 26 U. S. C. 6321, inasmuch as Mabel still survived, and that such being the case, William's interest was contingent on his outliving his stepmother.

The trial court reasoned that William's interest in the trust fund was contingent, not vested, and being contingent, was therefore beyond a creditor's reach under local Colorado law. Additionally, the trial court held that the taxpayer's interest being only contingent did not "as a matter of federal law" qualify as "property" or a "right to property" as those terms are read in 26 U. S. C. 6321. It was on this general basis that the trial court granted the trustee's motion for summary judgment and entered judgment for the trustee.

It is agreed that the "property rights" of the taxpayer in the instant case are to be determined as a matter of local Colorado law and that once William's rights have been thus determined, then resort should be made to federal law to ascertain whether such constitute "property" or "rights to property" within the meaning of the federal tax lien statute. Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509 (1960) and United States v. Bess [58-2 USTC 9595], 357 U. S. 51 (1958).

As applied to the instant case, the foregoing indicates that the trial court quite properly looked to Colorado law to determine the precise nature of William's (the taxpayer's) interest in the trust created in his favor under his father's will. As indicated, the trial court concluded that under Colorado law William's interest was contingent, i. e., he had no right to receive any monies from the trust unless he survived his stepmother, Mabel.

On appeal we were uncertain as to whether under Colorado law William's interest in the trust created in his favor under his father's will is a future interest subject to a condition precedent or a vested remainder subject to complete defeasance on the happening of a condition subsequent. Accordingly, pursuant to the provisions of Colorado Appellate Rule 21.1, we certified that question to the Colorado Supreme Court. The Colorado Supreme Court accepted such certification and in an adversary proceeding in that court, which included additional briefing, held that under Colorado law William's interest in the trust in question is not a future interest subject to a condition precedent, and therefore contingent, but on the contrary the taxpayer's interest is a vested interest subject to complete defeasance. See In Re Question Submitted by the United States Court of Appeals for the Tenth Circuit, 553 P. 2d 382 ( Colo. 1976).

The determination by the trial court in the instant case that William's interest was contingent was the keystone of its entire ruling. The subsequent determination by the Colorado Supreme Court that William's interest was not contingent, but vested, requires that the case be remanded to the trial court for reconsideration.

After the Colorado Supreme Court announced its ruling on our certification, the trustee filed in this Court a request to file a supplemental brief. In such supplemental brief the trustee sought to raise a matter which had not heretofore been presented to this Court and had not been passed on by the trial court. In such circumstance, the request to file a supplemental brief is denied. The matter sought to be thus raised should first be considered by the trial court.

Judgment reversed and case remanded for further consideration.

 

 

 

Samuel D. Magavern, As Executor and Trustee of the Last Will and Testament of Margaret C. Duncan, Deceased, Plaintiff-Appellant v. United States of America , Defendant-Appellee

(CA-2), U. S. Court of Appeals, 2nd Circuit, Docket No. 76-6111, 550 F2d 797, 2/24/77, Affirming District Court decision, 76-2 USTC 9670, 415 F. Supp. 217

[Code Secs. 6321, 6323, 6331, 7421 and 7426--result unchanged under '76 Tax Reform Act]

Lien for taxes: Levy: Beneficiary's trust interest: State law.--A divided Court of Appeals sustained a District Court decision that, under the terms of a trust and applicable state (New York) law, a delinquent taxpayer had a property right in the income and principal of the trust, and that the property in the hands of the trustee was therefore subject to a valid federal tax lien and to a levy based thereon. Although the taxpayer-beneficiary was not entitled to the income or principal pro rata, or to any other specific allocation, he had an enforceable claim on a "reasonable sum" for his "maintenance and care," and could not be excluded entirely from a trust distribution. (One Circuit Judge dissented on the grounds that the trustee's "good faith" payment of a nominal amount, or even of zero dollars, would satisfy the trust requirement, which was therefore meaningless; and that the beneficiary's property right was a non-transferable "blended trust" interest, which neither the federal government nor any other creditor could reach.) The District Court was found to have properly applied as authority a decision of the highest court of the state ( New York Court of Appeals) in a comparable case, rather than an ex parte decision of a lower state court with respect to the trust involved in the instant proceeding.

Samuel D. Magavern, Charles B. Draper, Magavern, Magavern, Lowe, Beilewich & Dopkins, 20 Cathedral Park, Buffalo, N. Y. 14202, pro se. Richard J. Arcara, United States Attorney, Buffalo, N. Y. 14202, Scott P. Crampton, Assistant Attorney General, Alfred S. Lombardi, Gilbert E. Andrews, Ernest J. Brown, Department of Justice, Washington, D. C. 20530, for defendant-appellee.

Before MOORE , OAKES and TIMBERS, Circuit Judges.

MOORE, Circuit Judge:

This case arises out of the efforts of the Internal Revenue Service to satisfy an outstanding tax assessment by levying on what it asserts is the taxpayer's interest in a testamentary trust established by his mother. The dollar amount being contested is relatively small, the parties having stipulated that the Government seeks to acquire only approximately $2,300. The legal issues confronted, however, are nonetheless significant.

I. Thomas W. Doran ("Doran"), the taxpayer herein, was deficient in his federal tax payments for various amounts during 1965, 1966 and 1968-1971, resulting in the assessment against him of federal taxes and interest in the aggregate amount of $112,753.51. On November 7, 1974 a total of $108,303.96, plus penalties and interest, remained unpaid. 1 As might be expected, the Government began to seek assets against which it could levy to satisfy this large unpaid assessment.

One asset against which the Government proceeded is the trust at issue here. Margaret C. Duncan, Doran's mother, had died in 1965 leaving the residue of her estate in trust for her husband, her son, Doran, and the children and grandchildren of Doran. In each of the years from 1968 to 1973, Doran had received small monetary amounts from the trust. 2 On December 5, 1973 , the Government served a notice of levy under 6321 and 6331 of the Internal Revenue Code ("Code"), 26 U. S. C. 6321 and 6331, on the trustee of the trust, appellant herein, Samuel D. Magavern. The levy purported to cover "all property and rights to property" belonging to Doran. However, the trustee refused to honor the levy on the ground that under the terms of the trust, Doran had no rights in the trust property.

On June 27, 1974 , the trustee commenced a proceeding in the Surrogate's Court of Erie County , New York , seeking to determine the validity and effect, if any, of the notice of levy on Doran's beneficial interest in the trust. The Government appeared specially in the Surrogate's Court, arguing only that the Surrogate had no jurisdiction to affect the levy. On December 27, 1974 the Surrogate filed a decision holding that he did not have jurisdiction to "vacate, annul, cancel or discharge" the levy, but that pursuant to his continuing jurisdiction over Margaret Duncan's Last Will and Testament he could decided whether or not the trust beneficiaries had any property rights in the trust. Accordingly, he proceeded to hold that by the trust's terms the trustee had complete and sole discretion to withhold the income from any individual member of the family group, and that as a consequence Doran had no property rights in the trust. In re Will of Duncan , 80 Misc. 2d 32, 362 N. Y. S. 2d 788 (Surr. Ct. Erie Co., 1974).

On August 23, 1974, while the Surrogate's Court proceeding was still pending, the trustee commenced the instant action in the Western District of New York seeking, pursuant of 7426(a) of the Code, 26 U. S. C. 7426(a), to enjoin enforcement of the levy. Upon announcement of the Surrogate's decision, the trustee moved for summary judgment on the basis of the Surrogate's finding that Doran had no right to property in the trust, and the Government cross-moved for enforcement of the levy. The district court on June 8, 1976 , rendered its decision, reported in [76-2 USTC 9670] 415 F. Supp. 217. It reasoned that under New York law the trust instrument by mandatory language requires the trustee to pay at least some income to each of the beneficiaries, including Doran, so that Doran had a right to the trust property which was subject to levy. Moreover, the district court held that the contrary decision of the Surrogate's court, though it must be afforded proper regard, was not binding on a federal court. Judgment was entered for the Government in the stipulated amount, and the trustee timely brought this appeal.

II. The Internal Revenue Code contains several sections dealing with the use of federal tax liens to collect unpaid taxes. See Plumb and Wright, Federal Tax Liens (2d ed. 1967). Section 6321 3 provides that a lien shall attach in favor of the United States on all property and rights to property of any person who, after demand, neglects or refuses to pay federal taxes for which he is liable. Section 6332 4 provides that any person in possession of property or rights subject to levy must surrender them upon demand of the Secretary or his delegate.

It is long-established, and conceded by both parties to this case, that in asserting its federal tax lien, the Government must look to state law for a determination of what legal rights and interests, if any, comprise "property and rights to property" to be attached. Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509 (1960); United States v. Durham Lumber Co. [60-2 USTC 9539], 363 U. S. 522 (1960); United States v. Bess [58-2 USTC 9595], 357 U. S. 51 (1958). As the Supreme Court stated in Aquilino:

"The threshold question in this case, as in all cases where the Federal Government asserts its tax lien, is whether and to what extent the taxpayer had 'property' or 'rights to property' to which the tax lien could attach. In answering that question, both federal and state courts must look to state law, for it has long been the rule that 'in the application of a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer had in the property, . . . sought to be reached by the statute.' Morgan v. Commissioner [40-1 USTC 9210], 309 U. S. 78, 82." 363 U. S. at 512-13 (footnote omitted).

Both parties here agree that the question before us is thus whether or not under New York law Doran had a property interest or right to property in the trust established by his mother.

Unfortunately, the parties' agreement as to the authority of New York law does not insure accord as to what that applicable law is, or how the federal courts should discover it. The trustee strongly urges upon us that the decision of the Surrogate's Court is binding on the federal courts. He suggests that under New York law the Surrogate's Court, the court which originally probated Mrs. Duncan's will, has continuing, exclusive jurisdiction over her estate, including construction of her will. He concludes that the Surrogate's interpretation of the trust instrument must be considered an in rem judgment binding for all purposes, in effect prohibiting any varying interpretations of the language of the will by federal courts.

But the Supreme Court has conclusively rebutted the trustee's argument. In Commissioner v. Estate of Bosch [67-2 USTC 12,472], 387 U. S. 456 (1967), the Court decided two cases concerned with the effect a federal court should give to a decision by a lower state court. In Bosch, the state court holding concerned the validity of a decedent's release of a power of appointment over a New York trust. The taxpayer had filed a petition in the Supreme Court of New York to obtain a decision on the validity of the release, which if declared invalid could have qualified the corpus of the trust for the federal tax marital deduction, 26 U. S. C. 2056. The state court held the release a nullity and the United States Tax Court looked on that decision as binding. A divided panel of this court affirmed, [66-2 USTC 12,412] 363 F. 2d 1009 (1966), but the Supreme Court reversed. The Court explained that a lower state court decision was a significant factor for a federal court in ascertaining state law, but federal tribunals should not consider lower state court decisions binding where the highest state court has not spoken on the point. As Mr. Justice Clark stated, speaking for the Court:

"[W]hen the application of a federal statute is involved, the decision of a state trial court as to an underlying issue of state law should a fortiori not be controlling. This is but an application of the rule of Erie R. Co. v. Tompkins, [304 U. S. 64 (1938)], where state law as announced by the highest court of the State is to be followed. This is not a diversity case but the same principle may be applied for the same reasons, viz., the underlying substantive rule involved is based on state law and the State's highest court is the best authority on its own law." 387 U. S. at 465.

The companion case decided in Bosch further confirms the point. The Supreme Court there affirmed the opinion of this court in Second National Bank v. United States [65-2 USTC 12,352], 351 F. 2d 489 (1965), where this court had expressly upheld a federal district court's finding that "decrees of the Connecticut Probate Court . . . under no circumstances can be construed as binding and conclusive upon a federal court in construing and applying the federal revenue laws." 351 F. 2d at 494, aff'g in part [63-2 USTC 12,167] 222 F. Supp. 446, 457 (D. Conn. 1963).

The trustee tries to avoid the consequences of the holdings in Bosch by suggesting that the instant case is distinguishable because here the Government appeared in the Surrogate's Court. But the Government only appeared specially, solely to contest that court's jurisdiction. It did not in any way address the merits of the trustee's claim and did not become a party to the proceedings. Indeed, the Surrogate recognized the limited purpose of the Government's appearance in ruling that he had no jurisdiction to affect the tax levy. 80 Misc. 2d at 33-34, 362 N. Y. S. 2d at 790. We are bound by the reasoning in Bosch, and we conclude that the decision of the Surrogate that Doran had no property rights in the trust was not binding on the district court.

Bosch also provides guidance for a federal court faced, as was the district court, with a state law question on which the highest state court has not yet ruled. The directive of the Supreme Court is that

"[i]f there be no decision by [the highest state] court then federal authorities must apply what they find to be the state law after giving 'proper regard' to relevant rulings of other courts of the State. In this respect, it may be said to be, in effect, sitting as a state court." 387 U. S. at 465.

The district court, a decision by the highest court of New York on the issue before it being lacking, was thus required to sit "as a state court" to decide the case as might a state tribunal, giving proper consideration to the ruling of the Surrogate's Court. Though the question is not without some doubt, we feel that the district court properly decided the merits here.

The relevant part of Mrs. Duncan's trust provision reads as follows:

"ARTICLE THIRD:

* * *

1. This Trust shall be held and administered for the benefit of the family group consisting of those from time to time living of my husband, MATTHEW DUNCAN, my son, THOMAS W. DORAN, his children and the issue of his children. My Trustee shall pay over or use, apply and expend whatever part or all of the net income or principal (even to the point of exhaustion thereof), or both, thereof he shall deem proper or necessary in order to provide comfortable support, maintenance and/or education (at any level) to the individual members of the said family group. My Trustee shall not feel bound, in making such payments, uses, applications or expenditures, to observe any rule or precept of equality as between the individual members of said family group."

While the meaning of these phrases is far from clear, the first sentence sets out in mandatory terms the trustee's duty to pay over: he "shall pay . . . whatever part or all of the net income or principal . . . to the individual members of the said family group" (emphasis added). The plain meaning of this primary sentence is to direct some payment to each beneficiary. The following sentence grants the trustee discretion to divide such payments unequally among the beneficiaries, but it does not give him the authority to deny a particular beneficiary anything at all. The trustee's discretion is not to determine who gets something, but rather to decide how much each is to be given. To interpret otherwise would allow the subordinate sentence, designed only to explain the permissible relativity of the payments, to swallow entirely the mandatory directive language.

The New York Court of Appeals has on only two occasions interpreted trust language at all similar to that presented here. The trustee relies heavily upon Hamilton v. Drogo, 241 N. Y. 401 (1926), in which the Court of Appeals held that a beneficiary of a testamentary trust did not have any right to income which a creditor could attach. But the will in that case expressly granted to the trustee uncontrolled discretion to use the trust income "for the maintenance and support or otherwise, for the benefit of all or any one or more exclusively of the other or others of him my said son" (emphasis added).

The Court of Appeals stressed the importance of this express instruction in discussing the Drogo case in Sand v. Beach, 270 N. Y. 281, 284-85 (1936). In Sand, the trustee was directed to pay the trust income "either direct and in person to my nephew . . . or for the use and benefit of my said nephew and those defendant upon him. . . ." The court reasoned that this directive gave the trustee discretion to distribute income either to the nephew directly or for the benefit of the nephew and his dependents. But absent clear language giving the trustee the choice of withholding all income from the nephew, he could not choose to deny the nephew any income at all.

As the district court found after a reasoned consideration of both these cases, the facts in the instant case are more akin to Sand than they are to Drogo. The trustee under the Duncan will "shall pay over" what amounts he deems proper "to the individual members of the . . . group." The trustee is bound to distribute some trust income to each of the beneficiaries for their "comfortable support, maintenance and/or education." Nothing in the will, either expressly or by reasonable implication, allows an entire deletion of any beneficiary. Nor is the trustee's own action in making annual payments to Doran from 1968 to October 31, 1973 5 to be ignored. Obviously Doran was considered one of the group regarded as entitled to some distribution.

New York law clearly establishes, moreover, that an aggrieved trust beneficiary can enforce his right to trust property or income against a trustee who refuses to exercise his discretion as directed in the trust instrument. Matter of Rosenberg , 269 N. Y. 247 (1935); Collister v. Fassitt, 163 N. Y. 281 (1900); Ireland v. Ireland , 84 N. Y. 321 (1881).

We also note, though the trustee has not contended otherwise, that the New York Court of Appeals has included taxes within the definition of the term "support" in a case involving enforcement of a federal tax lien against a beneficiary's rights in a spendthrift trust. Matter of Rosenberg , supra.

The district court, after proper consideration of relevant New York cases, found that Thomas W. Doran had a right to property in his mother's trust under New York law, a right which can be attached pursuant to the federal tax lien. We agree with that decision.

Affirmed.

1 The breakdown of this amount was as follows:

                                            Date              Unpaid

Period              Type of Tax         Assessed             Balance

1965              Income                 
10/2/72
          $ 1,182.98

1966              Income                 
5/19/67
            4,804.48

1969              Income                       6            6,809.56

1970              Income                 
7/31/71
              248.77

1965

(1Q & 2Q)         W/H & FICA             
12/1/72
            1,441.82

1968

(2Q-4Q)           W/H & FICA            
11/16/72
           48,857.67

1965-1971         W/H & FICA             
12/1/72
           44,958.68

                                                         $108,303.96

 

2 Payments were made to Doran as follows:

                                 Amount of

Year                          Distribution

1968 ................            $1,500.00

1969 ................             2,000.00

1970 ................             1,039.61

1971 ................             3,000.00

1/1/72-10/31/72 .....             2,000.00

11/1/72-10/31/73 ....             3,500.00


The Trustee had not paid Doran any trust proceeds from the date of the levy until Doran's death on February 19, 1975 . The amount here in issue, stipulated by the parties to be $2,305.50, is thus the amount allegedly due Doran for the period of December 5, 1973 (the date of the levy) to the date of his death.

3 Section 6321, 26 U. S. C. 6321, reads as follows:

"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."

4 Section 6332, 26 U. S. C. 6332, reads as follows:

"(a) Requirement.--Except as otherwise provided in subsection (b), any person in possession of (or obligated with respect to) property or rights to property subject to levy upon which a levy has been made shall, upon demand of the Secretary or his delegate, surrender such property or rights (or discharge such obligation) to the Secretary or his delegate, except such part of the property or rights as is, at the time of such demand, subject to an attachment or execution under any judicial process."

5 It is significant that annual payments ceased only after the levying of the Government's tax lien on December 5, 1973 .

Dissenting Opinion

OAKES, Circuit Judge (dissenting):

I agree with the majority that the decision of the Surrogate's Court in this case is not binding on the federal courts, but I disagree with its conclusion that the district court, "sitting as a state court," Commissioner v. Estate of Bosch [67-2 USTC 12,472], 387 U. S. 456, 465 (1967), correctly construed the trust instrument in light of applicable New York law. I would therefore reverse.

The majority concludes, as did the court below, that "[t]he trustee is bound to distribute some trust income to each of the beneficiaries. . . ." Ante at 1951 (emphasis added); see 415 F. Supp. at 220. This question is critical because, if the trustee were held not to be so bound, that is, if he could withhold payment from any beneficiary at his discretion, then Mr. Doran, the taxpayer beneficiary here, would concededly have no state property right in the trust income. Without such a right, there is nothing to which the Government tax lien may attach. See 26 U. S. C. 6321, 6331; Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509, 512-14 (1960). Significantly, in reaching their respective conclusions, neither the majority nor the court below indicates how much trust income the trustee must distribute to any particular beneficiary, and indeed no one could do so, since the decision rests entirely with the trustee under the terms of the trust instrument. The key sentence directs the trustee to "pay . . . whatever part or all of the net income or principal . . . he shall deem proper or necessary . . . to the individual members of the said family group" (emphasis added).

If this court and the court below were faced with the problem of determining the amount of money to which Mr. Doran, the taxpayer, had a claim--and thus the amount the Government could take via its tax lien--I believe a different result would be reached from that the parties by stipulation in effect reached here, agreeing as they have upon the amount the trustee will pay to the Government if the Government succeeds on the legal issues. The stipulation, it can be seen, permits the majority opinion to avoid facing the fact that the amount due from the trustee to any particular beneficiary is utterly undefinable and thus to avoid wrestling with the really vital question whether, for example, the payment of one dollar to Mr. Doran, if that sum were deemed "proper or necessary" by the trustee, would satisfy the trustee's obligation to convey, as the majority says, "some" funds from the trust to each beneficiary.

If it is conceded--and nothing I can find in the majority opinion is to the contrary--that a good faith payment of one dollar would satisfy the trustee's obligation to Mr. Doran, I am puzzled how a good faith "payment" of zero can be held not to satisfy that obligation. The difference between zero and one dollar is surely of no consequence either to Mr. Doran or the Government, and many of the beneficiaries of the trust here involved, including Mr. Doran himself for years prior to 1968, have accepted the trustee's failure to give them any payments for several years without, so far as the record indicates, asking a court to compel him to give them 'some" of the trust income. The trust instrument on its face certainly seems to give the trustee the option of deeming zero to be the "proper or necessary" level of funding for any particular beneficiary.

The construction suggested by the words of the instrument and by the inability of anyone to specify what is owed Mr. Doran is that this trust is what has been called a "blended trust." G. G. Bogert & G. T. Bogert, The Law of Trusts and Trustees 230 (2d ed. 1965). According to the Restatement (Second) of Trusts 161 (1959) [hereinafter cited as Restatement]:

If a trust is created for a group of persons and the interest of one member of the group is inseparable from the interests of the others, he cannot transfer his interest and his creditors cannot reach it.

Courts in the twentieth century have apparently always followed the Restatement view that a creditor cannot reach interests of this sort, even in cases where, as the majority construes the trust here, the trustee has "no right . . . totally to exclude any one beneficiary from benefits . . .." G. G. Bogert & G. T. Bogert, supra, 230, at 731; see A. W. Scott, The Law of Trusts 155, at 1184 (3d ed. 1967) ("Where a trust is created for the benefit of a person and the members of his family, . . . [e]ven if he is entitled to receive part of the income from the trust or to have it applied to his use, his interest may be so inseparable from that of the members of his family that it cannot be assigned and his creditors cannot reach it.") See also id. 161.

The trust here, moreover, is one for "support, maintenance and/or education," with regard to which a beneficiary has no right to compel payment by the trustee, see In re Martin's Will, 269 N. Y. 305, 312-13, 199 N. E. 491, 494 (1936); In re Cuff's Will, 118 N. Y. S. 2d 619, 624 (Sur. Ct. 1953); Restatement 128, Comment e, and creditors cannot reach the beneficiary's interest, see Ellis v. Chapman, 165 App. Div. 79, 150 N. Y. S. 673 (1914); Restatement 154. See also Restatement 182, Comment c. While the claim of the Government for taxes might be enforceable against the interest of a sole beneficiary of a trust for support, see Restatement 157(d); cf. In re Rosenberg, 269 N. Y. 247, 199 N. E. 206 (1935) (federal tax lien enforceable against beneficiary's interest in spendthrift trust), cert. denied, 298 U. S. 669 (1936), this rule does not apply when, as here, there are several beneficiaries with inseparable interests, see Herzog v. Commissioner [41-1 USTC 10,010], 116 F. 2d 591, 594 (2d Cir. 1941) (A. Hand, J.).

The problem of determining what amount is due Mr. Doran illustrates the soundness of the well-settled New York rule that the courts will not interfere on behalf of a creditor of a beneficiary with the exercise of the discretion vested in the trustee. Sand v. Beach, 270 N. Y. 281, 284, 200 N. E. 821, 822 (1936); Hamilton v. Drogo, 241 N. Y. 401, 404, 150 N. E. 496, 497 (1926); 26 Colum. L. Rev. 776, 776 (1926); see Restatement 155(1). In the one case relied on in the majority and district court opinions for the conclusion that "some" income must be paid out here, Sand v. Beach, supra, there was no interference with the trustee's discretion because the judgment debtor had a right "to require payment to him of the entire net income of the trust fund," either directly or through "its application for his use and benefit." 270 N. Y. at 286, 200 N. E. at 823 (emphasis added). A case in which the entire trust income must be paid to one beneficiary is manifestly different from the instant case, in which the most the majority can say is that "some" unspecified amount of trust income is due each of several beneficiaries. In the former or Sand v. Beach situation, it makes sense to require that the defined sum owed to a single, specific beneficiary be paid to his creditor. Here, where the trustee has virtually complete discretion to allocate funds among several beneficiaries, it makes no sense to impose a similar requirement, since the other beneficiaries, in favor of whom the trustee might otherwise exercise his discretion, will be the losers--the last result a settlor would wish.

The result reached by the majority thus violates the New York rule against interfering with a trustee's discretion and is not supported by the principal case the majority relies upon. The practical result it seems to countenance, moreover, by which a one dollar payment would be sufficient but a zero "payment" would not, cannot be seriously intended by my brothers in the majority, who concededly are spared having to face the question by a stipulation that may have made this case appear simpler than it is, but that should not control the legal result reached. I would reverse the judgment.

 

 

 

Laurence B. Howard, Jr., Petitioner (and Respondent) v. United States of America , Respondent (and Petitioner) and William F. Howard, Trustee, Respondent

Supreme Court of Tenn., at Nashville , 566 SW2d 521, 4/24/78

[Code Secs. 6321, 6331 and 6334--result unchanged by '76 Tax Reform Act]

Spendthrift trust: Income interest: Subject to tax lien: State v. Federal law.--Income from a spendthrift trust was subject to a lien for the payment of federal taxes. Under federal law, the income right was a property right reachable by a tax levy. Federal law, and not Tennessee state law, determined whether the income was exempt from federal taxation.

One Justice dissented.

[Code Sec. 6323--result unchanged by '76 Tax Reform Act]

Tax lien: Notice of: Filing: Legal registration: State v. federal law.--Two certified notices of tax lien were legaly registered and admissible as evidence in a state trial. They did not meet the state law requirements for admissibility, but they were validly filed under federal law, and federal law was held to be controlling.

Maclin P. Davis, Jr., Elliott Warner Jones, Waller, Lansden, Dortch & Davis, One Commerce Place, Nashville, Tenn. 37239, for petitioner (and respondent). Harold D. Hardin, United States Attorney, Nashville , Tenn. 37902 , for respondent (and petitioner). M. Carr Ferguson, Assistant Attorney General, Gilbert E. Andrews, Crombie J. D. Garrett, Carleton D. Powell, Department of Justice, Washington, D. C. 20530, for respondent (and petitioner). William F. Howard, pro se.

Opinion

HENRY, Chief Judge:

In this action of interpleader, the principal inquiry is whether the income from a spendthrift trust is subject to a lien for the payment of federal taxes.

The last will and testament of Laurence B. Howard established a residuary trust with his two sons, Laurence B. Howard, Jr. and William Felder Howard, designated as income beneficiaries, with income payable quarterly during their respective lives, and with the trust being terminated upon the death of the survivor. Item VI(m) reads, in pertinent part, as follows:

[N]either the principal nor the income of the trust estates shall be liable for the debts of any beneficiary nor shall the same be subject to seizure by attachment, garnishment or execution, nor by any writ of proceeding at law, in equity, in bankruptcy or receivership; nor shall the beneficiaries thereof have the right or power to sell, assign, transfer, pledge, mortgage or in any other manner encumber or anticipate or dispose of their interest in the trust estates or in the income therefrom.

All parties agree, and we hold, that this language operates to create a spendthrift trust.

It should be emphasized that the income beneficiaries do not have the legal title to the corpus of the trust estate, nor do they have any right to the use or possession of any part of the corpus. They are purely income beneficiaries.

On September 24, 1974 , the Nashville District of the Internal Revenue Service served upon William F. Howard, as trustee, a Notice of Levy reciting an indebtedness in the sum of $27,068.95 owed by Laurence B. Howard, Jr., for federal taxes.

Petitioner, Laurence B. Howard, Jr., disputes the entitlement of the Internal Revenue Service to levy upon the trust proceeds and makes other defenses to the claim. 1

The Chancellor, after a full evidentiary hearing, concluded that the federal tax lien attached to the trust income while in the hands of the trustee. The Court of Appeals "affirm[ed] the abstract legal conclusion of the Chancellor that the Federal Government is entitled to attach income from a spendthrift trust in spite of Tennessee Decisions and Statute" but declined to affirm the Chancellor's award in favor of the government on the basis of its view that the evidence necessary to document the government's claim was not competent.

I. Is the income from a spendthrift trust subject to seizure in satisfaction of a federal tax lien?

We respond to the captioned question in the affirmative and thus affirm both the Chancellor and the Court of Appeals as to this phase of the controversy. We specify our reasoning in some detail in view of the fact that there are no guiding precedents under Tennessee decisional law.

At first blush the answer would appear to be determined by Section 26-601, T. C. A., which reads as follows:

26-601. Grounds for discovery and subjection--The creditor whose execution has been returned unsatisfied, in whole or in part, may file a bill in the chancery court against the defendant in the execution, and any other person or corporation, to compel the discovery of any property, including stocks, choses in action, or money due to such defendant, or held in trust for him, except when the trust has been created by, or the property so held has proceeded from some person other than the defendant himself, and the trust is declared by will duly recorded or deed duly registered. Provided, however, that where the state of Tennessee shall be such judgment creditor, the chancery court shall have jurisdiction to subject such property to the satisfaction of the claims of the state, despite the fact that the trust has been created or the property so held has proceeded from some person other than the defendant himself and the trust declared by will duly recorded or deed duly registered.

The history of this statute is simultaneously significant and interesting. In 1831 Tennessee abolished imprisonment for debt. 2 As stated in 35 Tennessee Law Review 319, at 320, "[a]lthough this was entirely in keeping with the moral sense of Tennesseans at the time, it did have the effect of eliminating a part of the plaintiff's remedy at law."

While the decisions are conflicting, the case of Erwin v. Oldham, 14 Tenn. 185 (1834) (decided under the law as it existed prior to the adoption of Chapter 11, Public Acts of 1832), is clear authority for the proposition that in the absence of fraud, the court has no power to subject "stocks, credits, and rights of action" held by a debtor to the satisfaction of his indebtedness. The Court specifically relied upon the New York case of Donovan v. Finn, 1 Hopk. Ch. 59, 14 Am. Dec. 531 (N. Y. 1823), as "conclusively settling the point."

By Chapter 11, Public Acts of 1832, the Tennessee Legislature enacted a statute patterned after a New York act designed to meet Donovan. This statute forms the basis for Sec. 26-601, T. C. A.

Thus within a two-year period, a Tennessee creditor lost the remedy of imprisonment for debt, but gained the right to discover assets in equity and subject them to his demands.

But the equitable remedy was withheld for trust funds when the trust was created by a third person by recorded will or registered deed. This provision breathed the breath of life into spendthrift trusts in Tennessee . The landmark case is Jourolmon v. Massengill, 86 Tenn. 81, 5 S. W. 719 (1887).

There the Court, in an opinion by Justice Lurton, held that the 1832 act was "a rule of property, and . . . very many such trusts have been created in reliance upon it." Id. at 126, 5 S. W. at 734.

The last proviso of Sec. 26-601, T. C. A., excepts from the application of the statute cases where the state of Tennessee is the judgment creditor. This proviso, with additional language making it retroactive, was adopted by Chapter 108, Public Acts of 1943, in an abortive effort to reach the assets of three spendthrift trusts created for Rogers Caldwell by his parents, in satisfaction of an indebtedness to the state in an amount in excess of four million dollars. This Court, in State v. Caldwell, 181 Tenn. 74, 178 S. W. 2d 624 (1944), declared the 1943 amendment "invalid insofar as it is retrospective in character." The court declared that the 1832 act was a rule of property and "not an exemption statute for the benefit of poor debtors."

Thus spendthrift trusts are solidly entrenched in our law and it is clear that Sec. 26-601 is a rule of property and not an exemption statute.

If we were dealing solely with Tennessee statutory and decisional law, we would be inclined to hold that the income from spendthrift funds is insulated against the claims of all creditors, including the Internal Revenue Service; however, such is not the situation.

Article VI, clause 2 of the Constitution of the United States contains the Supremacy Clause:

This Constitution, and the laws of the United States which shall be made in pursuance thereof; [and all treaties] shall be the supreme law of the land; and the judges in every state shall be bound thereby, anything in the Constitution of laws of any state to the contrary notwithstanding.

The ensuing paragraph requires that all judges, state and federal, "shall be bound by oath or affirmation, to support this Constitution."

The imposition and collection of federal income taxes are governed by federal laws deriving their validity from the sixteenth amendment to the federal constitution. As a general rule, where there is a conflict between state laws and federal laws, the latter must prevail. United States v. Dallas National Bank [46-1 USTC 9117], 152 F. 2d 582 (5th Cir. 1946).

Under 26 U. S. C. Sec. 6321, it is provided that unpaid federal taxes, after demand

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. (Emphasis supplied).

There is no exception in favor of income beneficiaries under spendthrift trusts and most assuredly such income is embraced within the phrase "property and rights to property."

This section creates no property rights but merely attaches federally defined consequences to state created rights. See United States v. Bess [58-2 USTC 9595], 357 U. S. 51, 78 S. Ct. 1054, 2 L. Ed. 2d 1135 (1958) (construing a similar provision of the Internal Revenue Code of 1939). State law governs the question of the existence of "property" or "rights to property" and the "nature of the legal interest" that the taxpayer has in the property. Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509, 80 S. Ct. 1277, 4 L. Ed. 2d 1365 (1960).

Under Tennessee law, it is essential to the creation of a spendthrift trust that (1) legal title be vested in the trustee, (2) the gift to the donee be of an equitable interest in the income, and (3) the trust be active. Robertson v. Brown, 13 Tenn. App. 211 (1931). In the instant case these criteria are met; petitioner as income beneficiary has a vested property right in the income generated by the trust.

Once we have made the determination that under Tennessee law petitioner owns property or rights to property, federal law takes over for the purpose of determining whether a lien will attach. United States v. Bess, supra; Broday v. United States [72-1 USTC 9269], 455 F. 2d 1097 (5th Cir. 1972); United States v. Taylor [66-2 USTC 9522], 254 F. Supp. 752 (N. D. Cal. 1966).

As we have heretofore indicated, we are in full accord with petitioner Howard's position that Sec. 26-601, T. C. A., is not an exemption statute. See State v. Caldwell , supra. If it were, the results we reach would be no different. This follows from the established legal proposition that federal law exclusively governs what is exempt from federal taxation. United States v. Mitchell [71-1 USTC 9451], 403 U. S. 190, 91 S. Ct. 1763, 29 L. Ed. 2d 406 (1971).

The lien for federal taxation arises under 26 U. S. C. Sec. 6321 and covers "all property and rights to property." Levy is governed by Section 6331(a), and exemptions are enumerated in Section 6334(a). 3 Section 6334(c) specifically provides that "no property or rights to property shall be exempt from levy other than the property specifically made exempt by subsection (a)."

The fact that we do not deal with an exemption statute is of no significance. What is significant is the fact that we deal with "property and rights to property." The argument of petitioner Howard is precisely the same as was made by the taxpayer in Leuschner v. First Western Bank and Trust Company [58-2 USTC 9723], 261 F. 2d 705 (9th Cir. 1958). The Court responded thusly:

But the bastion of the claim built up by Leuschner is that he had a property right to receive this income. . . . It is for the very reason that Leuschner acquires a property right that the government has the power to levy thereon. (Emphasis supplied).

261 F. 2d at 708.

Petitioner Howard relies upon Meyer v. United States [64-1 USTC 9111], 375 U. S. 233, 84 S. Ct. 318, 11 L. Ed. 2d 293 (1963). But Meyer stands for the proposition that state law determines what is "property or rights to property," and generally it is the policy of Congress to recognize and give effect to state exemption laws. This holding was made in the context of the applicability of the doctrine of marshaling assets. The holding is not at variance with the general rule that federal law determines exemptions from federal taxation.

The conclusion of the Court of Appeals is fully validated by the cases it cited, notably United States v. Dallas National Bank, supra; Leuschner v. First Western Bank and Trust Company, supra; and In re Rosenberg's Will [35-2 USTC 9650], 269 N. Y. 247, 199 N. E. 206 (1935). We fully agree with petitioner that we are not bound by the decisions of the courts of our sister states nor of the federal system; however, we respect their decisions and are entitled to follow the conclusions reached in any well-reasoned opinion irrespective of source.

We affirm the action of the Chancellor and Court of Appeals and hold that respondent's share of the income generated by the spendthrift trust may be subjected to the payment of federal taxes, assuming a proper levy and the observance of all requisite procedural steps. 4

II. The Certificates of Assessments

The Court of Appeals held that the Certificates of Assessments and Payments were not properly validated or certified under Rule 44.01, Tenn. R. Civ. P., because (1) the signature of the Director of the Internal Revenue Service was affixed thereto by a deputy and (2) there is no provision in Rule 44.01 for certifying a "true extract."

We dispose of the latter contention first. Rule 44.01 provides for the proof of an official record "by a copy attested by the officer having the legal custody of the record, or by his deputy." We do not think it even arguable that the right to evidence an official record by the presentation of a certified copy does not carry with it the right to certify pertinent parts of the record. If other parts are germane, our rules contain ample procedures to require their production and inspection.

Under Rule 44.01, Tenn. R. Civ. P., official records, if in the custody of any public official within this state, "may be evidenced by an official publication thereof or by a copy attested by the officer having the legal custody of the record, or by his deputy." Clearly, under this rule the Certificates of Assessments and Payments could have been certified by Claude A. Kyle, the Director of the Internal Revenue Service Center for the Southeast Region, at Memphis , or by his deputy, Dale Crimpley, Branch Chief of the Certification Branch, who had been designated to sign Kyle's name.

The difficulty in this case stems from the fact that the Certificates bear the purported signature of Kyle, affixed by Crimpley, without any indication that it was so signed. The failure of Crimpley to sign his own name as Branch Chief, and therefore, as Kyle's "deputy," is unexplained in the record. While we view this as incredibly sloppy procedure, under the facts of this case, we hold that these records were admissible.

Not only were the documents certified over an official signature and under an official seal, but also the government presented these records by a senior technician employed at the Memphis Service Center , who testified that they were made under her supervision and personally verified by her. Further, the accuracy of these figures is not challenged. In the last analysis we deal with a formality that should not be permitted to frustrate the orderly reception in evidence of an official record.

III. Notice of Tax Liens

Two certified notices of tax lien were received in evidence by the Chancellor. Each was certified by the Deputy Register of Davidson County , but neither was acknowledged by an official of the Internal Revenue Service, and neither was witnessed. Instead, they contained a certificate over the signature of a Revenue officer. Below the signature of the Revenue officer appears this notation:

(Note: Certificate of officer authorized by law to take acknowledgments is not essential to the validity of Notice of Federal Tax Lien G. C. M. 26419, C. B. 1950-51, 125.)

The Court of Appeals, relying upon Sec. 64-2201, T. C. A., 5 held that these notices were not legally registered and were inadmissible in evidence. We disagree.

It is true, as noted by the Court of Appeals, that Haynes v. State, 213 Tenn. 447, 374 S. W. 2d 394 (1964), stands for the general proposition that an instrument will not be considered legally registered unless acknowledged by the maker or properly witnessed.

The filing of tax liens in Tennessee is governed by Sec. 64-2110, T. C. A., which reads, in pertinent part, as follows:

Notices of liens for taxes payable to the United States of America and certificates discharging such liens shall be filed in the office of the register of deeds of the county within which the property subject to such liens is situated.

It will be noted that there is no requirement that they be acknowledged or witnessed--merely that they be filed.

This statutory authorization for the filing of tax liens derives its efficacy from federal statutes, since remedies for the collection of federal taxes have "always been conceded to be independent of the legislative action of the States," and the federal statute (now 26 U. S. C. Sec. 6323[f]) "does not purport to permit the States to prescribe the form or the contents of that notice." United States v. Union Central Life Insurance Co., [62-1 USTC 9103], 368 U. S. 291, 293-94, 82 S.Ct. 349, 351, 7 L. Ed. 2d 294, 296-97 (1961). In the cited case the Court points out that allowing the respective states to prescribe the form and contents of tax notices would run "counter to the principle of uniformity which has long been accepted practice in the field of federal taxation." Id. at 294, 82 S. Ct. at 351, 7 L. Ed. 2d at 297. See also Atlas Finance Co. v. Wilkerson, 214 Tenn. 619, 382 S. W. 2d 529 (1964).

Further, as held in United States v. Estate of Donelly, 397 U. S. 286, 294, 90 S. Ct. 1083, 1038, 25 L. Ed. 2d 312, 319 (1970):

Acts of Congress are generally to be applied uniformly throughout the country from the date of their effectiveness onward.

Controlling federal law relating to form and contents is contained in 26 U. S. C. Sec. 6323(f)(3):

The form and content of the notice referred to in subsection (a) shall be prescribed by the Secretary. Such notice shall be valid notwithstanding any other provision of law regarding the form or content of a notice of lien. (Emphasis supplied).

The place of filing personal property liens is governed by 26 U. S. C. Sec. 6323(f)(1)(A)(ii), which provides that the notice shall be filed "in one office within the State (or the county, or other governmental subdivision), as designated by the laws of such State, in which the property subject to the lien is situated." Sec. 64-2110, T. C. A. is Tennessee 's designation. Notices so filed must meet the requirement of federal law. We hold that such notices need not be acknowledged or witnessed.

Finally, it is the declared purpose of Sections 64-2110-64-2115, T. C. A., to "authoriz[e] the filing of notices of liens in accordance with the provisions of Sections 6321-6326 of the United States Internal Revenue Code of 1954, and any acts or parts of acts of Congress amendatory thereof." Sec. 64-2114, T. C. A. This section points unerringly to federal law and by that law we are bound.

There is for further consideration the fact that the lien imposed by Sec. 6321 arises at the time the assessment is made; and, therefore, unlike other liens its perfection does not depend upon its recordation. In re DeKalb Avenue Reconstruction, Borough of Brooklyn , City of New York , 11 App. Div. 2d 240, 205 N. Y. S. 2d 125 (1960), aff'd mem., 12 N. Y. 2d 1051, 190 N. E. 2d 240, 239 N. Y. S. 2d 880 (1963).

IV. The Specific Claims

This suit involves two claims, asserted by the government. One of them was based on petitioner's ownership of Harding at Harding Car Wash; the other on his status as a responsible officer of Roman International, Inc. Involved were unpaid Withholding and Federal Insurance Contribution Act (FICA) taxes. Separate notices of tax liens were filed in the Register's office of Davidson County on May 30, 1974 . A notice of levy was served on the Trustee on September 24, 1974 , and prior demand had been made upon the Petitioner.

There is a presumption that tax assessments are valid and the burden is on the taxpayer to prove that they are erroneous. United States v. Rexach [73-2 USTC 9527], 482 F. 2d 10 (1st Cir. 1973). We agree with the Chancellor that there is no such proof in the record. Actually the taxpayer agreed to the assessment against Roman International. We concur in all factual findings made by the Chancellor and in the conclusion he reached.

V. Conclusion

The taxes in question were due and unpaid; assessments were legally made; the taxpayer had actual notice of the claim and demand for payment had been made; notices of liens were seasonably filed. We find nothing in this record that would justify giving relief to this taxpayer. Absent a bona fide dispute as to tax liability, we do not look with favor upon technical objections which, if sustained, would frustrate the government in the collection of tax revenues. This record does not reflect a bona fide defense to the claims asserted by the government.

This action is remanded to the Chancery Court at Nashville for the entry of a final order containing the current amount of the tax liability and such other matters as may be appropriate. The judgment heretofore entered in chancery will bear interest at the legal rate. All costs--both those in the trial court and those incident to this appeal--will be taxed one-half to the United States of America and one-half to the Petitioner. The entire judgment and Petitioner's share of the court costs are payable out of the income of the trust estate.

1 Simultaneously with the filing of the Complaint, the trustee tendered into the registry of the court all funds in his hands belonging to Laurence B. Howard, Jr., and has since paid into court all sums due him when and as income has accrued. The total so deposited as of the date of the hearing in Chancery Court was approximately $28,000.00.

2 Ch. 40, Public Acts of 1831, "An Act to abolish imprisonment for debt except in cases of fraud." This act would be suspect today--it prohibited the imprisonment of female debtors under any circumstances.

3 This section exempts wearing apparel and school books, fuel, provisions, furniture and personal effects, books and tools of a trade, business or profession, unemployment benefits, undelivered mail and workmen's compensation benefits.

4 Also in accord with the decision of this Court and the Court of Appeals is Sec. 157(d) of the Restatement (Second) of Trusts (1959): "Although a trust is a spendthrift trust or a trust for support, the interest of the beneficiary can be reached in satisfaction of an enforceable claim against the beneficiary . . . by the United States or a State to satisfy a claim against the beneficiary." See also the Comment on Clause (d).

5 Sec. 64-2201, T. C. A., provides:

To authenticate an instrument for registration, its execution shall be acknowledged by the maker, or proved by two (2) subscribing witnesses, at least.

Opinion Concurring in Part; Dissenting in Part

BROCK, Justice:

I concur in the opinion of the Court in all respects, except its determination that income from a Tennessee spendthrift trust is subject to a federal tax lien.

The United States Supreme Court has made in clear, I think, that federal law does not create any property rights or determine the nature, attributes, or quality of property rights of a taxpayer; instead, it has left that determination to the several states. Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509, 80 S. Ct. 1277 (1960); United States v. Bess [58-2 USTC 9595], 357 U. S. 51, 78 S. Ct. 1054 (1958); Morgan v. Commissioner [40-1 USTC 9210], 309 U. S. 78, 60 S. Ct. 424 (1940).

I also think it clear, as stated in the majority opinion, that under Tennessee law the interest of a beneficiary of a spendthrift trust is of such a nature and quality that it may not be alienated either voluntarily by the beneficiary-debtor or involuntarily by his creditors; inalienability is an attribute of such an interest. State v. Caldwell, 181 Tenn. 74, 178 S. W. 2d 624 (1944). Therefore, such a beneficiary, as a debtor for taxes owed to the United States, does not, insofar as his trust interest is concerned, own any property or rights to property within the terms of 26 U. S. C. 63.21. It is not a matter of such a beneficiary having property which is exempt from the claims of creditors; rather, he simply has never received from the settlor of the trust any right which he may alienate or which may be taken from him.

The question here presented is not answered merely by finding, as does the majority, that the debtor-taxpayer owns property or rights to property; it is necessary to go further and ascertain the nature of such property or rights, i. e., whether it is alienable by the taxpayer. In my view, the Aquilino decision clearly shows that this determination is one to be made by state courts based upon state law; it is not determined by federal statutes and the supremacy clause of the Constitution has no application.

In Aquilino, supra, the taxpayer was a general contractor. The government asserted its tax lien against an indebtedness allegedly owed by a property owner to the general contractor. A dispute concerning the nature and extent of the interest of the taxpayer-contractor ensued. Certain subcontractors, who had performed work on the job, asserted that the money actually received by the contractor-taxpayer and his right to collect amounts still due under the construction contract constituted a direct trust for the benefit of sub-contractors, and that the only property rights which the contractor-taxpayer had in the trust were to bare legal title to any money actually received and a beneficial interest in so much of the trust proceeds as remain after the claims of sub-contractors should be settled. The Federal Government, on the other hand, claimed that the New York State Lien Law merely gave sub-contractors an ordinary lien, and that the contractor-taxpayer's property rights encompassed the entire indebtedness of the owner under the construction contract. In dealing with this problem, the Supreme Court said:

"The threshold question in this case, as in all cases where the Federal Government asserts its tax lien, is whether and to what extent the taxpayer had 'property' or 'rights to property' to which the tax lien could attach. In answering that question, both federal and state courts must look to state law, for it has long been the rule that 'in the application of a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer had in the property . . . sought to be reached by (citation omitted). Thus, as we held two (citation omitted). Thus, aswe held two Terms ago, Section 3670 'creates no property rights but merely attaches consequences, federally defined, to rights created under state law . . .' United States v. Bess, (citation omitted). However, once the tax lien has attached to the taxpayer's state-created interest, we enter the province of federal law, which we have consistently held determines the priority of competing liens asserted against the taxpayer's 'property' or 'rights to property.' (Citations omitted.) The application of state law in ascertaining the taxpayer's property rights and of federal law in reconciling the claims of competing lienors is based both upon logic and sound legal principles. This approach strikes a proper balance between the legitimate and traditional interest which the State has in creating and defining the property interests of its citizens, and the necessity for a uniform administration of the federal revenue statutes." (Emphasis added.)

The Supreme Court continued:

"This conflict [regarding the nature of the contractor-taxpayer's interest] should not be resolved by this Court, but by the highest court of the State of New York . We cannot say from the opinion of the Court of Appeals that it has been satisfactorily resolved. We find no discussion in the court's opinion to indicate the nature of the property rights possessed by the taxpayer under state law. Nor is the application to be made of federal law clearly defined. We believe that it is in the interests of all concerned to have these questions decided by the state courts of New York . We therefore vacate the judgment of the Court of Appeals, and remand the case to that court so that it may ascertain the property interests of the taxpayer under state law and then dispose of the case according to established principles of law." (Emphasis added.)

80 S. Ct. at 1280, 1281.

It therefore conclude that Tennessee is free to determine the nature and quality of the interest of a beneficiary under a Tennessee spendthrift trust; that for more than 150 years it has been the law of Tennessee as shown by State v. Caldwell, supra, and other decisions of this Court and by T. C. A., 26-601, that such a beneficiary has no interest which may be alienated either voluntarily or involuntarily and thus is of a nature and quality which cannot be reached by creditors, even the United States government. Accordingly, I respectfully dissent from that portion of the majority opinion which is to the contrary.

 

 

 

Mercantile Trust Company v. George Hofferbert, Collector of Internal Revenue of the United States for the District of Maryland

District Court of the United States for the District of Maryland, Civil Action No. 2302, 58 FSupp 701, Filed December 21, 1944

Property subject to lien: Spendthrift trust: Paramount claim for U. S. taxes.--In a suit to quash notices of lien and warrants of distraint laid by the Collector against a trustee upon income belonging to a beneficiary to enforce collection of taxes against him where the trustee claimed the protection of a decree of the state court by the terms of which the income was to be held as a spendthrift fund free from the claims of creditors, it was held that the income from such trust in the hands of the trustee and payable to such beneficiary may validly be subjected to the claim of the government under the provisions of Code Sec. 3670, there being no distinction for tax purposes between spendthrift trusts established by a donor and those established or upheld by statutes or judicial decisions. The Court further held that the Collector's proceedings to collect were not made ineffective because the trust property was in custodia legis by the State court.

Arthur W. Machen, Alexander Gordon 3rd, 1209 Calvert Bldg., Baltimore 2, Md. , for plaintiff. Bernard J. Flynn, U. S. Attorney, P. O. Bldg., Baltimore 2, Md., for defendant.

Opinion

CHESNUT, District Judge:

The substantial question in this case is whether income payable to a beneficiary under a Maryland spendthrift trust may be subjected to a claim of the federal government for income taxes due from the beneficiary, while the income is still in the hands of the trustee before payment to the beneficiary. The question is presented by a motion to dismiss the trustee's complaint in this court against the Collector of Internal Revenue to quash or vacate notices of lien and levy and warrants of distraint laid by the Collector in the hands of the trustee, and to enjoin the Collector from further proceedings to enforce collection of the taxes. The motion to dismiss is based on three separate points: (1) that the complaint fails to state facts sufficient to constitute a cause of action; (2) that the plaintiff has an adequate remedy at law and (3) that the court is without jurisdiction of the subject matter under the express provisions of section 3653 of the Internal Revenue Code which prohibits the maintenance of any suit to restrain the collection of an internal revenue tax. The substance of the complaint may be briefly stated.

[The Facts]

Mary K. Findlay, the mother of the income taxpayer, John V. L. Findlay, died January 8, 1939 , leaving a will which was probated in the Orphans Court of Baltimore City . In it the testatrix gave to the Mercantile Trust Company of Baltimore as Trustee, a certain fund in trust to pay the net income arising therefrom to her son, John V. L. Findlay, during the term of his natural life, in monthly instalments, "his receipt alone to be a sufficient acquittance therefor."

The provisions of the will, a copy of which was filed with the complaint, were ambiguous and uncertain in application with respect to the composition and amount of the trust fund, and therefore required judicial construction to determine the respective rights of the life beneficiary and the residuary legatee under the will. Thereupon the plaintiff, as executor and trustee under the will, instituted a proceeding in the Circuit Court No. 2 of Baltimore City , a Maryland State Court, to which all persons having any interest under the will were made parties. Pending the proceeding the parties reached a compromise agreement which was carried out and made effective by decree of the court by which (1) the court assumed jurisdiction of the completion of the administration of the trust created by the will, all further actions of the trustee to be subject to the approval and supervision of the court; (2) the amount and composition of the trust fund was stated; and (3) the executor was directed to forthwith transfer and pay over to itself as trustee the securities and cash constituting the trust fund, and "that said trustee shall pay the net income therefrom in monthly instalments to the defendant, John V. L. Findlay, during his life, and not into the hands of any other person, whether claiming by his authority or otherwise". (italics supplied) and (4) that the court retain jurisdiction for the purpose of supervising the administration of the trust and for the purpose of deciding any question which may arise in the course thereof.

On July 1, 1944, the Collector laid in the hands of the trustee a notice of lien and levy advising that there was due and owing from the said John V. L. Findlay the sum of $1,158.61 federal income taxes for the years 1941, 1942 and 1943, and notifying the trustee that "the property rights to property, moneys, credits and/or bank deposits then in the plaintiff's possession and belonging to the said Findlay, and all sums of money owing from the plaintiff to the said Findlay were thereby seized and levied upon for payment of the said tax, and demand was made upon the plaintiff for payment of the said sum of $1,158.61 or for such lesser sum as the plaintiff might be indebted to the said Findlay". On the same day the Collector served upon the plaintiff copy of the tax levy for about the same amount; and again on the same day the Collector served upon the plaintiff three warrants of distraint to satisfy the income taxes due. On the 2nd day of August 1944, the Collector again caused the aforementioned notice of levy, lien and distraint to be served on the plaintiff.

[Spendthrift Trust]

On these facts the bill sets up the legal contention that the will of Mary K. Findlay as construed by the decree of the State Court constituted a "spendthrift trust for the benefit of the taxpayer, John V. L. Findlay, and therefore the income arising therefrom is not subject to attachment or distress levied against Findlay and laid in the hands of the trustee". In this connection attention is called to decisions of the Court of Appeals of Maryland that the income from a spendthrift trust cannot validly be subjected to the claims of creditors. And the complaint further alleges that under the decree of the State court the trustee is prohibited from paying the income from the trust estate except to the beneficiary and if the trustee otherwise pays it over to the Collector, the trustee would be in contempt of the decree of the State Court. It is then alleged that the Collector's proper remedy is to file his claim in the State Court and not levy on the fund in the hands of the trustee. In effect the complaint takes the position that the accrued income payable in due course to the beneficiary is not property of the beneficiary until it is in fact paid to him by the trustee. The complaint further states that the trustee had in its possession accrued income payable to the beneficiary in the amount of $449.50 on July 1, 1944 , and has further received similarly payable income in the amount of $555.38 up to the time of filing the complaint on August 9, 1944 .

[Established by Court Decree]

It may be observed that, before the decree of the State Court, it is doubtful whether the language in Mrs. Findlay's will was sufficient to create a spendthrift trust. Quite similar wording was held insufficient for that purpose by Judge Soper as District Judge in Dudley's Estate, 3 Fed. (2d) 831, affirmed 7 Fed. (2d) 118. The decree of the State Court was the result of a family compromise approved by the court. As the jurisdiction of this court is not based on diverse citizenship (Erie RR. v. Tompkins, 304 U. S. 64) but on a federal question, and as the government was not a party to the State Court case, there might have been some question whether the language of the decree construing the will as a spendthrift trust, is conclusive here as res adjudicata of the question. But there is no contention by counsel for the defendant that the decree of the State Court was collusive, and I take it that it must be considered binding here. Blair v. Commissioner, 300 U. S. 5 [37-1 USTC 9083].

[Government's Lien Claim]

The statutory authority for the Collector's action is to be found in the Internal Revenue Code, title 26 USCA, ss. 3670, 3678 and 3690 and 3692. Section 3670 reads as follows:

Sec. 3670. PROPERTY SUBJECT TO LIEN. If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, penalty, additional amount, or addition to such tax, 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.

Section 3678 authorizes suit to enforce the lien of the United States for taxes, all persons having interest in the property to be made parties. Section 3690 provides that if any person liable to pay taxes neglects or refuses to pay the same within ten days after notice and demand, the Collector may collect the taxes with interest by distraint and sale of the goods, chattels or effects including stock, securities, bank accounts and evidences of debt of the delinquent taxpayer. And section 3710 further provides that any person in possession of property or rights to property subject to distraint upon which levy has been made shall upon demand by the Collector surrender the property or rights to the Collector, and on failure to do so such person shall be personally liable to the United States in a sum equal to the value of the property or rights not so surrendered but not exceeding the amount of the tax (including penalty and interest).

After hearing the arguments of counsel, and consideration of their excellent briefs, I have reached the conclusion that the income under the spendthrift trust in the hands of the trustee and payable to the beneficiary, when the notices of lien and levy were given, may validly be subjected to the claim of the government for the unpaid taxes.

[Validity of Spendthrift Trusts]

There is a large volume of judicial decisions with respect to the validity of spendthrift trusts in general, and the extent to which, if at all, they can be subjected to the valid claims of creditors or other persons having lawful demands upon the beneficiary. A spendthrift trust is in the nature of a restraint upon alienation. In the English courts it was decided more than a hundred years ago that the restraint upon alienation similar to that in a spendthrift trust was invalid. In this country wide attention to the particular subject was first attracted in 1875 by the case of Nichols v. Eaton, 91 U. S. 716, in which the opinion by Mr. Justice Miller stated the view that the restraint, in view of our general recording statutes giving notice to creditors, should not be held invalid as a matter of public policy. Subsequently a considerable number of State Court decisions have followed to the same effect; and in still other States, the subject matter is controlled by statutes. In Maryland the first case dealing directly with the validity of a spendthrift trust is Smith v. Towers, 69 Md. 77 (1888). It upheld the validity of the trust as against creditors of the beneficiary although with a strong dissent by Chief Judge Alvey and Judge Bryan. In numerous subsequent cases the court has adhered to the same position, the most recent decisions being Bauernschmidt v. Safe Deposit and Trust Company of Baltimore, 176 Md. 351, and Medwedeff v. Fisher, 179 Md. 192.

[Effective Against General Creditors]

In some of the States where the spendthrift trust is held valid as against creditors, the income of the beneficiary may nevertheless be subjected to the valid claims of particular classes of persons especially the wife or children of the beneficiary; but there is yet no such Maryland decision. See Bauernschmidt v. Safe Deposit and Trust Co., supra; Vol. 4, Md. Law Rev. pp. 417-423. In A. L. I. Restatement of Trusts, s. 157, p. 389, it is stated--

Sec. 157. Particular Classes of Claimants.

Although a trust is a spendthrift trust or a trust for support, the interest of the beneficiary can be reached in satisfaction of an enforceable claim against the beneficiary.

(a) by the wife or child of the beneficiary for support, or by the wife for alimony;

(b) for necessary services rendered to the beneficiary or necessary supplies furnished to him;

(c) for services rendered and materials furnished which preserve or benefit the interest of the beneficiary.

See also Griswold, Spendthrift Trusts, c. 5, p. 289; Scott on Trusts, Vol. I, s. 157.

It has been held that the beneficiary's interest in a spendthrift trust, as to both principal and income, does not pass to his trustee in bankruptcy where the spendthrift trust is valid by the applicable State decisions. But this results from the particular provisions of the Bankruptcy Act which give the trustee in bankruptcy no greater rights than the bankrupt himself possessed. Eaton v. Boston Trust Co., 240 U. S. 427; Medwedeff v. Fisher, 179 Md. 192, 196; Suskind & Berry v. Rumley, 4th Cir. 37 Fed. (2d) 304.

[No Bar to U. S. Taxes]

There have been only a very few judicial decisions dealing with the enforceability of federal tax claims against the income from a spendthrift trust. The first and still the leading case upon the subject is Re Rosenberg, 269 N. Y. 247, cert. den. 298 U. S. 669. There, a New York statute exempted 90 per cent of the spendthrift trust income from the claims of creditors, but the court held that the whole income was subject to the claims of the United States under the same federal statute here relied on (s 3670). (See also U. S. v. Guaranty Trust Co. of New York, 2d Cir. 76 Fed. (2d) 747 [35-1 USTC 9274]). In United States v. City of Greenville , S. C., 4th Cir. 118 Fed. (2d) 963, 965 [41-1 USTC 9381], in speaking of a claim of the government for income taxes, Judge Parker said: "Nor can it be affected by homestead, spendthrift trust or stock transfer acts of the states", citing among other cases the Rosenberg case, supra. In United States v. Canfield, D. C. Cal. 29 Fed. Supp. 734 [39-2 USTC 9641], the taxpayer, one Canfield, was the beneficiary of a spendthrift trust which was held reachable by the United States . The Rosenberg case was again cited favorably for the proposition. A state statute was again involved. See Canfield v. Security-First National Bank, 13 Cal. 2d. 1, 12; 87 P. 2d. 831. United States v. Dallas Nat. Bank, (D. C. Texas) 56 Fed. Supp. 181 [44-2 USTC 9426], is apparently to the contrary, but it will be noted from the brief opinion that the question was also complicated by the apparent invalidity of the tax assessment. Counsel inform me that the case is now pending on appeal. With the exception of this last mentioned case, there seems to be no prior reported judicial decision with respect to the impact of federal taxes on a spendthrift trust valid under the State law unaffected by a State statute. The reasons which have actuated some courts, as in Maryland, to uphold spendthrift trusts against the claims of creditors do not necessarily apply to tax claims of the government either federal or State. Griswold, supra, s. 342, p. 302. The public policy involved is quite different. In the one case the donor of the property has the right to protect the beneficiary against his own voluntary improvident or financial misfortune; but in the other the public interest is directly affected with respect to collection of taxes for the support of the government. The imposition of the tax burden is not voluntary by the beneficiary. In a sense the property itself incurs the tax; or rather the property is held cum onere.

[No Distinction of Types]

Counsel for the plaintiff concedes the correctness of the decision in the Rosenberg case and others that have followed it where state exemption statutes were involved, but contends they do not apply to the instant case where the spendthrift trust was created by the voluntary will of the donor. It is said that in the latter case a rule of property is involved, entirely separate and apart from any statute; and that in making the gift the donor had the absolute right to impose limitations on the application of the income. See State of Tennessee v. Caldwell , 178 S. W. 2d. 624; 151 A. L. R. 1410, 1422. But I am unable to concur in the soundness of the distinction sought to be made. Public policy is the determining factor whether the restraint on alienation involved in a spendthrift trust is upheld by statute or judicial decision. In the one case the public policy is expressed by the Legislature of the State and the other by its courts. If, as is conceded, the public policy of the State expressed in a statute must yield to federal taxes, so also must trust instruments created by a donor. In many States spendthrift trusts are not validated either by judicial decision or by statute; but federal income taxes are intended to be uniform in their application throughout the Nation. (See Lyeth v. Hoey, 305 U. S. 188 [38-2 USTC 9602].) The invalidity of the attempted distinction between the effect of statutes and judicial decisions is aptly expressed by Professor Griswold in his text book on Spendthrift Trusts, p. 306, as follows:

Again, the Rosenberg case involves an interest made inalienable by a statute rather than as a result of an express provision in the terms of the trust. But the same result should follow in either case. In either event, spendthrift trusts exist because of policy and not because of logic. If the policy declared by the legislature yields to a claim for taxes, the declarations of the settlor should be no more effective. In the quotation from the Rosenberg opinion set out above, the court refers to the New York statutory restraint as an exemption law. This was in accordance with previous decisions in New York . The consequence is no different if the exemption is obtained from the terms of the trust rather than from statute. The state is not an ordinary creditor, and its claims should not be made dependent on the will of a former owner of the property.

Subject to such general exemptions as the state sees fit to grant to all taxpayers, all property should be equally subject to tax claims. There is no reason for granting to the beneficiaries of trusts an immunity not shared by the other owners of property.

See also for somewhat analogous situations in which the government is entitled to reach the income from a spendthrift's trust, Griswold, ss. 343-344, and Scott on Trusts, Vol. I, s. 157.4.

[Although in Court's Custody]

Counsel for the plaintiff also argues that the notice of levy, lien and distraint should be vacated because the spendthrift trust constitutes property now in custodia legis by the State court. This proposition is at least doubtful. Commonwealth Co. v. Bradford, 297 U. S. 613; Hinckley v. Art Students League, 4th Cir. 37 Fed. (2d) 225: Compare United States v. Swink (D. C. Va.) 41 Fed. Supp. 98 [41-2 USTC 9794]. It is also contended that if the plaintiff trustee yields to the Collector's demand and pays the accrued income to the Collector it will subject itself to contempt proceedings in the State Court. On this premise it is argued that the proper procedure for the Collector is to petition the State Court for an order on the trustee to honor the government's claim for the taxes. No doubt the latter procedure is now permissible after the Collector has made the levy and distraint, and I am inclined to think that would be the preferable course in this case. Similar action seems to have been taken by the Collector in the Rosenberg case, supra. But however that may be, I think there is no warrant here for vacating the Collector's notice of levy, lien and distraint. Indeed that procedure seems to be a condition precedent to the enforced collection of the tax hereafter, whether by petition to the State Court or by proceedings in this court under the federal statutes above referred to. Nor is there any necessity to vacate the Collector's notices to enable the trustee to avoid a possible conflict of State and federal authority. The Collector's notices in this case to the trustee are not of themselves self-executing with respect to the payment of the accrued interest. If the trustee considers it necessary or prudent so to do, it can itself petition the State Court for authority to make the payment of income to the Collector, and presumably on such a petition a rule would be served upon the beneficiary, from whom the income taxes are alleged to be due, to show cause against the requested order; and from an adverse decision either the trustee or the beneficiary would doubtless have the right to appeal, ultimately if necessary, to the Supreme Court of the United States on the federal question involved.

[Procedural Points Discussed]

This conclusion on the substantial question requires the dismissal of the complaint. But as the case may be appealed, it is appropriate to briefly consider the procedural points included in the defendant's motion to dismiss. If the plaintiff's contention on the substantial point that the spendthrift trust income is not property of the income taxpayer reachable by the government were sound, I would not think this court is without jurisdiction of the complaint under s. 3653 of title 26 USCA, which provides that no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court. Hubbard Inv. Co. v. Brast, 4th Cir. 59 Fed. (2d) 709 [1932 CCH 9366]; Rothensies, Collector, v. Ullman, 3d. Cir. 110 Fed. (2d) 590 [40-1 USTC 9308]; Allen v. Regents of the University System of Ga., 304 U. S. 439 [38-2 USTC 9321]; Cannon v. Nicholas, 10th Cir. 80 Fed. (2d) 934 [35-2 USTC 9672].

But the other procedural ground relied upon by the defendant, that the plaintiff has an adequate remedy at law, is, I think, good in this case. As heretofore pointed out, the Collector's notices to the trustee are not self-executing with respect to the collection of the taxes; and the Collector has not undertaken to actually sell under the notice of distraint. If the demand for payment is refused by the trustee, the right of the United States to enforce collection will necessitate a sale under the distraint by the Collector, or an independent judicial proceeding by the United States under section 3678 to enforce the lien by sale or a suit against the trustee for individual liability under section 3710; or a petition by the trustee filed in the State Court. To any such proceeding the trustee will have the opportunity to present any legal defenses that it may have. If the Collector should undertake to sell under the distraint, or to sue the trustee under section 3710, which applies by its terms only with respect to property subject to distraint (ss. 3690 and 3692), the question may arise whether the accrued income in the possession of the trustee was liable to distraint under the federal statute. This particular question has not been argued by counsel and it is not necessary here to decide it. It is sufficient now to note apparently conflicting decisions on the point. In some cases it has been held, or at least assumed, that a chose in action of the character here involved is subject to distraint. Cannon v. Nicholas, 10th Cir. 80 Fed. (2d) 934 [35-2 USTC 9672]; United States v. Long Island Drug Co., 2d. Cir. 115 Fed. (2d) 983 [41-1 USTC 9140]; Commonwealth Bank v. United States, 6th Cir. 115 Fed. (2d) 327 [40-2 USTC 9769]; United States v. Penn Mutual Life Ins. Co., 3d. Cir. 130 Fed. (2d) 495, 497 [42-2 USTC 9623]. But other cases, some quite recent, are seemingly to the contrary. United States v. Metropolitan Life Ins. Co., 2d. Cir. 130 Fed. (2d) 149 [42-2 USTC 9609]; United States v. Morris & Essex R. Co., 2d. Cir. 135 Fed. (2d) 711 [43-1 USTC 9432]; United States v. Aetna Life Ins. Co. of Hartford, Conn., (D. C. Conn.) 46 Fed. Supp. 30 [42-1 USTC 9266]; Re Rosenberg , 269 N. Y. 253.

For all these reasons I have concluded that the complaint must be dismissed with taxable court costs against the plaintiff. Counsel may submit the appropriate order.

 

 

United States of America, Complainant, v. Charles O. Canfield, Security-First National Bank of Los Angeles, a corporation, Laura Elaine Votion, Daisy C. Moreno, Caroline E. Spalding, Dorothy C. Cheseldine, Florence E. Whitney, Eilleen C. Himes, Defendants

District Court of the United States in and for the Souther District of California , Central Division, No. Q-53-M, 29 FSupp 734, Decided July 24, 1939

Enforcement of lien: Spendthrift trust.--A lien on taxpayer's portion of the income from a testamentary spendthrift trust is enforcible in collecting his tax liability for 1922, 1923, 1925, and 1926, where the defendant bank received adequate notice, the Government's right and lien is paramount to the claims of all other defendants herein, and an alleged compromise was vitiated.

Ben Harrison, U. S. Attorney, Eugene Harpole and C. L. Christie, Special Attorneys, Treasury Department, and Armond Monroe Jewell, U. S. Attorney, Los Angeles, Calif., for plaintiff. Newlin & Ashburn, by Allen W. Ashburn and Hudson B. Cox, 1020 Edison Bldg., Los Angeles, Calif., for Security-First National Bank; Wm. W. Lovett, Jr., and H. S. Hazeltine, 824 Richfield Bldg., Los Angeles, Calif., for Caroline C. Spalding; Lawler, Felix & Hall and C. L. Tupper, by Oscar Lawler and L. C. Tupper, 800 Standard Oil Bldg., Los Angeles, Calif., for Florence E. Whitney and Dorothy C. Cheseldine; Neblett, Warner & McDonald, by Allen H. McCurdy, 1009 Transamerica Bldg., Los Angeles, Calif., for Laura E. Votion; Walter H. Robinson, Bank of America Bldg., Beverly Hills, Calif., for Eilleen C. Himes.

Memorandum of Conclusions

MCCORMICK, District Judge:

We have reviewed the entire record of this action, as well as causes No. 0-3-H and 7427-S.

During the time that the suit has been pending, various motions have been made and rulings entered which reflect this court's views of issues which at such times have been presented for decision. Throughout the trial many important and crucial questions of evidence have been determined, and the transcript fully discloses the opinion of the court in such matters.

We have concluded that a further detailed memorandum is unnecessary, not only because the findings of fact and conclusions of law which have been made and entered this day fully and formally decide all issues, but also because the progressively increasing penalties and interest assessable under the law against the defendant until final judgment should be avoided without unnecessary delay.

[General Conclusions Summarized]

General conclusions from the entire case may be thus summarized:

It is indisputable that income taxes, interest and penalties for the calendar years 1922, 1923, 1925 and 1926 in an aggregate amount exceeding $32,750 are due, owing and unpaid from Charles O. Canfield, and that every possible effort has been made by the government to collect from the taxpayer, wholly without success, and that if the United States is unable to reach the property right of Canfield in a trust created in his father's will and of which defendant bank is trustee and enforce payment of such taxes in this suit, complete avoidance and evasion of the large tax obligation will have been achieved. We think such result should be obviated, as we believe it has been, by the application of the legal principles invoked by the United States in this action.

[Property Reached by Process]

The government has seasonably and regularly pursued all of the requirements of applicable federal statutes for the assessment, collection, attachment of liens and enforcement of payment of the income taxes of Canfield for the years in question as to the taxpayer, and the processes invoked by the government should, and we believe do, reach all property and rights to property of Canfield in the trust of which defendant bank is trustee. Matter of Rosenberg , 269 N. Y. 247. There is also respectable authority to the effect that issues of the legality of the assessments or the collection of the taxes of Canfield cannot be raised by the defendant bank, as it is not the taxpayer. United States v. First Capital National Bank (C. C. A. 8, 1937) 89 F. (2d) 116 [37-1 USTC 9201]; United States v. American Exchange Irving Trust Co., 43 F. (2d) 829 [2 USTC 577].

[Lien Enforceable]

The taxpayer Canfield having failed and refused to pay and discharge the tax obligations, under Title 26, Sections 1545, 1560, et seq., U. S. C. A., a lien arose and attached to all property or rights to property of Canfield in the trust established for him and for his benefit by his father's will. Such lien arose by virtue of the receipt of the assessments by the Collector of Internal Revenue at the respective times which the evidence proves the assessments were in the hands of the Collector, and these liens have continued and are still effective and enforceable. The respective assessments are also, under Bull, Executor, v. United States, 295 U. S. 247, at pp. 259 and 260 [35-1 USTC 9346], given the force of a judgment, and seizure of all property rights of the defaulting taxpayer is lawful to satisfy the debt. The enforcement of the lien for unpaid taxes upon all property and rights to property of Canfield and the subjecting of such property to the payment of his unsatisfied taxes exists not only because of applicable statutes of the United States, but also arises by virtue of the service of summons issued pursuant to the bill in equity in this action under Section 1568 of Title 26, U. S. C. A.

The United States has all the rights that any other creditor may enjoy under the processes of equity. The amended bill of complaint may be considered in the light of the Federal Rules of Civil Procedure as a creditor's bill establishing in addition to the statutory liens an equitable one also. See Canfield v. Security-First National Bank ( California Supreme Court) 87 Pac. (2d) 830.

[Acts of Defendant Bank]

Upon as early as July 16, 1927, when notice of levy was served upon the defendant bank, and later, and also upon the filing of the complaint in this suit, at times when said defendant had in its possession or under its control property and rights to property, adequate notice of Canfield's defaulted tax obligations and liabilities was given to said defendant, and it was required to withhold from Canfield and surrender to the government amounts in satisfaction of the unpaid tax obligations of the taxpayer Canfield. Instead of complying with the demands of the government and the requirement of the federal statutes relative to the surrender and payment of income taxes that Canfield owes to the United States, the defendant trustee has yearly since 1927 allocated and paid from the income of the trust estate of Canfield sums of money ranging from approximately $51,785 in 1927 to more than $35,000 in 1932. The entire amount of unpaid taxes due from Canfield to the United States at this time is less than $35,000.

It has been unquestionably settled that Canfield at all times involved in this action had an interest in the income of the trust created and vested by his father's will. And it can no longer be disputed that Canfield's right to receive income from the trust was and is property or a right to property belonging to Canfield, which was reachable by the United States in satisfaction of the government's unpaid tax claim under Section 1610 of Title 26, U. S. C. A. Canfield, et al., v. Security-First National Bank, supra; Matter of Rosenberg, supra.

We also find from the record before us that the government's right and lien upon Charles O. Canfield's portion of the income from the testamentary spendthrift trust is and has been at all times paramount and preferential to the rights or claims of all other defendants herein.

In ascertaining the legal attendants to the investiture of the property and rights to property of Canfield by the allocation of trust income to him, it should be noted that before giving money to Canfield the trustee must necessarily decide to give it to him, and that during appreciable time, however brief, the allocation and award must precede the delivery of the income Canfield is to receive, and during that time the lien of the sovereign taxing power attaches. The lien for taxes is thus definitely affixed to the allocations before manual delivery to Canfield takes place, and the trustee in failing to observe and discharge the lien, and indeed by frustrating the purpose of the lien, has rendered itself liable under federal tax laws for the amount of income taxes, interest and penalties due from Charles O. Canfield for the years 1922, 1923, 1925 and 1926.

[No Compromise]

The record before us fails to establish any enforceable compromise or settlement of the tax obligations of Canfield which operates to relieve the defendant trustee of liability to the government in this case. The true factual situation as we have found it from the evidence shows willful falsification of existing material facts which misled the United States and which vitiates the alleged compromise averred in the pleadings in this action.

Judgment is ordered for plaintiff, with costs, in accordance with the findings of fact and conclusions of law filed this day which constitute the decision in this action.

 

 

 

United States of America , et al., Plaintiffs v. Riggs National Bank, et al., Defendants

U.S. District Court, D.C., 84-2889, 4/30/86 , 636 FSupp 172, (636 FSupp 172.)

[Code Sec. 6321 ]

Lien for taxes: Property subject to: Trusts: Spendthrift clause.--Income generated by a trust created under Maryland law was subject to a lien for taxes owed by the taxpayer-beneficiary and the trustee was ordered to turn over the income to the government until the tax liabilities are satisfied. Although the trust's spendthrift and forfeiture provisions could shield the beneficiary from ordinary creditors, and even if the tax collection process triggered forfeiture by the beneficiary under state law, such provisions could not defeat the tax lien as a matter of federal law.

MEMORANDUM

FLANNERY, District Judge:

This matter comes before the court on the parties' cross-motions for summary judgment. Oral argument was heard on April 4, 1986 . For the reasons set forth below, the government's motion is granted and defendant Riggs National Bank's motion is denied.

I. Background

In her last will and testament, Isabel G. Zantzinger established a trust fund. By the terms of the fund, her three children were entitled to distributions of income generated by the trust fund during their lifetimes and her grandchildren were entitled to distributions of both income and principal during their lifetimes. There were certain spendthrift and forfeiture provisions attached to the entitlements. Defendant Riggs National Bank ("Riggs") is the trustee of the trust fund.

In 1983, the Internal Revenue Service ("IRS") determined that William D. Zantzinger, one of Isabel Zantzinger's three children, owed $78,182.05 in unpaid federal income taxes, interest and penalties. By "Notice of Levy," served October 18, 1983 , and "Final Demand," served May 23, 1984 , the IRS seized all property in possession of Riggs belonging to William Zantzinger, not to exceed $78,182.05.

Until service of the levy, Riggs made regular distributions of the trust's income to William Zantzinger. Once the levy was served, Riggs took the position that certain forfeiture provisions of the trust wiped out William Zantzinger's entitlement under the trust. Therefore, Riggs paid over to the IRS $1,948.23 in income accumulated prior to October 18, 1983 but not distributed to Zantzinger. Riggs maintains, however, that any further income has been forfeited. Income that has accrued since October 18, 1983 therefore has been accumulated and held by Riggs pending the outcome of this litigation.

Under the trust, there is a paragraph which limits William Zantzinger's life estate in the trust income ("Trust C"). The paragraph begins with what is called a "spendthrift" clause, which prevents William Zantzinger from transferring his right to the income or from subjecting it to the claims of his creditors. It reads:

No part of the income or principal of the Trust C estate hereunder shall be pledged, assigned, transferred, sold, or in any manner whatsoever accelerated, anticipated, or encumbered by my said son, William Devereux Zantzinger, nor shall any part of the income or principal of said trust estate hereunder be in any manner subject to or liable, in the hands of the Trustee, for the debts, contracts, or engagements of my said son, whether existing at the time of my death or arising subsequently.

The same paragraph ends with what is called a "forfeiture" clause, which strips William Zantzinger of the right to the income should he try to alienate it and gives the trustee considerable discretion in then distributing the trust funds. It reads:

Should my said son attempt in any manner to anticipate, encumber, or charge his interest in this trust or any part thereof, and in the event of bankruptcy or the rendition of any judgment or decree against the interest of my said son, or the levy of any execution, or writ of attachment, or garnishment thereon, or if, in the judgment of the Trustee, it shall be to my said son's interest, then any amounts which would otherwise be paid over directly to my said son, shall, in the discretion of the Trustee, be applied directly for his support and maintenance, or be allowed to accumulate in the hands of the Trustee and be treated as and form a part of the principal of the trust estate from which it was derived and be disposed of as a part thereof.

The IRS believes that these clauses are not properly invoked in this case and that the income accumulated since 1983 (rather than paid over to William Zantzinger) is now owed the IRS. Riggs believes that William Zantzinger's right to the income was forfeited and that the discretionary aspect of the trust prevents treating the income as a property right against which the government may levy to satisfy a tax assessment. The IRS responds that the property right was not forfeited, and even if the forfeiture clause was triggered, it cannot defeat an internal revenue assessment as a matter of federal law.

To ensure that William Zantzinger's three children do not choose to participate in this action, this court has received statements from each to that effect, filed April 25, 1986 .

II. Discussion

Inasmuch as there appears to be no genuine issues of fact in dispute, this matter is appropriately dealt with on cross-motions for summary judgment. The question presented is whether the United States can reach the income stream of the Zantzinger trust (despite its "spendthrift" and "forfeiture" provisions) pursuant to the government's statutory tax liens against all "property and rights to property" of a delinquent taxpayer. This involves two analytically separate issues: (1) was there a property right forfeited by William Zantzinger; and (2) can, as a matter of federal law, such a forfeiture provision defeat an internal revenue assessment.

A. Was a Property Right Forfeited by William Zantzinger? 26 U.S.C. 6331 -32 establish the IRS' ability to levy against property belonging to a taxpayer and 26 U.S.C. 7403 provides for foreclosure of a tax lien. Determining whether certain proceeds are the "property" of an individual, however, requires this court to review state property law. Magavern v. United States [77-1 USTC 9249 ], 550 F.2d 797, 800 (2d Cir.), cert. denied, 434 U.S. 826 (1977). The parties appear to agree and this court concludes that determination of the property passed by Isabel Zantzinger's trust must be done in accordance with the law of the State of Maryland , where the trust was created.

Maryland accepts the use in a trust of a "spendthrift" clause subject to certain exceptions. Watterson v. Edgerly, 388 A.2d 934, 935-36 (Md. Ct. Spec. App. 1978). If income is withheld under such a clause, the beneficiary may sue to get it; therefore there is a property right upon which someone such as the IRS may levy a claim.

Yet many states allow the use of forfeiture and trustee-discretion provisions to create a "protective trust", whereby if either the beneficiary or his creditors try to alienate the beneficiary's right to trust income, then that right ceases and the trustee is given discretion to distribute the income among some group that may or may not include the prior beneficiary. See Restatement (Second) of Trusts, 150 , Comment c (1959). Since the beneficiary has no right to the income until the trustee decides when and how to distribute it, the beneficiary in such a situation has no property right upon which the IRS may levy. See Nichols v. Eaton, 91 U.S. 716, 722-25 (1875) (protective trust, after forfeiture, confers no "substantial rights," or right which a court would enforce, so a right to income did not pass to assignee in bankruptcy); McGavern v. United States, 550 F.2d 797 (2d Cir.), cert. denied, 434 U.S. 826 (1977) (government lien was effective under trust in which income payments were not completely discretionary with the trustee); United States v. Taylor [66-2 USTC 9522 ], 254 F. Supp. 752 (N.D. Cal. 1966) (where forfeiture provision is illusory and beneficiary may continue to receive entire income, a property right exists and a levy may occur). Though Riggs cites no Maryland law supporting such treatment of a "protective trust," this court agrees that a Maryland court would treat the use of forfeiture and trustee discretion provisions as creating a "protective trust."

The question then becomes whether the government's levy or other collection efforts triggered a permanent forfeiture of William Zantzinger's interest. Riggs contends that it is now within Riggs' discretion to use the income that would have gone to William Zantzinger either (1) for the support and maintenance of William Zantzinger or (2) as part of the principal of the trust estate, to be disposed of as part thereof. Since this determination is a discretionary one, William Zantzinger has had no right to income from the trust since October 18, 1983 and has had no enforceable interest upon which the IRS can levy.

The government contends that the language of the forfeiture clause shows that mere service of an administrative internal revenue levy was not intended to trigger a forfeiture of William Zantzinger's right to trust income. The government interprets the clause to require both an attempt by Zantzinger to alienate his interest and an external event such as bankruptcy, judgment, or levy of execution. The trustee could only invoke the clause on its own if Zantzinger attempted to alienate his interest. Since Zantzinger never tried to alienate his interest, the forfeiture clause is inapplicable.

Riggs responds that the language shows that either an attempt to alienate or some external event triggers forfeiture. This court agrees with Riggs that either situation can lead to forfeiture; the clear intent of the trust was to prevent William Zantzinger from recklessly mortgaging away all his future rights in the trust income.

Riggs believes that forfeiture was triggered by an encumbrance caused by William Zantzinger. When someone fails to pay tax liabilities after demand, a statutory lien on all his property arises in favor of the government. 26 U.S.C. 6321 . By neglecting to pay his taxes, William Zantzinger caused all his property--including his interest in the trust income--to be encumbered by a statutory lien. Riggs also believes that the government's levy triggered forfeiture. Both lien and levy come within the natural meaning of the testamentary language and are broad enough to include such actions taken administratively rather than just judicially.

The government argues that Zantzinger did not "attempt" to encumber his trust income in the sense meant by the trust language. Further, the service of an internal revenue levy is not a "rendition of any judgment or decree against the interest" of Zantzinger, nor a "levy of any execution, or writ of attachment, or garnishment . . .". As the government sees it, a prejudgment internal revenue levy is an administrative levy that falls outside the language of the trust. A "levy of execution" is a term of art under Maryland law referring to the act of execution by a judgment creditor on a judgment already obtained.

This court agrees with the government. Maryland law requires that a will which purports to limit a beneficiary's enjoyment of his interest under a spendthrift clause must state that limitation in clear and unequivocal terms. Manders v. Mercantile Trust & Deposit Co., 128 A. 145, 149 ( Md. 1925). While it is clear that Mrs. Zantzinger sought to restrict her son from squandering his future income stream, this court sees a distinction between language designed to prevent general creditor foreclosure and language that would stop government assessments. Other states have accepted distinctions in trust language based on whether the creditor is a private or public entity. See, e.g., Industrial National Bank v. Budlong, 264 A.2d 18 (R.I. 1970) (inherent distinction exists between private creditors and the government in respect of the underlying purpose of a forfeiture clause in a spendthrift trust). As that court noted:

We perceive nothing in the language employed from which it may be reasonably inferred that the intent of the testator was to relieve the beneficiary from the payment of obligations which arise out of his status as a member of society, particularly such as the payment of taxes properly and legally assessed. We have carefully scrutinized the language used by the testator and find nothing therein that is persuasive of an intention that the limitation on the liability of the income to payment of debts was to extend beyond those debts arising out of normal and conventional commercial transactions.

264 A.2d at 24. This court finds that while Mrs. Zantzinger may have intended to protect her grandchildren from having their interests in her estate dissipated by reckless spending by her son, she could not have intended that her son be able to avoid liability for income taxes on some of the very income he earned from the trust. Therefore, it was improper for Riggs to treat the tax collection process itself as triggering foreclosure under Maryland law.

B. Can Such a Forfeiture Provision Defeat a Federal Assessment? Even if forfeiture did occur under Maryland law, it would not be effective against an IRS assessment. Whether state law can prevent a federal tax lien from attaching to a state-created interest by creating a forfeiture whenever the government tries to levy is a question of federal law. Aquilino v. United States [60-2 USTC 9538 ], 363 U.S. 509, 512-13, 80 Sup. Ct. 1277, 1280 (1960). Many courts have held that a simple spendthrift trust cannot defeat a federal tax lien. See, e.g., First Northwestern Trust Co. v. Internal Revenue Service, 622 F.2d 387 (8th Cir. 1980). One federal court has held that a spendthrift trust combined with a forfeiture clause is not effective to defeat a federal tax lien. United States v. Taylor [66-2 USTC 9522 ], 254 F.Supp. 752 (N.D. Cal. 1966). In Taylor , the forfeiture was found illusory; in this case William Zantzinger may continue to receive benefits from the trust for his "support and maintenance." Taylor reached this result after balancing the policies of state property law and policies of federal tax collection, as called for in Aquilino:

(O)nce the tax lien has attached to the taxpayer's state-created interests, we enter the province of federal law, which we have consistently held determines the priority of competing liens asserted against the taxpayer's "property" or "rights to property." . . . This approach strikes a proper balance between the legitimate and traditional interest which the State has in creating and defining the property interest of its citizens, and the necessity for a uniform administration of the federal revenue statutes.

363 U.S. at 513-14, 80 Sup. Ct. at 1280-81 (citations omitted).

The reasoning behind all the cases that say a federal tax lien cannot be defeated by a pure spendthrift trust supports the idea that it also cannot be defeated by a forfeiture provision. The point is that while such trust clauses create a legitimate property right under state law which can shield the beneficiary from ordinary creditors, such trusts cannot be effective against a federal tax lien, as a matter of federal law. Cf. United States v. Mitchell [71-1 USTC 9451 ], 403 U.S. 190, 91 S. Ct. 1763 (1971) (wife liable for federal income tax on marital property even though state law right to such property was renounced). It would be offensive and disruptive to federal tax law for a beneficiary to receive an income stream for years without paying taxes on it, only to have the income stream disappear once the IRS discovers the misfeasance and moves against it.

An appropriate Order accompanies this Memorandum.

Order

ORDERED that the motion for summary judgment of defendant Riggs National Bank be, and the same hereby is, DENIED; and it is further

ORDERED that the motion for summary judgment of plaintiff United States of America be, and the same hereby is GRANTED; and it is further.

ORDERED that the statutory liens of the United States pursuant to 26 U.S.C. 6321 in respect of the unpaid income tax liabilities of defendant William D. Zantzinger for the years 1976, 1977 and 1978, be and hereby are FORECLOSED as against all income earned by Trust C of the Trust known as the Isabel G. Zantzinger Trust u/w C b/o William No. 011047-01, from October 18, 1983 until said liabilities are satisfied, or until the death of William D. Zantzinger, whichever first occurs; and it is further

ORDERED that defendant Riggs National Bank shall immediately turn over to the United States all such income earned by said Trust from October 18, 1983 until the date of this Order, excepting the $1,948.23 of such income which defendant Riggs National Bank has previously turned over to the United States; and it is further

ORDERED that defendant Riggs National Bank shall continue to turn over to the United States at regular intervals, and no less than semi-annually, all income earned by said Trust from the date of this Order until the tax liabilities described above have been fully satisfied, or until the death of William D. Zantzinger, whichever first occurs

 

 

 

LaSalle National Bank, as Trustee under Trust of Virginia Schnadig Bensinger, Plaintiff v. United States of America, Defendant

U.S. District Court, No. Dist. Ill. , East. Div., 85 C 7760, 7/2/86 , 636 FSupp 874

[Code Sec. 6321 ]

Liens: Attachable property: Spendthrift trust.--A federal tax lien could be imposed against an interest in a spendthrift trust created for the taxpayer's benefit. The interest in a trust qualified as attachable "property" under Illinois law. A state law barring the attachment of liens against trust property was superseded by federal law sanctioning tax liens against any property.

Thomas F. Roche, James F. Flanagan, Halfpenny, Hahn & Roche, 20 North Wacker Drive , Chicago , Ill. 60606 , for plaintiff. Joseph Cammarata, Department of Justice, Washington , D.C. 20530 , for defendant.

ORDER

BUA, District Judge:

This action was brought by LaSalle National Bank (plaintiff), under 26 U.S.C. 7426 , as Trustee under the trust of Virginia Schnadig Bensinger seeking an order that a levy served upon LaSalle, as trustee, by the Internal Revenue Service (IRS) was unlawful, and also seeking an injunction prohibiting enforcement of said levy by the United States. Before the Court are the parties' cross-motions for summary judgment. For the reasons stated below, this Court denies the plaintiff's motion and grants defendant's motion for summary judgment.

I. FACTS

On February 18, 1960 , Virginia Schnadig Bensinger established a trust, naming the plaintiff as trustee. The settlor died on October 11, 1961 . Upon her death, Hope Allen became the sole beneficiary of the trust. Upon the death of Hope Allen on October 28, 1963 , Edward S. Mayer became and continues to be the sole beneficiary under the trust.

Since 1980, the trust has made and continues to make monthly payments on behalf of Mayer for rent, food, insurance, water, utilities, and clothing. Other expenses provided for by the trust include reasonable medical, legal, and accounting fees. The trust also paid for a new automobile in 1980, tuition at Sheldon State Technical School in 1983, income tax liability in 1984, and will provide for income tax liability in 1985. Since Mayer is currently unemployed, all but an insignificant portion of his support, maintenance and medical needs are paid by the trust. The value of the corpus of the trust was approximately $148,000 as of December 31, 1985 .

On June 11, 1984 , an assessment was made against Mayer for income tax, interest, and penalty for the year 1983. The assessment was attributable, in part, to the liquidation and distribution of the assets of another trust which was established by Mayer's grandmother. He failed to pay the amount demanded. On June 22, 1985 , the Internal Revenue Service served a Notice of Levy upon LaSalle National Bank, as trustee, seeking collection of the unpaid tax assessment. The amount of the unpaid assessment for the 1983 income tax liability, interest and penalty is $9,348.02, plus statutory additions from the date of assessment equaling a total of $11,232. LaSalle National Bank, as trustee, has refused to honor the levy, despite being requested in 1984 by Mayer to pay the tax. A Notice of Federal Tax Lien was filed on February 28, 1986 with the Cook County Recorder of Deeds.

II. DISCUSSION

Plaintiff asserts that Mayer's interest in the Bensinger Trust does not constitute "property or right to property" under Illinois law and therefore may not be attached by the Internal Revenue Service pursuant to 26 U.S.C. 6321 .

In addition, plaintiff asserts that Mayer's beneficiary interest in the trust is protected from creditors by Chapter 110, 2 -1403 of the Illinois Revised Statutes. Briefly, this statute provides that a trust established in good faith by a third party for the debtor may not be attached by a creditor.

The defendant, United States , asserts that Mayer's beneficiary interest does constitute "property or right to property" under Illinois law and therefore LaSalle National Bank is in possession of an attachable interest under tax lien statutes. Defendant further states that once a legal interest is defined by state law, the legal consequences of such an interest are determined solely by federal law and that Chapter 110, 2 -1403 is inapplicable to tax liens imposed by the IRS.

The first key issue to be determined by the Court is whether Mayer's interest in the trust constitutes "property or right to property" under Illinois law. The Court must then determine what consequences, if any, derive from this legal interest.

A. Existence of Property Right

Pursuant to 26 U.S.C. Section 6321 , a federal tax lien arises in favor of the United States in the amount of any unpaid tax upon all property and right to property of any person who, after demand thereof, refuses to pay said tax. Both parties agree that the Court must use Illinois law because "state law controls in determining the nature of the legal interest which the taxpayer had in the property." Aquilino v. United States [60-2 USTC 9538 ], 363 U.S. 509, 513 (1960), quoting Morgan v. Commissioner [40-1 USTC 9210 ], 309 U.S. 78, 82 (1940).

Plaintiff argues that the Bensinger Trust, which is a spendthrift trust, does not constitute a property interest under Illinois law. Defendant states that Mayer's interest in the Bensinger Trust does constitute a property interest. Two important factors which must guide the Court on this issue are the settlor's intent and prior case law.

Settlor's intent is important when determining trust construction. Bond v. Moore , 236 Ill. 576 (1908). In the instant case, there is strong evidence to indicate the intention of the settlor to create a property interest in the beneficiary. The trust agreement provides in Article One, Paragraph (c): "I declare that my primary intent is to provide adequate care, support, maintenance needed for him during his lifetime and I desire that the use of income and principal be dependent on his needs." The Court finds that this wording indicates a clear intent to establish an equitable interest in the beneficiary.

The fact that the settlor intended to limit the trustee's discretion is evidenced by the fact that the agreement states in Article One, Paragraph (c), "the trustee shall use . . . ." The word "shall" indicates that an obligation to pay is imposed on the trustee. This obligation is also supported by deposition testimony on the part of LaSalle National Bank's Administrator, Nancy O'Leary. Finally, the fact that the trust does in fact pay a significant portion of Mayer's expenses, support, and maintenance lends support to the contention that the settlor intended to create a property interest in the beneficiary.

Illinois common law supports defendant's claim that a beneficiary's interest in a spendthrift trust constitutes "property or right to property." There are several cases in which the courts have found that a spendthrift trust created an equitable fee interest. Wagner v. Wagner, 244 Ill. 101 (1910); Steib v. Whitehead, 111 Ill. 247 (1884); Moore v. Braun, 263 Ill. App. 243 (2nd Dist. 1931); Lake Shore National Bank v. Coyle [68-2 USTC 12,548 ], 286 F.Supp. 412 (N.D.Ill. 1968); rev'd on other grounds, 419 F.2d 958 (7th Cir. 1969); and DeKorwin v. First Nat. Bank of Chicago , 170 F.Supp. 112 (N.D.Ill. 1958), aff'd, 275 F.2d 755 (7th Cir. 1960). Moreover, plaintiff has failed to point out, and there seems to be no cases directly stating that a beneficiary's interest in a spendthrift trust does not constitute "property or right to property" under Illinois law.

After examining evidence of the settlor's intent and prior Illinois case law, the Court is persuaded that Mayer's beneficiary interest in the trust constitutes "property or right to property."

The Court is not persuaded by plaintiff's assertion that Chapter 110, 2 -1403 is a "rule of property" and therefore serves to protect Mayer's interest. Plaintiff's argument proves too much. Section 2 -1403 protects a beneficiary's interest in spendthrift trusts from attachment by certain creditors. A property interest must exist in order for it to be protected by the statute. Therefore, the existence of this statute implies that a property right exists in a beneficiary's interest in a spendthrift trust.

B. Attachment of IRS Levy

Defendant's position is that, once a property interest has been defined under state law, consequences are to be defined solely by federal law. Defendant further asserts that, when there is a conflict between federal tax liens and state protection statutes, the tax lien will prevail over the state statute. Plaintiff counters that Edward Mayer's beneficiary interest falls squarely within the protection of Chapter 110, 2 -1403 of the Illinois Revised Statutes which states:

No court shall order the satisfaction of a judgment out of any property held in trust for the judgment debtor if such trust has, in good faith, been created by, or the fund so held in trust has proceeded from a person other than the judgment debtor.

The general rule is that, once the court finds that the taxpayer has property or a right to property in a trust under state law, any state law is inoperative to prevent attachment of a lien created by federal statutes. U.S. v. Bess [58-2 USTC 9595 ], 357 U.S. 51 (1958). The rule which is often enunciated was stated by the Court of Appeals of New York in In re Rosenberg's Will, 199 N.E. 206 (N.Y. 1935), cert. denied, Rosenberg v. U.S. , 298 U.S. 669 (1936). This rule states: "No policy of state may interfere with power of Congress to levy and collect income taxes." This rule has been followed in several federal courts. Mercantile Trust Co. v. Hofferbert [45-1 USTC 9124 ], 58 F.Supp. 701 (D.Md. 1944); U.S. v. Canfield [39-2 USTC 9641 ], 29 F.Supp. 734 (S.D.Cal. 1939). See generally, First Northwestern Trust Company v. Internal Revenue Service, 622 F.2d 387 (8th Cir. 1980); U.S. v. Rye [77-1 USTC 9264 ], 550 F.2d 682 (1st Cir. 1977). The Illinois Supreme Court has recently ruled that, under certain circumstances, a competing state statute can prevail over Chapter 110, 2 -1403. In Re Matt, 473 N.E.2d 1310 ( Ill. 1985).

In the instant case, it has been established that there is "property or right to property" under Illinois law. Therefore, a federal tax lien will attach under 26 U.S.C. 6321 and Chapter 110 2 -1403 of the Illinois Revised Statutes will be ineffective to protect the property from the IRS levy attaching. Since LaSalle National Bank, as trustee, was in possession of the trust at time of attachment, it is obligated to pay the tax liability arising from the assessment, under 26 U.S.C. 6332(a) .

III. CONCLUSION

For the reasons stated above, plaintiff's motion for summary judgment is denied and defendant's motion for summary judgment is granted.

IT IS SO ORDERED.

 

 

 

Dallas National Bank, Successor Trustee Under the Will of Belle Shumard, Deceased, et al., Appellants, v. United States of America , Appellee

(CA-5), In the United States Circuit Court of Appeals for the Fifth Circuit, No. 12237, 167 F2d 468, April 16, 1948

Appeal from the District Court of the United States for the Northern District of Texas.

Property subject to lien: Spendthrift trust: Future income.--A District Court decree was herein affirmed, such decree being in accordance with the remand opinion of the Circuit Court of Appeals to the effect that the United States tax lien attached to taxpayer's monthly income under a spendthrift trust, as well to that income accumulated since the judgment date as to that due when suit was filed. Affirming District Court decree rendered pursuant to remand of the Circuit Court of Appeals, 164 Fed. (2d) 489, 47-2 USTC 9405, which reversed the decision of the District Court, 67 Fed. Supp. 573, 46-2 USTC 9311, rendered pursuant to remand of the Circuit Court of Appeals, 152 Fed. (2d) 582, 46-1 USTC 9117, which reversed the decision of the District Court, 56 Fed. Supp. 181, 44-2 USTC 9426.

Dexter Hamilton and Hoyet A. Armstrong, both of Dallas , Texas , for the appellants. Melva M. Graney and Sewall Key, Special Assistants to the Attorney General; Theron L. Caudle, Assistant Attorney General, all of Washington, D. C., and William P. Fonville, Assistant U. S. Attorney, Dallas, Texas, for the appellee.

Before HUTCHESON, HOLMES, and WALLER, Circuit Judges.

PER CURIAM:

When this case was last here, 1 we said:

"In the former opinion 2 we held the taxpayer had an interest in the trust property, but not an interest that could be sold; but that her share in the income after it accrued and was ready to be paid over to her was fully her property and could be subjected to the tax lien of the United States, and that the lien could be fastened on the future monthly income as it became payable to the taxpayer."

The decree appealed from follows the mandate to make a new judgment "in accordance with this opinion." It is

Affirmed.

1 United States v. Dallas National Bank, 164 Fed. (2) 489 [47-2 USTC 9405].

2 United States v. Dallas National Bank, 152 Fed. (2d) 583 [46-1 USTC 9117].

[Concurring Opinion]

HOLMES, Circuit Judge, specially concurring:

In many states, including Texas , the validity of spendthrift trusts is upheld. 1 In other American jurisdictions, the rule is that a trust, which restrains the alienability of property, is invalid as against public policy. 2 In our second opinion in this case, we are said to have held that the taxpayer had an interest in the trust property but not an interest that could be sold. 3 Since the appellee has not prayed for a sale of said interest, I think the statement or holding that the same could not be sold was unnecessary and should be withdrawn.

The taxpayer is the equitable owner for life of an undivided interest in Texas realty, which under local law is not subject to seizure or sale for ordinary debts incurred by the taxpayer; but this does not mean that testamentary restraints against alienation should prevail against the fastening of a lien for federal income taxes on the taxpayer's equitable interest in the trust estate. We are, in fact, holding the contrary in this case.

Homestead-exemption statutes of a state must give way to the fixation and enforcement of a federal lien for income taxes. 4 Testamentary restraints on alienation by the creation of what are known as spendthrift trusts, although respected by state laws, are likewise ineffective as to the lien for federal income taxes. 5

The lien sought to be enforced in this case has attached to the taxpayer's equitable interest in the corpus of the trust estate, notwithstanding the testamentary provisions against its alienation, seizure, and sale. That is the effect of our decision.

1 42 Tex. Jur., Sec. 92, p. 705; 54 Am. Jur., p. 126, et seq.; 65 C. J., p. 238, et seq.

2 54 Am. Jur., p. 129, note 14; 65 C. J., p. 238, note 97.

3 164 Fed. (2) 489 [47-2 USTC 9405].

4 Shambaugh v. Scofield, 132 F. (2) 345 [42-2 USTC 9826].

5 Matter of Rosenberg , 269 N. Y. 247 [35-2 USTC 9650]; An article in Harvard Law Review, entitled "Reaching the Interest of the Beneficiary of a Spendthrift Trust," Vol. 43, p. 63, 68. Cf. Glass City Bank v. U. S., 326 U. S. 265 [45-2 USTC 9449].

 

 

 

United States of America , Appellant, v. Dallas National Bank, Successor Trustee Under the Will of Belle Shumard, Deceased, et al., Appellees

(CA-5), United States Circuit Court of Appeals for the Fifth Circuit, No. 11832, 164 F2d 489, December 4, 1947

Appeal from the District Court of the United States for the Northern District of Texas.

Lien for taxes: Spendthrift trust: What subject to lien.--In a former appeal an opinion was rendered and the case remanded to the District Court and the government moved in that court to enter a judgment subjecting to a tax lien all monthly payments due to the taxpayer from a spendthrift trust. Counsel for the taxpayer considered that the opinion applied only to $54.45 due when suit was filed. Held, that the lien can be enforced by requiring the trustee to pay over all the money now in his hands belonging to the taxpayer, both the $54.45 which he had when suit was filed and what has been added to it since the judgment date. Reversing the decision of the District Court, 46-2 USTC 9311.

James J. Shepard and Sewall Key, Special Assistants to Attorney General, both of Washington, D. C., and William P. Forville, Assistant U. S. Attorney, Dallas, Texas, for appellant. Dexter Hamilton and Hoyet A. Armstrong, both of Dallas , Texas , for appellee.

Before SIBLEY, HOLMES, and MCCORD, Circuit Judges.

SIBLEY, Circuit Judge:

In a former appeal, United States v. Dallas National Bank, 152 Fed. (2d) 582, [46-1 USTC 9117] an opinion was rendered and the cause remanded to the district court for further proceedings conformable to the views so announced. Counsel for the United States moved in the district court to enter a judgment subjecting to the tax lien all monthly payments then due the taxpayer from the trust involved and withheld since the institution of this suit, and also all payments that may subsequently become due and payable, till the demand of the United States shall be fully extinguished. Counsel for the taxpayer considered that our opinion applied only to the one payment of $54.45 due when the suit was filed. The last stated view was adopted by the district judge, 67 Fed. Supp. 573 [46-2 USTC 9311], and judgment was entered accordingly. This appeal followed.

The original suit prayed for a judgment establishing the tax liability; and for an injunction against paying over any income pending the suit; for the establishment of a tax lien against the taxpayer's share in the trust property, and that a foreclosure of it be adjudged and the taxpayer's interest in the trust be sold, "together with all accumulations of her distributive share of the income therefrom in the possession of the defendant successor trustee at the termination of this suit". In the former opinion we held the taxpayer had an interest in the trust property, but not an interest that could be sold; but that her share in the income after it accrued and was ready to be paid over to her was fully her property and could be subjected to the tax lien of the United States, and that the lien could be fastened on the future monthly income as it became payable to the taxpayer. Although no sale of anything is to be had, the lien can be enforced by requiring the trustee to pay over all the money now in his hands belonging to the taxpayer, both the $54.45 which he had when the suit was filed, and what has been added to it since the date of judgment, conformably to the prayer of the petition. The judgment should be thus modified. The judgment rendered is set aside the the cause remanded with direction to make one in accordance with this opinion.

REVERSED.

 

 

 

Jud Plumbing & Heating, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Alice Gorrell Jud (Wife of Ed. J. Jud), Transferee, Petitioner, v. Commissioner of Internal Revenue, Respondent Ed. J. Jud, Transferee, Petitioner, v. Commissioner of Internal Revenue, Respondent

(CA-5), United States Circuit Court of Appeals for the Fifth Circuit, No. 11481, 153 F2d 681, February 18, 1946

Petitions for review of decisions of the Tax Court of the United States (District of Texas).

Accounting methods: Dissolved corporation: Income from uncompleted long-term construction contracts.--Where taxpayer carried on a business for two-thirds of the taxable year and then dissolved after assigning and transferring all its assets and liabilities, including several long-term construction contracts still uncompleted, to its chief stockholder and made no return of income from such contracts for that year, it is held that such corporation is liable for the taxes on income earned from such contracts during the year of its dissolution even though it had for previous years reported its income thereon under the completed-contract method of accounting. Accordingly, the Commissioner's determination was approved in allocating income for the year of dissolution between the corporation and its stockholder, who completed the contracts, based upon the relative percentages that the cost paid by the corporation during that part of the tax year prior to the dissolution and the cost paid by such stockholder after dissolution each bore to the profit from the completed contracts. Affirming the decision of the Tax Court.

A. N. Moursund, San Antonio , Texas , for petitioners. Richard H. Forster, Los Angeles , Calif. , Amicus Curiae. Harold C. Wilkenfeld, J. Louis Monarch, Special Assistants to the Attorney General, Sewall Key, Acting Assistant Attorney General, J. P. Wenchel, Chief Counsel, Bureau of Internal Revenue, Bernard D. Daniels, Special Attorney, Bureau of Internal Revenue, all of Washington, D. C., for respondent.

Before MCCORD, WALLER, and LEE, Circuit Judges.

[The Facts]

WALLER, Circuit Judge:

Ed. J. Jud was the President and owned substantially all of the capital stock of Jud Plumbing & Heating, Inc., a corporation under the laws of Texas , which corporation was dissolved on September 5, 1941 . In the dissolution all assets of the Corporation were transferred, as of August 31, 1941 , to the chief stockholder, Jud, who assumed all of its obligations, with the result that the contracts which the Corporation had begun before its dissolution were continued and completed without interruption.

From the year 1933 to the date of its dissolution the Corporation had made its income tax returns from the "completed contract" or "job cost" method of accounting as to all income from contracts where the amount involved exceeded $100. This method of accounting enabled the corporation accurately to ascertain and report the profit derived from each contract, and apparently had been satisfactory to the Commissioner of Internal Revenue throughout former years.

Upon the dissolution of the Corporation, Jud not only completed the existing contracts of the Corporation, but undertook to continue the same method of accounting, holding the view that since the Corporation would not have reported or accounted for income on any of the contracts until same had been completed, and since it had not completed the contracts involved, and had transferred all of its assets, including its profits, it, therefore, was not required to account, in whole or pro tanto, for any unrealized and undetermined profits under any of the contracts which the Corporation had begun but which Jud, as an individual, had completed; and since he had succeeded to all assets and liabilities of the Corporation, he should likewise account for the profits on each of the contracts when ascertained upon completion; that completion of contract determined not only income but liability for the tax on such income.

Jud and his wife reported, on the community basis, the net income from all of the contracts of the Corporation which Jud had completed within the tax year, and they insist that since the Corporation made no completions of these contracts it realized no profits and had no income to report therefrom, and to taxes to pay thereon.

Income from repair work, or from jobs which did not exceed $100, was reported and accounted for on the cash basis and is not involved in this controversy.

The Commissioner computed the gross income of the Corporation so as to include the sum of $32,854.06 as its income for the year 1941 which had accrued to it out of the contracts which it had begun but which it had not completed at the time of its dissolution. The Commissioner did not reject the completed-contract method of accounting that had been previously followed by the Corporation, but thought that such a method of accounting, under the facts in this case, did not reflect the income that should be allocated to the Corporation.

The Commissioner recognized the right of the taxpayer to adopt and follow the method of waiting until the completion of the contract in order to ascertain the profits therefrom, but rejected the contention that none of the income from the contracts so completed was allocable to the Corporation. The Commissioner used the completed-contract method to ascertain the profits, but then computed, by what he considered an equitable and proper method, the portion of the income from such contracts that should be charged to the Corporation. This method was to determine the total cost incurred for each job prior to the transfer, by ascertaining from the books of the Corporation and from the books of Jud and items in each job that the Corporation and its successor each had paid. He thus determined the total cost of each completed job, as well as the profits therefrom. The percentage of job cost paid by the Corporation to the total cost was ascertained as determinative of the percentage of completion of the contract by the Corporation. This percentage of completion so obtained was then applied to the ultimate profit so as to ascertain, or to approximate, the income that had accrued to the Corporation at the time of the transfer of its assets and liabilities to its chief stockholder. 1

The Corporation had twenty-two uncompleted contracts at the time of its liquidation. There was an ultimate profit in all except two, but the profit or loss from eighteen of these contracts was so inconsequential that the Commissioner disregarded them and made his determination only on four which involved substantial sums and which were all completed within the same tax year as the corporate dissolution.

It is not disputed that the transfer of the assets rendered the Corporation insolvent, and that if the Corporation is liable for taxes, its transferees are likewise liable. Nor is the question as to whether or not the Corporation realized a capital gain or a capital loss by the transfer involved here.

It is conceded, also, that the Corporation, prior to its dissolution, received progress payments from its contracts as the work went forward. These payments would be a part of the gross income of the Corporation unless the dissolution or transfer would otherwise alter their character.

The Tax Court [CCH Dec. 14,573] upheld the Commissioner.

The question involved is whether, under the completed-contract method of accounting which had been used by a corporation in previous years, such corporation was liable for taxes on income, earned during the year of its dissolution, from long-term contracts entered into by it but completed by its successor after the dissolution of the corporation; and whether the Commissioner used, and the Tax Court approved, an erroneous method of accounting, under Secs. 41, 42, and 45, Internal Revenue Code, in allocating income for the year of dissolution between the Corporation and its successor, based upon the relative percentages that the cost paid by the Corporation during that part of the tax year prior to its dissolution and the cost paid by its successor after dissolution each bore to the profit from the completed contracts.

Sec. 41 of the Internal Revenue Code [26 U. S. C., 1941 ed., Sec. 41] provides that the net income should be computed in accordance with the method of accounting regularly employed in keeping the books of the taxpayer, but that if the method employed does not clearly reflect the income, the computation should be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income.

Sec. 42 of the Internal Revenue Code [26 U. S. C., 1941 ed., Sec. 42] provides that all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer unless under some other lawful method of accounting such amounts are to be properly accounted for at a different period, and in case of the death of the taxpayer, the net income accruing up to the date of his death shall be computed as his net income unless it is properly includable in some other tax period.

Sec. 45 of the Internal Revenue Code [26 U. S. C., 1941 ed., Sec. 45] authorizes the Commissioner to distribute, apportion, or allocate gross income or deductions between two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests, if he determines that some distribution, apportionment, or allocation is necessary in order to prevent an evasion of taxes or clearly to reflect the income of such organizations, trades, or businesses.

Appropriate Treasury regulations relating to the use of the completed-contract method of accounting have been promulgated. 2

The Sixteenth Amendment gave Congress the power to lay and collect taxes on incomes from whatever source derived, and we agree with the Tax Court that it is a fundamental concept of taxation that income is chargeable to him who earns it, in the absence of statutory exemption or provision to the contrary.

It should be apparent that a corporation, by a transfer of all of its assets and liabilities, cannot absolve itself from liability for income taxes due to the United States, and that any right to an exemption from reporting income received by the taxpayer must be found in the federal law, rather than in the acts of the taxpayer.

A corporation being a separate legal entity, its net earnings, whether ascertained or not, belong to it, and the tax upon unexempt income in each taxable year is chargeable to it [Sec. 13(b) Int. Rev. Code], and this liability cannot be discharged by the simple expedient of dissolution and the turning over of all its assets, including current and unreported income, to its sole stockholder, even though such corporation receives no money consideration for the transfer of such income. It is the actuality of income rather than its disposition that is important in determining the tax consequence.

A taxpayer has the option of reporting his income on either a cash, accrual, or completion-of-contract, basis if the method selected clearly reflects his income. But where a corporation: (a) carries on a business for two-thirds of the taxable year; (b) thereupon dissolves; (c) assigns and transfers all of its assets and liabilities to its chief stockholder; and (d) makes no return of its income; an annual return made by the corporation's chief stockholder and his wife, on the community basis, wherein they charge themselves with the net profits that they and the Corporation had earned during the tax year, could not be said to be such a method of accounting as would clearly reflect the income of the Corporation.

In the absence of a statute that compels such a result the courts should not undertake to bestow upon a corporation the privilege of having its income reported by the community as if it were a participant in the marital relation. To sustain the Petitioner's contention here would be in disobedience of this principle. This statement may be dictum but it serves to demonstrate the unsoundness of any effort to avoid the charging of corporate income taxes to other than the corporation.

If the Corporation's income was not returned in a manner that would clearly reflect its income, such a return need not be accepted by the Commissioner, regardless of the method of accounting used. The Commissioner has definite statutory authority [Secs. 41, 42, and 45, Int. Rev. Code] not only to reject the method but to require the use of a method that does clearly reflect such income.

Without doubt, a taxpayer, ordinarily, has the right to adopt the completed-contract method of accounting where such method clearly reflects his income, but it cannot avoid taxes by the simple expedient of not completing its contracts; and where a corporation puts itself in such position that it could never complete its contracts, it is in no position to insist that even if it had income it has no tax liability, or that its tax liability can be measured only by completed contracts.

Moreover, the Commissioner followed the completed-contract method in that he has computed profits only from contracts that were completed, during the taxable year, by the Corporation's successor. Instead of striking down that method of accounting he has recognized and followed it, but because of the dissolution and death of the Corporation he has found it necessary to allocate the income so as to reflect that which belonged to the Corporation--a detail which the completed-contract method of accounting by the transferees did not supply.

The completed-contract method of accounting determines profits, but it does not always, necessarily and conclusively, determine legal rights to those profits, nor the tax liabilities thereon. "Ascertainment of income" is chiefly a matter of accounting. "Allocation of income" is chiefly a matter of the application of income tax law to basic legal rights. The terms are not synonymous.

The Petitioners have defended a method of accounting that in actuality has not been assaulted. They have decried a method of allocation, or apportionment, of income as improper, meanwhile failing either; (a) to show that the method produced an illegal, or a substantially inaccurate, result; or (b) to suggest a better method.

The decisions of the Tax Court are affirmed.

1 The computation of the Commissioner on the four contracts was:

                                                Costs                              Per Cent

                                             Incurred            Total or         Completed                             Profit to

                                            to August               Final            August              Total             August

Name of Job Cost Account                     31, 1941                Cost          31, 1941             Profit           31, 1941



Lincoln

 Courts ...................         $68,334.97         $ 69,785.15             97.70         $13,861.55         $13,573.23



Victoria

 Courts ..................          97,968.03          154,765.95             63.30          22,304.61          14,118.82



Temporary
 
Buildings

, 

Randolph



Field, 

Texas

 .....................          10,736.02           18,219.63             58.93           8,344.37           4,917.34

Fred Poage ...                               1,041.02            2,362.78             44.06             555.32             244.67

                                                                                                                        32,854.06

 

2 "Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. * * * Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon either of the following bases:

"(a) Gross income derived from such contracts may be reported upon the basis of percentage of completion. * * *

"(b) Gross income may be reported for the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. * * *." [Italics supplied.] [Sec. 19.42-4, Treasury Regulation 103.]

 

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