6332 - Annotations - Reasonable Cause

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Annotations- Reasonable Cause

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6332 Annotations: Reasonable Cause- Levy

 

Penalty for Failure to Surrender Property: Reasonable Cause

 

[60-1 USTC 9365]Dan O. Hoye, as Controller of the City of Los Angeles, and Dan O. Hoye, Appellants v. United States of America and Robert A. Riddell, Director of Internal Revenue, Appellees Dan O. Hoye, as Controller of the City of Los Angeles, Dan O. Hoye and The City of Los Angeles, Appellants v. United States of America and Robert A. Riddell, Director of Internal Revenue, Appellees

(CA-9), U. S. Court of Appeals, 9th Circuit, Nos. 15,964, 16,553, 277 F2d 116, 3/17/60, District Court's decision affirmed, 59-1 USTC 9148, 169 F. Supp. 474 and 59-1 USTC 9416, 172 F. Supp. 532. Cause in No. 15,964 dismissed

[1954 Code Sec. 6332]

Tax lien: Surrender of property: Municipal controller.--A municipal controller was required to surrender wages accrued to a delinquent taxpayer upon notice of levy in accordance with Code Sec. 6332, regardless of the procedures prescribed by state law concerning creditors. Payment to the Government pursuant to levy is a complete defense against any action which the taxpayer might bring against the controller to recover the withheld wages and interest thereon, or to recover damages because of such withholding. While the controller was not personally liable for a penalty because of his actions in seeking to resolve a conflict between federal and state law, it was proper for the court to retain jurisdiction to enter a personal judgment against him should the city fail to make prompt payment to the District Director.

Roger Arnebergh, City Attorney, and Bourke Jones, Alfred E. Rogers, T. Paul Moody and Ralph J. Eubank, Assistant City Attorneys, Los Angeles, Calif., for appellants. Charles K. Rice, Assistant Attorney General, Davis W. Morton, Lee A. Jackson, I. Henry Kutz and Joseph Kovner, Department of Justice, Washington, D. C., and Laughlin E. Waters, United States Attorney, and Edward R. McHale and Robert H. Wyshak, Assistant United States Attorneys, Los Angeles, Calif., for appellees.

Before BARNES, HAMLEY, and JERTBERG, Circuit Judges.

HAMLEY, Circuit Judge:

These appeals bring into question the duties and obligations of a city controller who has received from a director of internal revenue a notice of levy upon unpaid wages of a city employee to secure payment of federal taxes and a demand for payment of the sum levied upon.

[Levy Against City Employee's Wages]

On March 19, 1957, Robert A. Riddell, District Director of Internal Revenue for the Los Angeles District, California, served upon Dan O. Hoye, Controller of the City of Los Angeles a notice of levy for unpaid income taxes in the amount of $155.93 owing and unpaid by an employee of the city for the year 1955. In this notice the Controller was advised that pursuant to section 6321, Internal Revenue Code of 1954, 26 U. S. C. A. 6321, all sums of money or other obligations owing from the city to the named taxpayer were thereby levied upon and seized for satisfaction of the unpaid tax. The notice also contained a demand for the amount necessary to satisfy the tax liability or such lesser sum for which the city might then be indebted to the taxpayer.

On the day such notice was received by the Controller the city was indebted to the taxpayer in the sum of $158.78 for wages. The Controller failed to pay over this sum or any part of it to the United States pursuant to the notice of levy described above. On June 25, 1957, the District Director served upon the Controller a "final demand" giving notice that failure to comply would result in enforcement proceedings as provided in section 6332 of the Internal Revenue Code of 1954, 26 U. S. C. A. 6332.

[City Controller Sues to Quash Notice of Levy]

On September 10, 1957, the controller filed in the United States District Court for the Southern District of California, Central Division, a complaint to quash a notice of levy and final demand served on a municipal corporation by the Director of Internal Revenue. The defendants named in this complaint were the United States , Riddell as Director of Internal Revenue, and the taxpayer. The taxpayer was never served and did not otherwise appear in the action.

In this complaint the Controller disclaimed any interest in the sum owing to the taxpayer other than for the purpose of paying it to the parties legally entitled thereto. The Controller asked that in addition to quashing the levy and final demand the court determine that he was bound to pay the money over to the Director only in accordance with California law which would exempt him from personal liability.

[State Law Governing Judgment Creditors]

It is alleged in the complaint as the sole reason for nonpayment that the United States had not complied with the requirements of section 710, California Code of Civil Procedure. This section provides in part that a judgment creditor may garnish the salary of a municipal employee by filing with the official whose duty corresponds to that of auditor an authenticated abstract or transcript of the judgment together with an affidavit stating the exact amount then due. The official is then required to pay into court the sum levied upon, less certain deductions not here material.

[Judgment Sought Against Controller]

On November 8, 1957, the United States filed a motion to intervene. Appended thereto was a proposed complaint in intervention to recover a penalty under section 6332(b) of the 1954 Internal Revenue Code. On the same day the United States filed a motion to dismiss and a supporting memorandum. The motion to dismiss was made on the ground that the court lacked jurisdiction over the United States and over the subject matter, and because the District Director was not a proper party.

On February 6, 1958, the district court granted the government's motion to intervene.

On the 24th day of the same month the United States filed an amended complaint in intervention. In the amended complaint the government sought not only a foreclosure of its tax lien but also a personal judgment against the Controller, Dan O. Hoye, in the amount of $155.93 and interest. The amended complaint in intervention also named the City of Los Angeles as a defendant in intervention.

On March 10, 1958, the district court granted the government's motion to dismiss the Controller's complaint. The motion was granted on the ground that in his complaint the Controller sought certain injunctive relief which is specifically prohibited by 26 U. S. C. A. 7421(a), and sought declaratory relief which is specifically prohibited by 28 U. S. C. A. 2201.

It was recited in the order of dismissal that "this is not a final order under Fed. R. Civ. P. 54(b), since the United States of America has filed its complaint in intervention." Seven days later the Controller appealed to this court from the order of March 10, 1958, the cause being docketed here as No. 15964.

The appeal came on for argument before this court on December 3, 1958. On March 2, 1959, an order was entered therein vacating the order of submission. It was further provided in such order that the determination of that appeal would be held in abeyance pending disposition in the trial court of the government's complaint in intervention, and until such time as either an appeal were taken from the judgment in intervention or the time for taking such an appeal had expired.

The government's complaint in intervention thereafter came on for trial, the facts being established by stipulation. The Controller had theretofore voluntarily deposited with the clerk of the court a payroll check payable to the taxpayer.

[Federal Collection Procedures Enforced Uniformly]

The basic question dealt with at this trial was whether the collection procedures of the Internal Revenue Service in the collection of monies past due under the internal revenue laws are to be enforced uniformly without regard to conditions prescribed by a state legislature for judgment creditors. Answering this question in the affirmative, the trial court concluded that section 710, California Code of Civil Procedure, is not relevant or applicable. The court held that federal internal revenue statutes are supreme and that levies thereunder are self-executing. In addition, the court stated, section 710 is not applicable because it relates only to a "judgment for the payment of money."

Consistent with this and other findings and conclusions, a judgment was entered on April 22, 1959 [59-1 USTC 9148, 59-1 USTC 9416], dismissing the Controller's complaint, denying the government personal recovery against the Controller, and granting judgment in favor of the United States against the City of Los Angeles enforcing its tax lien with costs. The Controller was ordered to issue and deliver a check in the sum of $178.78 to the District Director of Internal Revenue. The district court retained jurisdiction to enter a personal judgment against Hoye should the judgment against the city be not promptly paid upon its becoming final.

[Protection Sought for Controller Individually]

The defendants in intervention have appealed from the judgment of April 22, 1959, this appeal being docketed as No. 16553. In this second appeal the correctness of the district court ruling that the levy made by the Director of Internal Revenue is to be honored without regard to section 710, California Code of Civil Procedure, or other state statutes is not seriously challenged. It is urged, however, that because of the asserted conflict between section 710, California Code of Civil Procedure, and 26 U. S. C. A. 6332, a decision of this court is necessary to protect Hoye individually "and all other public officials similarly situated." Appellants also argue that the action of the district court in dismissing the Controller's original complaint was error.

[Payment to Government Pursuant to Levy is Defense Against Taxpayer]

Section 6331(a) of the Internal Revenue Code of 1954, 26 U. S. C. A. 6331(a), authorizes the Secretary or his delegate (District Director of Internal Revenue) to levy upon all property and rights to property (with certain exceptions not here material) belonging to any taxpayer who has neglected or refused to pay a tax for which he is liable. Section 6332(a) of the same code, 26 U. S. C. A. 6332(a), provides that 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 by the Secretary or his delegate surrender such property or rights to the Secretary or his delegate, with exceptions not here material. Paragraph (b) of the same section provides that any person who fails or refuses to surrender such property or rights when demand is made shall be personally liable in a sum equal to the value of the property or rights not so surrendered. Paragraph (c) of the same section defines "person" as used in that section to include "an officer or employee of a corporation . . .."

Since section 6332(c) makes no distinction in its applicability to different classes of corporations, it includes municipal corporations such as the City of Los Angeles . See Sims v. United States, 359 U. S. 108 [59-1 USTC 9338], holding that a state is a "person" within the meaning of section 6332. Being a federal statute, it controls over any state statute prescribing procedures to be followed by city officials in connection with levies and garnishments. Florida v. Mellon, 273 U. S. 12, 17 [1 USTC 205].

It follows that the Controller was obliged to proceed as provided in section 6332, whether or not section 710, California Code of Civil Procedure specifies a different course. The judgment of April 22, 1959, correctly so provides, requiring the City of Los Angeles to pay $178.78 to the Director of Internal Revenue. We need not decide whether section 710 was intended to apply with regard to a levy made under the Internal Revenue Code.

Payment to the government pursuant to such levy is a complete defense against any action which the taxpayer might bring against the Controller to recover the withheld wages and interest thereon, or to recover damages because of such withholding. United States v. Eiland, 4 Cir., 223 F. 2d 118, 121-122 [55-1 USTC 9487]. The trial court correctly so ruled in its memorandum opinion of December 11, 1958 [59-1 USTC 9148].

Had the Controller surrendered the accumulated wages to the taxpayer after notice of the tax levy, he would have been personally liable to the government under section 6332(b). Sims v. United States, 359 U. S. 108, 114 [59-1 USTC 9338]. He did not do so, however, but sought only a judicial determination of his obligation in regard to the levy. The trial court was therefore correct in concluding that Hoye is not personally liable for a penalty because of his actions taken up to now. It was also proper to retain jurisdiction to enter a personal judgment against Hoye should the City of Los Engeles fail to make prompt payment to the Director of Internal Revenue.

It is not necessary to decide whether the trial court erred in dismissing the Controller's complaint on jurisdictional grounds. If it was error it was not prejudicial, since every issue of substance which was raised by way of that complaint was also raised by the complaint in intervention, and has been disposed of in the manner which has not prejudiced Hoye.

The judgment under review in docket No. 16553 is affirmed. The appeal in No. 15964 is dismissed as moot.

 

[74-2 USTC 9632] United States of America , Plaintiff v. Trans-World Bank, Defendant

U. S. District Court, Central Dist. Calif., No. 73-1829-HP Civil, 382 FSupp 1100, 7/17/74

[Code Sec. 6332]

Tax levy: Failure to surrender property: Personal liability: Bank.--A bank that was entitled to set off all of the taxpayer-depositor's account in order to satisfy the depositor's outstanding loan was held to be personally liable for its refusal to honor an IRS levy on the funds in the account since at the time of the levy the bank had not exercised its right of set-off. Also, since the taxpayer acted without reasonable cause it was liable for a penalty equal to fifty percent of the amount recoverable under the levy.

William D. Keller, United States Attorney, Arthur M. Greenwald, Assistant United States Attorney, Los Angeles, Calif., for U. S. Morris L. Davidson, 9200 Sunset Blvd., Los Angeles, Calif., for defendant.

Findings of Fact and Conclusions of Law

PREGURSON, District Judge:

Plaintiff , United States of America , filed suit seeking to have this Court declare Defendant, Trans-World Bank (hereafter "Defendant-Bank") personally liable for its refusal to honor an Internal Revenue Service levy served upon it on November 1, 1971. 1 In addition, Plaintiff requested that a penalty equal to fifty percent (50%) of the amount recoverable under the levy be imposed against Defendant-Bank, since it acted without "reasonable cause" in failing to honor the levy. 2

On May 3, 1974, Plaintiff filed its motion for summary judgment supported by a memorandum of points and authorities and attached exhibits. Therefore, on May 20, 1974, Defendant-Bank filed its points and authorities in opposition to Plaintiff's motion. The matter was heard by this Court on June 10, 1974. Assistant United States Attorney Arthur M. Greenwald appeared for Plaintiff and Attorney Morris L. Davidson appeared for Defendant-Bank.

Defendant-Bank, through its attorney, Morris L. Davidson, represented to the Court at the June 10, 1974 hearing that there were no genuine issues of material fact to be resolved. Prior to the hearing, Defendant-Bank did not file a "statement of genuine issues" setting forth all material facts as to which it contended there existed a genuine issue to be litigated. 3 Moreover, Defendant-Bank did not file any affidavit controverting the facts claimed by Plaintiff in its motion; therefore, the facts claimed by Plaintiff are deemed admitted. 4

In its motion, Plaintiff contended that the sum of $1,260.35 on deposit in a checking account maintained at Defendant-Bank by taxpayer, Arnold A. Winter (hereafter referred to as "Taxpayer Winter") was "property or rights to property subject to levy," as that term is used in Section 6332(a) of Title 26, United States Code. 5 Moreover, since Defendant-Bank refused to turn over this sum to Plaintiff, as required by the levy, Defendant-Bank, under the provisions of Section 6332(c)(1), became personally liable to Plaintiff for the sum of $1,260.35. Furthermore, because its refusal was without reasonable cause, Defendant-Bank became liable for the fifty percent (50%) penalty imposed by Section 6332(c)(2).

In opposing Plaintiff's motion, Defendant-Bank contended that on the date the levy was served, it did not hold any property belonging to Taxpayer Winter which was subject to levy because on that date, it was entitled to set off against the sum of $1,260.35 in Taxpayer Winter's checking account debts in excess of that amount then owed it by Taxpayer Winter. At the June 10, 1974 hearing, Defendant-Bank acknowledged that it had not exercised any right of setoff before the levy was served.

Defendant-Bank also contended that it should not be subjected to the penalty imposed by Section 6332(c)(2) because it had reasonable cause to refuse to honor the levy, since this action was to be a test case in this Circuit.

In response to Defendant-Bank's arguments, Plaintiff contended that it is the exercise of the right of setoff that determines whether the property in question is subject to levy, not the existence of that right.

Further, Plaintiff contended that in the light of long standing judicial recognition of the importance of the government's ability to collect revenue expeditiously, it is essential that reasonable cause not encompass a clearly erroneous view of the law. In this regard, Plaintiff referred to the dissent of Circuit Judge Friendly in the case of United States v. Sterling National Bank & Trust Co. of New York [74-1 USTC 9336], 494 F. 2d 919, 923 (2d Cir. 1974).

This Court, having considered the pleadings, exhibits, memoranda, and arguments of counsel, and being fully advised, now makes the following findings of fact and conclusions of law:

I

Findings of Fact

1. This action was commenced by Plaintiff pursuant to Section 7401 of Title 26, United States Code, at the direction of the Attorney General and at the request of and with the authorization of the Chief Counsel, Internal Revenue Service, a delegate of the Secretary of the Treasury.

2. On September 30, 1970, Taxpayer Winter and his wife, Betty L. Winter, borrowed $2,710.62 from Defendant-Bank. This loan was secured by certain personal property, as more particularly described in a financial statement filed with the California Secretary of State on October 21, 1970. 6

3. On May 14, 1971, for the taxable year 1968, Plaintiff assessed Taxpayer Winter the sum of $10,296.82. This assessment consisted of unpaid income taxes in the amount of $7,265.59, together with the penalty provided by Section 6651(a)(1) of Title 26, United States Code in the amount of $1,791.40, plus the penalty provided by Section 6653(a) of Title 26, United States Code in the amount of $358.28, together with interest thereon as provided by law in the amount of $881.55. Moreover, on May 14, 1971, notice of the assessment and demand for payment of the sum of $10,296.82 were made upon Taxpayer Winter by Plaintiff.

4. In connection with this 1968 assessment of $10,296.82, Taxpayer Winter has made payments to Plaintiff totaling $912.90. To date, there is due and owing to Plaintiff from Taxpayer Winter for unpaid 1968 income taxes the sum of $9,383.92 plus interest thereon as provided by law.

5. On August 11, 1971, Taxpayer Winter borrowed the additional sum of $1,845.96 from Defendant-Bank. This second loan also was secured by certain personal property, as more particularly described in a security agreement dated August 11, 1971, signed by Taxpayer Winter. 7

6. On September 29, 1971, Plaintiff filed a notice of tax lien with the Los Angeles County Recorder's Office regarding its May 14, 1971 assessment.

[Notice of Levy]

7. On November 1, 1971, Plaintiff served a notice of levy upon Defendant-Bank. The notice declared that, as of November 1, 1971, Taxpayer Winter was indebted to Plaintiff in the amount of $10,579.48, that demand had been made upon him for this amount, and that he had neglected and refused to pay that sum. In addition, the notice told Defendant-Bank that all property, rights to property, monies, credits and bank deposits in its possession on November 1, 1971 which belonged to Taxpayer Winter were levied upon and seized to satisfy his tax liability, and furthermore, that demand was being made on Defendant-Bank to surrender these properties to Plaintiff to be applied against Taxpayer Winter's tax liability.

8. On November 1, 1971, the loans of September 30, 1970 and August 11, 1971 were in default in the amounts of $1,064.73 and $1,697.13, respectively.

9. On November 1, 1971, the date the levy was served, Taxpayer Winter maintained at Defendant-Bank a checking account (Account Number 01-010-206) in the name of Arnold A. Winter, d/b/a Winter's Building Maintenance. On that date, the checking account had a balance of $1,260.35. The checking account had not been pledged as security for either the September 30, 1970 or August 11, 1971 loans.

10. Because Defendant-Bank failed to surrender to Plaintiff the funds maintained by Taxpayer Winter in this checking account, Plaintiff, on November 30, 1971, served upon Defendant-Bank a final demand, which directed Defendant-Bank to honor the levy as required by Section 6332(a) of Title 26, United States Code. To date, Defendant-Bank has failed to honor the levy.

11. Before Defendant-Bank was served with notice of levy, it had not exercised any right of setoff on Taxpayer Winter's checking account in connection with any loans owed it by Taxpayer Winter.

12. On November 29, 1971, Morris L. Davidson, attorney for Defendant-Bank, wrote a letter to Revenue Officer R. D. Leslie of the Internal Revenue Service stating that Defendant-Bank would surrender the sum of $1,260.35, if the Internal Revenue Service would execute a "hold harmless" agreement indemnifying Defendant-Bank from any claim asserted by Taxpayer Winter in connection with this sum.

13. No November 30, 1971, Revenue Officer R. D. Leslie replied to Mr. Davidson's letter and advised him of the protection afforded by Section 6332(d) of Title 26, United States Code. 8

[Security Interest]

14. On December 6, 1971, Mr. Davidson wrote another letter to Revenue Officer R. D. Leslie stating that Defendant-Bank would not honor the levy because it had a security interest relating to certain obligations owed by Taxpayer Winter to Defendant-Bank which had priority over Plaintiff's tax claims against Taxpayer Winter. The nature of the security interest and the legal basis upon which the alleged priority was asserted were not set forth in Mr. Davidson's letter.

15. The following Conclusions of Law, insofar as they may be considered Findings of Fact, are so found by this Court to be true in all respects.

From the foregoing facts, the Court concludes:

II

Conclusions of Law

1. This Court has jurisdiction by virtue of Section 7402(a) of Title 26, United States Code and Sections 1340 and 1345 of Title 28, United States Code.

2. On November 1, 1971, the sum of $1,260.35 in Taxpayer Winter's checking account, Number 01-010-206, at Defendant-Bank was "property or rights to property subject to levy," within the purview of Section 6332(a) of Title 26, United States Code, because Defendant-Bank had not exercised any right of setoff on this checking account before it was served with the notice of levy on November 1, 1971. See United States v. First National Bank of Arizona [72-2 USTC 9654], 348 F. Supp. 388 (D. Ariz., 1970), affirmed per curiam, [72-2 USTC 9655] 458 F. 2d 513 (9th Cir. 1972); and United States v. Sterling National Bank & Trust Co. of New York, (S. D. N. Y., 1973), [74-1 USTC 9336] affirmed in part and reversed in part, 494 F. 2d 919 (2d Cir. 1974).

3. The defense of lien priority is not appropriate in a suit to enforce a levy under Section 6323(c) because a person served with a tax levy has only two defenses for a failure to comply; these are: (1) that the person is not in possession of taxpayer's property or (2) that the taxpayer's property is subject to a prior judicial attachment or execution. United States v. Manufacturers Trust Co. [52-2 USTC 9417], 198 F. 2d 366, 369 (2d Cir. 1952). See also Bank of Nevada v. United States [58-1 USTC 9228], 251 F. 2d 820, 824 (9th Cir. 1957), cert. denied, 356 U. S. 938 (1958); United States v. Bank of America National Trust & Savings Association [64-2 USTC 9533], 229 F. Supp. 906, 909 (S. D. Cal. 1964), aff'd per curiam, 345 F. 2d 624 (9th Cir. 1965), cert. denied, 382 U. S. 927; United States v. Sterling National Bank & Trust Co. of New York, supra.

Other means were available to Defendant-Bank to determine the question of lien priority. First, pursuant to Section 7426 of Title 26, United States Code, Defendant-Bank could have honored the levy and instituted an action against Plaintiff to recover a money judgment based upon Defendant-Bank's claim of lien priority. Second, pursuant to Section 2410 of Title 28, United States Code, and Section 386 of the California Code of Civil Procedure, Defendant-Bank could have instituted an interpleader action in state court asserting its claim to lien priority. Third, pursuant to Section 2410 of Title 26, United States Code and Rule 22 of the Federal Rules of Civil Procedure, Defendant-Bank could have instituted an interpleader action in federal court asserting its claim of lien priority. Finally, other procedural means may have been available in accordance with Section 1346 of Title 28, United States Code. 9

4. Under the terms of Section 6332(c)(2) of Title 26, United States Code, Defendant-Bank, having dishonored the levy of November 1, 1971, is personally liable to Plaintiff for the sum of $1,260.35.

5. Defendant-Bank did not act with reasonable cause when it refused to surrender the sum of $1,260.35 to Plaintiff.

1 Section 6332(c)(1) of Title 26, United States Code provides:

"(c) ENFORCEMENT OF LEVY.

(1) EXTENT OF PERSONAL LIABILITY. Any person who fails or refuses to surrender any property or rights to property, subject to levy, upon demand by the Secretary or his delegate, shall be liable in his own person and estate 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 taxes for the collection of which such levy has been made, together with costs and interest on such sum at the rate of 6 percent per annum from the date of such levy. Any amount (other than costs) recovered under this paragraph shall be credited against the tax liability for the collection of which such levy was made."

2 Section 6332(c)(2) of Title 26, United States Code provides:

"(c) ENFORCEMENT OF LEVY.

(1) EXTENT OF PERSONAL LIABILITY. * * *

(2) PENALTY FOR VIOLATION. In addition to the personal liability imposed by paragraph (1), if any person required to surrender property or rights to property fails or refuses to surrender such property or rights to property without reasonable cause, such person shall be liable for a penalty equal to 50 percent of the amount recoverable under paragraph (1). No part of such penalty shall be credited against the tax liability for the collection of which such levy was made."

3 Local Rule 3(g)(2) provides:

"Any party who opposes the motion [for summary judgment] shall, not later than five (5) days after service of the notice of motion upon him, serve and file a concise 'statement of genuine issues' setting forth all material facts as to which it is contended there exists a genuine issue necessary to be litigated."

4 Rule 56(e) of the Federal Rules of Civil Procedure provides:

"(e) FORM OF AFFIDAVITS; FURTHER TESTIMONY; DEFENSE REQUIRED. Supporting and opposing affidavits shall be made on personal knowledge, set forth such facts as would be admissible in evidence, and shall show affirmatively that the affiant is competent to testify to the matters stated therein. Sworn or certified copies of all papers or parts thereof referred to in an affidavit shall be attached thereto or served therewith. The court may permit affidavits to be supplemented or opposed by deposition, answers to interrogatories, or further affidavits. When a motion for summary judgment is made and supported as provided in this rule, an adverse party may not rest upon the mere allegations or denials of his pleading, but his response, by affidavits or as otherwise provided in this rule, must set forth specific facts showing that there is a genuine issue for trial. If he does not so respond, summary judgment, if appropriate, shall be entered against him."

Local Rule 3(g)(3) provides:

"In determining any motion for summary judgment, the Court may assume that the facts as claimed by the moving party are admitted to exist without controversy except as and to the extent that such facts are controverted by affidavit filed in opposition to the motion."

5 Section 6332(a) of Title 26, United States Code provides:

"SEC. 6332. SURRENDER OF PROPERTY SUBJECT TO LEVY.

(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."

6 Section 9302(1) of the California Commercial Code requires the filing of a financial statement by the Defendant-Bank to perfect a security interest in the property pledged as collateral for the loan. Section 6401(1) of the California Commercial Code required the filing of the instant financial statement with the California Secretary of State.

7 Section 9203(1)(b) of the California Commercial Code provides, in pertinent part, that a security interest is not enforceable against the debtor or third parties unless the debtor has signed a security agreement which contains a description of the collateral pledged.

8 Section 6332(d) of Title 26, United States Code provides:

"(d) EFFECT OF HONORING LEVY.

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 who, upon demand by the Secretary or his delegate, surrenders such property or rights to property (or discharges such obligation) to the Secretary or his delegate (or who pays a liability under subsection (c)(1) shall be discharged from any obligation or liability to the delinquent taxpayer with respect to such property or rights to property arising from such surrender or payment. In the case of a levy which is satisfied pursuant to subsection (b), such organization shall also be discharged from any obligation or liability to any beneficiary arising from such surrender or payment."

9 Section 7426 of Title 26, United States Code, in pertinent part, provides:

"SEC. 7426. CIVIL ACTIONS BY PERSONS OTHER THAN TAXPAYERS.

(a) ACTIONS PERMITTED.

(1) WRONGFUL LEVY. If a levy has been made on property or property has been sold pursuant to a levy, any person (other than the person against whom is assessed the tax out of which such levy arose) who claims an interest in or lien on such property and that such property was wrongfully levied upon may bring a civil action against the United States in a distrct court of the United States. Such action may be brought without regard to whether such property has been surrendered to or sold by the Secretary or his delegate.

* * *

(b) ADJUDICATION. The district court shall have jurisdiction to grant only such of the following forms of relief as may be appropriate in the circumstances:

* * *

(2) RECOVERY OF PROPERTY. If the court determines that such property has been wrongfully levied upon, the court may--

* * *

(B) grant a judgment for the amount of money levied upon. . . ."

Section 2410 of Title 28, United States Code, in pertinent part, provides:

"SEC. 2410. ACTIONS AFFECTING PROPERTY ON WHICH UNITED STATES HAS LIEN.

(a) Under the conditions prescribed in this section . . . the United States may be named a party in any civil action or suit in any district court or in any State court having jurisdiction of the subject matter--

(1) to quiet title to,

(2) to foreclose a mortgage or other lien upon,

(3) to partition,

(4) to condemn, or

(5) of interpleader or in the nature of interpleader with respect to,

real or personal property on which the United States has or claims a mortgage or other lien."

* * *

Section 1346 of Title 28, United States Code, in pertinent part, provides:

"SEC. 1346. UNITED STATES AS DEFENDANT.

(a) The district courts shall have original jurisdiction, concurrent with the Court of Claims, of:

(1) Any civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected, or any penalty claimed to have been collected without authority or any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws;

* * *

(c) The jurisdiction conferred by this section includes jurisdiction of any setoff, counterclaim, or other claim or demand whatever on the part of the United States against any plaintiff commencing an action under this section."

 

[74-1 USTC 9336] United States of America , Plaintiff-Appellee v. Sterling National Bank & Trust Company of New York , Defendant Third Party Plaintiff-Appellant v. Charles S. Smith, Third Party Defendant

(CA-2), U. S. Court of Appeals, 2nd Circuit, Docket Nos. 73-2300, 73-2301, 494 F2d 919, 3/27/74, Aff'g and rev'g District Court, 73-2 USTC 9494, 360 F. Supp. 917

[Code Sec. 6332(c)]

Levy: Property subject to: Failure to surrender: Penalty: Reasonable cause.--A bank was under a duty to comply with an IRS levy on funds in a depositor's account. Under state law, the entire amount of those funds was property of the bank. However, the penalty for failure to comply with the levy should not have been assessed. Prior decisions gave the bank reasonable cause to believe some of the money belonged to the customer.

One dissent.

Paul J. Curran, United States Attorney, David P. Land, Assistant United States Attorney, New York, N. Y., for plaintiff-appellee. Harry Gurahian, Sterling Nat'l Bank & Tr. Co., New York , N. Y., for defendant and third party plaintiff-appellant. David M. Huggin, H. Rodgin Cohen, Sullivan & Cromwell, 48 Wall St., New York, N. Y., for third party defendant.

Before LUMBARD, FRIENDLY, and TIMBERS, Circuit Judges.

LUMBARD, Circuit Judge:

This appeal concerns the duty of a bank to comply with a levy upon the checking account of one of its customers imposed by the Internal Revenue Service (IRS) under the authority given it by the Internal Revenue Code of 1954, as amended by the Federal Tax Lien Act of 1966, Pub. L. No. 89-719, 80 Stat. 1125. The Sterling National Bank and Trust Company of New York appeals from an order entered on June 5, 1973, in the Southern District of New York which granted the United States ' motion for summary judgment and imposed a penalty of $1,889.82 on the bank for not complying with a tax levy of the Internal Revenue Service. [73-2 USTC 9494] 360 F. Supp. 917 (S. D. N. Y. 1973).

[Background]

1. On February 13, 1970, the IRS made an income tax assessment and demand for payment against Charles S. Smith and his wife, jointly and severally, in the amount of $8,211.38 for the year 1968. Thereafter, Smith borrowed $6,097.32 from the Sterling Bank of June 23, 1970, giving in turn a promissory note. Under the terms of the note, the bank had a "continuing lien and/or right to set-off" for the amount due on the note, whether matured or unmatured, against any balance that Smith had in his accounts at the bank, which the bank could exercise at its option without giving Smith any notice. Subsequently on August 14, 1970, the IRS made a second assessment and demand for $6,475.20 in back taxes due from the Smiths for the year 1969. Pursuant to Int. Rev. Code of 1954, 6321-23, the IRS filed notices of its liens concerning the two assessments with the Register of New York County on November 5, 1970 and March 3, 1971, respectively.

On June 9, 1971, the IRS served the bank with a notice of levy which informed it that Smith was indebted to the United States in the amount of $15,531.25 in back taxes and statutory additions and which directed the bank to remit to IRS all of Smith's property which it held. At that time Smith's checking account had a balance of $5,132.36. Prior to the service of the levy, the bank had not restricted Smith's right to draw upon his account, and Smith had not fallen behind in his installment payments on the loan.

The bank did not remit the funds as requested and on June 18, 1971, the IRS served on the bank a final demand to turn over the funds in Smith's account. On July 2, the bank, exercising its alleged right of setoff under the terms of the June 23, 1970, loan, deducted from the funds in Smith's checking account the $3,779.64 which was still outstanding on the loan and turned over to the IRS the balance of $1,352.72. On August 5, the IRS wrote the bank a letter which stated that the IRS had a right to the entire amount in the account and demanded the remaining $3,779.64. When the bank did not comply with this demand, the United States instituted this action against the bank to recover the $3,779.64, a statutory penalty of 50% of that amount under Int. Rev. Code of 1954, 6332(c)(1), and interest and costs. The claim for the $3,779.64 was rendered moot when Smith died and his estate subsequently paid his tax indebtedness with interest in full. The government, however, continued its suit to recover the statutory penalty of $1,889.64 on the ground that the bank did not have reasonable cause when it refused to comply with the tax levy. Judge Palmieri granted judgment for the government, and the bank appeals.

[The Law]

II. Section 6332(a) of the Internal Revenue Code of 1954 provides (with an exception not relevant here) that "any person in possession of (or obligated with respect to) property or rights to property subject to levy upon which levy has been made" shall upon demand by the Internal Revenue Service surrender such properties and rights to the Service unless such property or rights is subject to attachment or execution under any judicial process at the time of the demand. Section 6332(c)(2) provides that any person who fails to surrender property to the IRS without reasonable cause is subject to a penalty of 50% of the amount demanded.

Three defenses are asserted here on the bank's behalf: (1) the bank held no property of Smith at the time of the levy other than the $1,352.72 it turned over; (2) the bank's right of setoff gave it a lien priority over the government's tax lien; (3) and, in any event, no penalty should be imposed because the bank was acting with reasonable cause. We have previously held that a person served with a tax levy has only two defenses for a failure to comply with the demand, which are either that the person is not in possession of the taxpayer's property or the property is subject to a prior judicial attachment or execution. United States v. Manufacturers Trust Co. [52-2 USTC 9417], 198 F. 2d 366, 369 (2d Cir. 1952). See also Bank of Nevada v. United States [58-1 USTC 9228], 251 F. 2d 820, 824 (9th Cir. 1957), cert. denied, 356 U. S. 938 (1958); United States v. Bank of America National Trust & Savings Association [64-2 USTC 9533], 229 F. Supp. 906, 909 (S. D. Cal. 1964), aff'd per curiam [65-1 USTC 9429] 345 F. 2d 624 (9th Cir.), cert. denied, 382 U. S. 927 (1965). Therefore, the defense of lien priority is not before us. 1 Concerning the other two defenses, we hold that the bank did hold property of Smith's which it was obligated to turn over to the IRS, but that since the legal question was movel it should not have been penalized for its failure to comply.

The question of whether the bank held property or a right to property of Smith is one of state law, in this case New York 's. Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509 (1960). It is maintained that the bank had no property of Smith other than the $1,352.72 turn over since the bank had a right to set off against the checking account any unpaid balance on the loan. Therefore, it is argued, at any one moment only the balance of the checking account funds over any unpaid obligations is property of the taxpayer held by the bank. In support of this proposition 151 of the New York Debtor and Creditor Law is cited. That provision provides in part that upon "the issuance of a warrant attachment against any property" of a creditor, the debtor may set off and apply the property against the creditor's indebtedness to him. Cases are also cited that have allowed banks to offset other obligations from account. See, e.g., Kress v. Central Trust Co. of Rochester, 246 App. Div. 76, 283 N. Y. S. 467 (1935), aff'd mem., 272 N. Y. 629, 5 N. E. 2d 365 (1936).

We are not convinced by this argument. The cases cited deal only with the right of setoff, and not with whether the full amount in the account is "property" of the bank's customer. The literal language of 151 quoted above would indicate that the full amount in the account is the customer's property. Under any realistic definition of "property" the full amount in Smith's account was his property or his right to property. Until the bank acted to restrict his right to draw on the funds, Smith was entitled to write checks up to the full amount in the account. Clearly then all the funds in Smith's checking account were his property at the time that the IRS served the bank with notice of levy. In similar circumstances, the Ninth Circuit has reached the same conclusion. Bank of Nevada v. United States, supra; United States v. Bank of America National Trust & Savings Association, supra.

To support the bank's position, two cases from the Southern District are cited. In United States v. Hampton Garment Co., 71-1 USTC 9357 (S. D. N. Y. 1971), Hampton Garment owed money to a contractor. Under the terms of a collective bargaining agreement, Hampton was obligated to pay the wages of the contractor's employees if the contractor defaulted in payment. The contractor did so default, but prior to notice of the default the IRS served notice of a tax levy on Hampton because of the contractor's unpaid taxes. Judge Mansfield held that, unless Hampton agreed to pay the contractor all that was due it regardless of whether Hampton was obliged to pay the contractor's workers, Hampton need only turn over the difference between the two obligations to the IRS.

The case before us is clearly distinguishable from Hampton Germent. The thrust of that case is that the government can stand in no better position that the taxpayer whose property or right to property is being levied upon. See also United States v. Winnett [48-1 USTC 9115], 165 F. 2d 149 (9th Cir. 1947); Karno-Smith Co. v. Maloney [40-2 USTC 9533], 112 F. 2d 690 (3d Cir. 1940). Here Smith had full freedom to use the funds in his checking account until the bank acted to restrict his use. At any time up to when the IRS served its notice of levy, Smith could have written a check payable to the IRS for the balance of his account. Here the IRS was asserting no right to the funds in the checking account that Smith did not already have.

The second case cited for the bank's position is United States v. Bank of the United States [1934 CCH 9099], 5 F. Supp. 942 (S. D. N. Y. 1934). There the bank's customer gave a demand note in return for a loan. The customer had a checking account at the bank which he regularly used for deposits and withdrawals. The government served notice of levy upon the customer's account and the bank refused to honor it. The district court held that the government was entitled to nothing because the amount outstanding on the loan was greater than the amount in the checking account. The court reasoned that since the bank could have demanded payment on the note at any time, the right of the customer to withdraw funds from his account was really a "revocable license" which the bank could withdraw even after notice of a tax levy was served. 5 F. Supp. at 945. We think this decision completely ignores the reality of the situation. Until the bank acts to restrict the right of its customer to withdraw funds from his account, the bank is holding the customer's property or his right to property. Therefore, we hold that Sterling Bank had a duty to honor the tax levy upon Smith's checking account. 2 To the extent the Bank of United States is contrary to this holding, it is overruled.

[Penalty]

III. We now turn to the question of whether the 50% penalty of 6332(c)(2) should be imposed on the bank for its failure to comply with the tax levy. No penalty can be imposed if the bank acted with "reasonable cause" in resisting the levy. A Senate report accompanying the Tax Lien Act of 1966 stated that "it is intended that a bona fide dispute over the amount owing to the taxpayer (by the property holder) or over the legal effectiveness of the levy itself is to constitute reasonable cause under this provision." S. Rep. No. 1708, 89th Cong., 2d Sess. (1966), in 3 [1966] U. S. Code Cong. & Admin. News 3722, 3740.

Since the facts were undisputed and there were cases within this circuit that supported the bank's position, the issue here is whether a bona fide legal dispute over the amount that the bank owed the taxpayer is sufficient excuse for the bank's failure to honor the levy. We have recently stated that a regional director of the National Labor Relations Board did not have the reasonable cause necessary to get a preliminary injunction under the National Labor Relations Act when it was clear that a court would not enforce an order of the Board finding that the conduct sought to be enjoined violated the Act. Danielson v. Joint Board of Coat, Suit & Allied Garment Workers' Union, ILGWU, slip op. pp. 1979-2009 (2d Cir. Feb. 27, 1974). The clear holding of that case is that a non-frivolous, but erroneous, argument of law is not sufficient reasonable cause for obtaining a preliminary injunction under the National Labor Relations Act.

We see no reason to extend the interpretation given "reasonable cause" in the National Labor Relations Act to the same phrase in the Tax Lien Act. The same words can have different meanings in different statutes. The harm caused by a court granting a preliminary injunction against certain labor activity when it believes that activity does not violate the Labor Act is obvious. The question here is whether we should penalize the Sterling Bank for forcing the government to litigate an unsettled question of law. There is no reason to believe that Congress would wish to penalize the holder of the property levied upon for litigating a test case. Nor do we believe that failing to impose the 50% penalty in situations like this will detract from the congressional purpose of requiring compliance with tax liens. Only for purposes of this initial case did the Sterling Bank refuse to honor the tax levy with reasonable cause. It and other banks confronted with levies in similar circumstances after this decision cannot reasonably refuse to comply.

Accordingly, we affirm the district court's order insofar as it held that Sterling Bank had a duty to comply with the IRS levy and we reverse the order insofar as it imposed the 50% penalty upon the bank. No costs.

1 As the district court noted, 360 F. Supp. at 922-23, there are other procedures to determine who has lien priority.

2 We do not think that United States v. Bank of Shelby [4 USTC 1226], 68 F. 2d 538 (5th Cir. 1934), is relevant here. It appears that the bank there might not have permitted the customer to withdraw funds from his account. All the funds in the account had been derived from a loan on a note and by the time the notice of levy was served on the bank, the security for the note had been sold and the customer was insolvent.

[Dissenting Opinion]

FRIENDLY, Circuit Judge (dissenting):

I respectfully dissent.

In light of Judge Lumbard's convincing demonstration that the Sterling National Bank was bound to honor the tax levy upon the entire amount of Smith's checking account, I cannot agree that a national bank, fully warned (in the IRS' August 5 letter) of the Service's position, of the strong authorities therefor, and of its intention to enforce its position, can be said to have had "reasonable cause" to believe that the levy need be honored only for the excess of the account over the amount owed to the bank. In light of longstanding judicial recognition of the importance of the Government's being able to collect the revenues swiftly and surely, see Murray's Lessee v. Hoboken Land & Improvement Co., 59 U. S. (18 How.) 272 (1856), it seems to me even more essential in this area than in the context presented by Danielson v. Joint Board of Coat, Suit & Allied Garment Workers' Union, ILGWU, -- F. 2d --, -- (2 Cir. 1974), slip op. 1979, 1996-2009, that "reasonable cause" should not be read to include a clearly erroneous view of the law, stubbornly adhered to after investigation should have disclosed the error. The majority's ruling permits a bank to pay the Government whatever its lawyers say it should, with no risk beyond having to pay the balance if it turns out to be wrong. Surely the distinctions between this case and Hampton Garment, the antiquarian unreality of Judge Woolsey's opinion in United States v. Bank of United States [1934 CCH 9099], 5 F. Supp. 942 (S. D. N. Y. 1934), and the force of the Ninth Circuit decisions, all so ably elucidated in the majority opinion, should not have escaped the notice of Sterling's experienced counsel.

The majority says, quite properly, that no bank in the Second Circuit can ever again claim reasonable cause to act precisely as Sterling did, and the Government will scarcely founder through its failure to collect the $1,889.82 penalty here at issue. But lawyers will dream up other "reasons" why parties holding property belonging to a taxpayer should not pay this to the Government as 6332(c) requires. I would not permit collection of the revenues to be delayed on first appearance of each such question in each jurisdiction where, as here, the question is not really close, the party had access to competent legal advice, temporary sacrifice of the funds and pursuit of other remedies against the Government would not represent any hardship, and the IRS proceeded deliberately and gave ample notice of its intention and the sound view of the law on which this was based.

I would affirm the judgment of the District Court.

 

 

[76-1 USTC 9151] United States of America v. Willard B. Davis, etc.

U. S. District Court, East. Dist. Va., Richmond Div., Civil Action No. 75-0166-R, 12/8/75

[Code Sec. 6332(a)]

Levy: Property subject to: Failure to surrender: Setoff claim.--A building contractor was under a duty to comply with an IRS levy on funds agreed to be paid but remaining unpaid, under a work performance agreement, to taxpayer corporation which had assessments made against it for unpaid federal taxes. The building contractor's failure to claim and prove setoffs against the money belonging to taxpayer corporation in November 1970, when notice of levy and final demand were made, precluded him from asserting them four and a half years later when the United States filed a complaint under Code Sec. 6332(a).

Davis A. Schneider, Assistant United States Attorney, Richmond , Va. , for plaintiff. Irving M. Blank, Paul, Smith & Blank, P. O. Box 8557 , Richmond , Va. , for defendant.

Memorandum Order

WARRINER, District Judge:

In April 1968 defendant contractor entered into an agreement with Karl Corporation, taxpayer, wherein Karl Corporation agreed to perform certain carpentry work for defendant who in turn agreed to pay Karl some $190,000. The work was completed but defendant did not pay the full consideration and continues to hold $19,800 which was due and owing Karl Corporation under the agreement.

Subsequent to the above transaction, assessments were made against Karl Corporation for unpaid federal taxes. There remains outstanding a total assessed unpaid balance of $22,938.42 plus accrued interests as provided by law. These unpaid taxes constitute a lien against any property or rights to property belonging to Karl Corporation as of the dates the assessments were made. 26 U. S. C. 6332(a).

On 3 November 1970 a Notice of Levy was served upon defendant which, levied upon all property rights of Karl Corporation held by defendant, namely the money retained by defendant which was due and owing to Karl Corporation. On 25 November 1970, a Final Demand was served upon defendant demanding the money defendant had retained from Karl Corporation.

Despite the Notice of Levy and Final Demand, defendant refused to surrender the money to the United States. In response, for four and a half years the United States did nothing. Finally, on 1 April 1975, the United States filed a complaint in this Court charging that defendant's refusal to tender the money violated Section 6332(a) of the Internal Revenue Code of 1954.

On 19 May 1975 defendant filed an answer admitting that he held money belonging to Karl Corporation, but alleging he was entitled to a setoff against a portion of it. The answer further stated that defendant had not yet determined the amount of the setoff, but that, when he did, he would "gladly pay" the balance to the government.

Thereafter in June, interrogatories were served on defendant in order to require defendant to develop the nature and amount of the setoff so vaguely claimed in his answer. The answers to the interrogatories were characterized by equal vagueness. With respect to most questions defendant responded that the facts "were unknown at the time."

A pretrial order was entered on 29 September and a supplement thereto on 3 October 1975 setting up an agreed procedure to resolve the matter. In the order, judgment was granted in favor of the United States against defendant for the amount of $19,800 with interest from 25 November 1974. 1 The order further provided for a briefing schedule to address the question of whether defendant was entitled to his claim of setoff. The time accorded for the briefing schedule having expired, this matter is now ripe for decision.

When the United States served Notice of Levy and Final Demand against defendant in November 1970 it became defendant's duty to pay over to the government all assets in his hands belonging to Karl Corporation. See 26 U. S. C. 6321, 6322. If he had any reason for not paying over to the government the money ($19,800) by reason of setoff or otherwise, it was incumbent upon him to have asserted such reason at that time, if not before. See United States v. Sterling National Bank and Trust Company of New York [74-1 USTC 9336], 494 F. 2d 919 (2d Cir. 1974); United States v. Barker, 309 F. Supp. 1369 (W. D. Va. 1970). Instead, the record indicates that defendant did nothing to assert his claim until a complaint was filed against him on 1 April 1975. In fact, defendants' affidavit, filed pursuant to the Court's order of 3 October 1975, for the first time set forth specific sums of money which he claimed in setoff, for various and sundry reasons, totalling $10,155.98.

No matter what intent defendant may have had to claim a setoff prior to this time, it is clear that said intent had not been consummated prior to or at the time of the levy since the evidence is totally to the contrary.

Under these circumstances, the Court is compelled to hold that the alleged claims of setoff are late discovered or late asserted claims which defendant is precluded by law from now asserting. See United States v. Sterling National Bank and Trust Company of New York, supra, and United States v. Barker, supra. The fact that the government did not seek judgment on its lien until it did, does not excuse defendant for his failure to timely assert his claims.

Accordingly, it is hereby ORDERED that the claim of setoff be DENIED and that judgment enter for the United States against defendant in the amount of $19,800 with interest thereon from 25 November 1970 with costs.

Let the Clerk send a copy of this memorandum order to counsel of record and to the United States Attorney for this District.

Judgment

This action having been fully briefed before the Court, Honorable D. Dortch Warriner, United States District Judge, and a memorandum decision having been duly rendered,

It is Ordered and Adjudged that the plaintiff, UNITED STATES OF AMERICA, recover of the defendant, WILLARD B. DAVIS, a/k/a W. B. DAVIS, d/b/a W. B. DAVIS CONTRACTOR and W. B. DAVIS GENERAL CONTRACTOR, the sum of NINETEEN THOUSAND EIGHT HUNDRED AND NO/100 DOLLARS ($19,800.00) with legal interest thereon from the 25th day of November 1970, at the rate of Eight Per Cent (8%) per annum, and its costs of action.

1 The year specified from which interest would accrue was in error. The interest should accrue at the latest from the time of Final Demand, 25 November 1970. This order corrects that error in date.

 

[73-2 USTC 9751]United States of America v. First National Bank of Commerce in New Orleans

U. S. District Court, East. Dist. La., Civil Action No. 72-247, Section B, 10/10/73

[Code Sec. 6332]

Levy: Bank checking account: Penalty for failure to surrender property.--A bank at the time of levy was entitled under state law to set off against the balance in the delinquent taxpayer's checking account only those debts owed to the bank by the taxpayer which were liquidated and demandable at the time of the levy. The bank was not entitled to set off charges posted after the date of the levy for services rendered before that date for several returned checks (NSF) and for cancelled Bank Americard transactions which had been previously credited upon deposit on or before the date of the levy. Further, the bank was liable for the penalty (costs and interest at a rate of 6% per annum from the date of the levy) since its failure to honor the levy was not due to reasonable cause.

Gerald J. Gallinghouse, United States Attorney, John R. Schupp, Assistant United States Attorney, New Orleans, La., for U. S. Henry P. Dart, III, Dart & Dart, 1008 Nat'l Bank Commerce Bldg., New Orleans, La., for defendant.

HEEBE, District Judge:

In this civil action brought pursuant to 26 U. S. C. 6332, the United States of America seeks to recover from the First National Bank of Commerce in New Orleans (hereinafter referred to as the Bank) the amount of money in the checking account of a delinquent taxpayer, Leisure Systems, Inc., which the Bank failed to surrender upon a notice of a tax levy served on April 29, 1971. The government also seeks a penalty pursuant to 26 U. S. C. 6332(c)(2), together with interest and costs.

It is the contention of the Bank that the amount of money shown by the taxpayer's bank statement to be in its account on the date in question was not the true balance on that day. The Bank asks this Court to subtract from that figure various charges posted after April 29, 1972 for services rendered prior to that date and several "Returned Checks" (NSF) and cancelled Bank Americard transactions which had been previously credited upon deposit on or before April 29, 1972.

The Bank further asks that penalties not be assessed according to 26 U. S. C. 6332(c)(2) which states in pertinent part, ". . . if any person required to surrender property or rights to property fails or refuses to surrender such property or rights to property without reasonable cause, such person shall be liable for a penalty equal to 50 per cent of the amount recoverable . . .." The Bank maintains that the amount was not immediately ascertainable since, for example, checks returned NSF may take several weeks before they are actually debited and that, therefore, it was reasonable to fail to surrender the money to the government.

The Bank has filed a third party complaint against the taxpayer, Leisure Systems, Inc., to which the third party defendant has not answered.

In addition, the Bank filed an offer of judgment pursuant to Rule 68 of the Federal Rules of Civil Procedure for an amount approximately equal to the "adjusted" balance of the taxpayer's account.

Findings of Fact

1. On April 29, 1973, a Notice of Levy upon the account of Leisure Systems, Inc., was served on the First National Bank of Commerce in New Orleans by the Internal Revenue Service.

2. On April 29, 1971, Leisure Systems, Inc., had a balance of $1,925.30 in its checking account. Included in this sum were credits for checks which had not yet been paid as well as credits for accounts receivable vouchers arising out of Bank Americard transactions. The taxpayer was permitted to draw upon these credits.

3. Having received no remittance from the Bank, the Internal Revenue Service served a Final Demand on the Bank on May 20, 1971.

4. Still having received no remittance from the Bank, the Internal Revenue Service served a second Notice of Levy on the Bank on May 25, 1971, on which date Leisure Systems, Inc., had a balance of $189.91 in its checking account.

5. On April 29, 1971, the Bank failed to "freeze" the account of Leisure Systems, Inc., and permitted it to be drawn upon until May 25, 1971.

6. On June 2, 1971, the Internal Revenue Service received a check for $189.91 from the Bank.

7. Between April 30, 1971, and June 28, 1971, the Bank debited the checking account of Leisure Systems, Inc., for various Returned Checks (NSF) which checks had been credited to Leisure System's account prior to April 29, 1971, for check printing and Bank Americard charges for services rendered prior to April 29, 1971, and for cancelled Bank Americard transactions which arose prior to April 29, 1971, totalling $201.41.

Conclusions of Law

1. 26 U. S. C. 6332 provides for the surrender of property or rights to property of a delinquent taxpayer in possession of any person upon whom a levy has been made.

2. This Court must look to Louisiana law to determine the extent to which a taxpayer had property or rights to property subject to levy by the Internal Revenue Service. Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509, 80 S. Ct. 1277, 4 L. Ed. 2d 1365 (1969); United States v. St. Johns Community Bank [69-2 USTC 9518], 302 F. Supp. 149 (E. D. Mo. 1969).

3. Under Louisiana law the bank, at the time of the levy, was entitled to set-off (also referred to as "compensation" under Louisiana law) against the $1,925.30 in the taxpayer's checking account only those debts owed to the Bank by the taxpayer which were liquidated and demandable at the time of the levy. L. S. A.-C. C. Arts. 2207, 2208, 2209; see also, Hughes Realty, Company v. Pfister, 245 So. 2d 757 (4th Cir. 1971).

4. The charges totalling $201.41 which the Bank seeks to set-off against the $1,925.30 in the taxpayer's account on April 29, 1971, were not "liquidated and demandable" on April 29, 1971; they became "liquidated and demandable" only after April 29, 1971, when actually debited against the taxpayer's account.

5. Therefore, the Court concludes that on April 29, 1971, the $1,925.30 in the taxpayer's checking account constituted property of the taxpayer in possession of the Bank which the Bank failed to surrender without reasonable cause.

6. Plaintiff is entitled to judgment in the amount of $1,735.39 (the difference between the $1,925.30 in taxpayer's account and the $189.91 which the Bank eventually remitted) together with a penalty of $867.70 pursuant to 26 U. S. C. 6332(c)(2) for a total of $2,603.09, plus interest dating from April 29, 1971. Since the amount recovered by the government is greater than the Bank's offer of judgment, the government is entitled to costs, and the motions of the United States to strike the offer of judgment and of the defendant to correct the offer of judgment are declared to be moot.

7. While the Bank, as third party plaintiff, may be entitled to judgment by default against the third party defendant, Leisure Systems, Inc., the Court cannot enter such judgment until the Bank complies with Rule 55(b) of the Federal Rules of Civil Procedure.

Let judgment be entered accordingly.

Partial Judgment

This cause came on for trial on a former day, and after hearing the evidence, the Court took the matter under submission.

Now, therefore, considering the written reasons of the Court and the direction as to entry of judgment;

It is ORDERED, ADJUDGED AND DECREED that plaintiff, United States of America, is entitled to judgment in the amount of $1,735.39 (the difference between the $1,925.30 in taxpayer's account and the $189.91 which the Bank eventually remitted) together with a penalty of $867.70 pursuant to 26 U. S. C. Sec. 6332(c)(2) for a total of $2,603.09, plus interest dating from April 29, 1971, plus costs.

 

[74-2 USTC 9494]United States of America, Plaintiff-Appellee v. First National Bank of Commerce in New Orleans, Defendant-Third Party Plaintiff-Appellant, Leisure Systems, Inc., et al., Third Party Defendants-Appellees

(CA-5), U. S. Court of Appeals, 5th Circuit, No. 73-4039, Summary Calendar, *, 493 F2d 1228, 5/9/74, Aff'g District Court, 73-2 USTC 9751

[Code Sec. 6332]

Levy: Failure to honor: Bank: Effect.--A bank improperly failed to honor an IRS levy on funds in a depositor's account and was liable for the penalty for such a failure. The bank was not entitled to set off charges it made against the depositor's account after the date of levy for services it rendered prior to that date.

Gerald J. Gallinghouse, United States Attorney, Michaelle F. Pitard, John R. Schrupp, Assistant United States Attorneys, New Orleans, La., Marlow R. Preston, 569 Jacinto Bldg., 911 Walker St., Houston, Tex., for plaintiff-appellee. Henry P. Dart, III, 1008 First Nat'l Bank of Commerce Bldg., New Orleans, La., for defendant-third party plaintiff-appellant.

Before COLEMAN, DYER and RONEY, Circuit Judges.

PER CURIAM:

In this appeal from a bench trial the district court's findings of fact are not attacked. After a careful review of the record we are satisfied that the court applied proper legal standards, and the judgment entered below should therefore be

Affirmed. 1

* Rule 18, 5 Cir.; See Isbell Enterprises, Inc. v. Citizens Casulalty Co. of New York et al., 5 Cir., 1970, 431 F. 2d 409, Part I.

1 Although the district court made no finding or conclusion concerning the sufficiency of the service of the levy on the Bank's Vice-President and Controller we find the Bank's contention that the service was invalid to be without merit.

 

[86-1 USTC 9337] United States of America, Plaintiff v. Bell Credit Union, Defendant United States of America, Plaintiff v. Golden Plains Credit Union, Defendant

U.S. District Court, Dist. Kan., 84-1024, 3/18/86, 635 FSupp 501, (635 FSupp 501.)

[Code Secs. 6232 and 6332 ]

Levy and distraint: Competing liens: Penalties, civil: Failure to honor tax levy.--Neither state law nor contractual rights entitled two credit unions to disregard tax levies served upon them by the IRS and use funds in their possession to set off claims against their debtors. Moreover, in the absence of a bona fide dispute regarding the legal effectiveness of the levy, their delay in turning over the funds to the government justified an award of the 50-percent penalty.

OPINION AND ORDER

THEIS, District Judge:

These companion cases present the question of competing claims between the Internal Revenue Service and the respective credit unions to funds on deposit in the credit unions. They are before the Court on the defendants' motions for Summary Judgment, and the United States' cross motions for Summary Judgment.

There is no dispute as to the material facts. In April of 1983 the credit unions were served with Internal Revenue Service Notices of Levy upon the deposits of Derald and Charlene Thomas (Thomas) and upon Lawrence Black Jr. and/or B & B Trucking (Black). Thomas had funds on deposit in the Bell Credit Union, and loans outstanding though not in default with it. Black had funds on deposit with the Golden Plains Credit Union, and outstanding, delinquent loans with it. This action by the Internal Revenue Service notices of Levy apparently prompted both credit unions to thereafter declare default on the loans and apply the shares of Thomas and Black to the loan balances. Until the credit unions applied the shares to the loans, in the absence of some additional factor coming to the credit unions' attention respecting ability to pay or impairment of security Thomas and Black would have been able to withdraw the shares from the credit unions without objection. After the shares were applied to the loans, no funds were left to satisfy the levy. The United States brought these actions for failure to honor the levies and to recover from the defendants the amount of the levied funds in their possession at the time the levies were served. In addition, the United States seeks imposition of a 50 percent penalty against the credit unions pursuant to 26 U.S.C. 6332(c)(2) .

The defendant credit unions oppose the action, and have filed a joint motion for summary judgment against the United States for a determination that they have no liability to the United States. They also seek costs against the United States. The United States opposes the joint motions, and has filed a cross motion for summary judgment against the credit unions as to both the levied amounts and the 50 percent penalty.

The Court is familiar with the standards governing the consideration of motions for summary judgment. Summary judgment is a drastic remedy to be applied with caution in order to preserve a litigant's right to trial. Machinery Center, Inc. v. Anchor Nat'l Life Ins. Co., 434 F.2d 1, 6 (10th Cir. 1970). To rule favorably on a motion for summary judgment, the Court must first determine that the matters on file regarding the motion "show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. P. 56(c). The Court must look at the record in the light most favorable to the non-moving party. Lindley v. Amoco Production Co., 636 F.2d 671, 672 (10th Cir. 1981). Before summary judgment may be granted, the moving party must establish its entitlement to summary judgment beyond a reasonable doubt. Ellis v. El Paso Natural Gas Co., 754 F.2d 884, 885 (10th Cir. 1985). Pleadings and documentary evidence must be liberally construed in favor of the party opposing the motion. Harmon v. Diversified Medical Investments Corp., 488 F.2d 111, 113 (10th Cir. 1973), cert. denied, 425 U.S. 951 (1976). If the facts support an inference that would permit the non-movant to prevail, summary judgment is inappropriate. Thomas v. United States Dep't of Energy, 719 F.2d 342, 344 (10th Cir. 1983). A party resisting a motion for summary judgment, however, must set forth specific facts showing that there is a genuine issue for trial. Dart Industries, Inc. v. Plunkett Company of Oklahoma, Inc., 704 F.2d 496, 498 (10th Cir. 1983).

Defendants support their motion for summary judgment on the basis that they were the holder of a security interest superior to that of the IRS. It is well settled that a bank that exercises its right of setoff after receiving notice of a tax lien will lose to the IRS as to the levied/setoff funds. See B. Clark, The Law of Bank Deposits, Collections and Credit Cards, 11.11 (1981). The defendants would argue that they did not exercise a right of setoff but foreclosed a valid and prior lien against the shares of levied taxpayers. Unlike banks, credit unions do not receive "deposits" creating a debtor/creditor relationship. Instead credit union "shares" are part of the capital stock of the credit union, and such shares become liens against any outstanding loans. Defendants argue that this lien is both statutory and contractual in nature. For this they rely on K.S.A. 17-2212 which reads in part "[a] credit union shall have a lien and right of setoff on the shares of any member . . . for and to the extent of any obligation of the member." They also rely on certain loan documents creating a contractual lien. As such, defendants would assert a prior interest to the tax levy, citing The Trust Company of Columbus v. United States [84-2 USTC 9614 ], 735 F.2d 447 (11th Cir. 1984) to give them a superior right to the funds in question.

The Court is not persuaded by defendants statutory arguments. Although a cursory reading of the statutes would seem to support their argument distinguishing credit unions rights and remedies from those of banks, the Court finds the differences here in issue to be more apparent than real. Moreover, the United States has directed the Court's attention to Stann v. Mid American Credit Union, 39 BR 246 (D. Kan. 1984), where Judge Crow of this District, addressing the same statutory provision, held "[a]lthough the statute refers to 'lien,' the right conferred by the statute is an equitable right of setoff." Id. at 248. This ruling, which this judge considers salutory and precedential, vitiates defendants' carefully drawn distinction between credit unions and banks regarding setoff.

Parenthetically, the Court would note that it is troubled by the failure of defendant's attorney to draw the Court's attention to this case, or to otherwise address it. The duty of an attorney to direct the Court's attention to contrary holdings is well known. While the Court usually is willing to assume that an adversary's failure to address such authority is mere oversight, it is more difficult to make such an assumption in a case such as this one where the ruling goes directly to the issue at hand, was handed down by another judge of the same District Court that the instant case is before, was only a year and a half before the briefs in the instant case were filed, and most importantly was handed down in a case in which the defendant's attorney was the same man as defendant's attorney here.

The Court likewise is not persuaded by defendants' contractual arguments. The Court has been provided with documentary evidence as to the existence of a contractual lien on the taxpayers' accounts as defendants allege. The Court is willing to assume for these purposes that such a contractual lien existed. But the inquiry does not stop there. The question of property or property rights to which a federal tax levy can attach is a question of state law, but the question of when a state created lien is substantially perfected that it can defeat a federal tax lien is a question of federal law. United States v. Hunt [75-1 USTC 932], 513 F.2d 129, 133 (10th Cir. 1975). So assuming a valid lien on the credit union accounts the question becomes one of its priority vis-a-vis the tax levy.

It is well settled that in order for a state created lien to be superior to a federal tax levy, it must be both choate and first in time. United States v. Pioneer American Insurance Co. [63-2 USTC 9532 ], 374 U.S. 84, 88; 83 S.Ct. 1651, 1655 (1963). To be choate, the lien must be perfected so that there is nothing more to be done, that the identity of the lienor, the property subject to the lien, and the amount of the lien are established. United States v. New Britain, 347 U.S. 81, 84-86, 74 S.Ct. 367, 369-71 (1954); Priest v. Progressive Savings & Loan Assoc., 712 F.2d 1326, 1327-28 (9th Cir. 1983); New York City Transit Authority v. Paradise Guard Dogs, Inc., 565 F.Supp. 388, 390 (E.D.N.Y. 1983). These requirements of first in time and choateness given federal tax liens an extraordinary priority, justifiable only by the importance of securing adequate revenues to discharge national obligations, and limited therefore to tax liens. United States v. Kimbell Foods, Inc., 440 U.S. 715, 734, 99 S.Ct. 1444, 1461-62 (1979).

The liens relied on by the defendant credit unions are simply not choate liens, if for no other reason than that the property subject to the lien is clearly not established and isolated. Defendants have admitted that prior to the filing of the tax levy and the subsequent setoff, the depositors were free to withdraw any or all of the amounts in their accounts. Therefore, the defendants' interest is inferior to that of the IRS' interest.

In passing, the Court would also note that even if the defendant credit unions had a prior lien in the accounts in question, a prior lien is not a defense to a federal tax levy. Instead, the proper procedure in contesting the levy is to surrender the funds and then litigate the priority of the liens. This the credit unions failed to do, despite the fact that even The Trust Company of Columbus which defendants themselves cited for their "valid and senior security interest" argument so holds. While noting that the court there decided that a holder of a senior lien would prevail over the government's levy, they failed to note that The Trust Company followed the proper procedure of surrendering the funds and then litigating the priority. 735 F.2d at 449. Although defendants likewise argued senior lien here, they did not choose to first surrender the funds.

The United States seeks also a penalty equal to 50 percent of the amount of liability recoverable from the credit unions, pursuant to 26 U.S.C. 6332(c)(2) . That statute authorizes such a penalty if "any person required to surrender property or rights to property fails or refuses to surrender such property or rights to property without reasonable cause" (emphasis added). The Court views the imposition of the penalty as a serious punishment, one to be imposed only after careful consideration. The penalty should in no way be imposed as the price of making a merely unsuccessful argument, nor should it be imposed in any way which would discourage the free access to courts to litigate matters of dispute. But the importance of the collection of tax revenues dictates that the penalty is appropriate when frivolous arguments are made merely to delay the collection of monies legally due the IRS. The court would be reluctant to impose the penalty if any legal dispute existed in any facet of the controversy, but is compelled by law to order its imposition if no reasonable argument was made.

In this instance, the Court must consider the arguments that defendants made. They argued that state law gave them a prior lien to their deposits as opposed to a right of setoff, but they failed to disclose that their attorney had already made this argument once to this District, and had been unsuccessful. They argued that they also had a prior contractual lien superior to the tax levy, but they failed to demonstrate how such a contractual lien was choate and first in time, giving it priority over the tax levy. Indeed, they failed to discuss the pivotal doctrine of choateness at all. And, in fact, their lien was not choate, and therfore was not superior to the tax levy. Finally, while arguing that their liens were prior, they failed to either note or follow the proper procedure in contesting a tax levy. Case law is clear that claim of a prior lien may not be interposed as a defense to a tax levy. United States v. Citizens & Southern Nat. Bank, 538 F.2d 1101, 1106 (5th Cir. 1976). United States v. Trans-World Bank [74-2 USTC 9632 ], 382 F. Supp. 1100, 1105 (C.D. Cal. 1974). Instead, as The Trust Co. of Columbus explains, the proper procedure is to surrender the funds, and then litigate the priority of the lien. 735 F.2d at 449. See also 26 U.S.C. 7426 .

Defendants oppose the imposition of the 50 percent penalty on the grounds that there was a bona fide dispute regarding the legal effectiveness of the levy. The Court does not see any reasonable, bona fide dispute. The Court finds the law of this matter to be clear, and notes that defendants constructed their arguments completely apart from the controlling doctrines. Therefore the Court finds no other alternative but to impose the statutorily prescribed penalty.

IT IS THEREFORE ORDERED that defendants Bell Credit Union's and Golden Plains Credit Union's joint motion for summary judgment against the United States is hereby denied.

IT IS FURTHER ORDERED that plaintiff United States of America's cross-motion for summary judgment is hereby granted, and the defendant credit unions are ordered to pay to the United States the amount of the original tax levies, together with interest.

IT IS FURTHER ORDERED that plaintiff's motion for summary judgment on defendants' liability for the 50 percent penalty pursuant to 26 U.S.C. 6332(c)(2) is hereby granted.

IT IS FURTHER ORDERED that the United States prepare a journal entry of judgment setting out the precise amounts due pursuant to this order, circulate it for approval among the attorneys for the parties, and present it to this Court by March 31, 1986.

 

[83-2 USTC 9648]United States of America v. First National Bank of Bellaire

U. S. District Court, So. Dist. Tex., Houston Div., C. A. No. H-82-2567, 8/12/83

[Code Sec. 6332]

Surrender of property subject to levy: Bank accounts: Reasonable cause.--A bank was ordered to pay over to the government a depositor's funds upon which a notice of levy had been served. The effectiveness of the notice of levy and seizure does not depend upon a prior judicial determination of the depositor's liability to the government for unpaid taxes. The bank was also ordered to pay a penalty because its refusal to pay over the funds when the notice of levy was served was not due to reasonable cause.
Order

CIRE, District Judge:

Came to be heard Plaintiff's motion for summary judgment. Having considered the motion, the responses and the law, the Court concludes that the motion should be and hereby is GRANTED.

During the calendar year 1980, the Internal Revenue Service made assessments against Juan Rodriguez, Inc. ("Rodriguez") for unpaid federal income taxes, penalties and interest totalling $4,435.65. Despite notice of these assessments and demands for payment, Rodriguez did not pay the amounts due. Consequently, on August 24, 1981, a delegate of the Secretary of the Treasury served on Defendant, the First National Bank of Bellaire, a Notice of Levy on all property and rights to property belonging to the taxpayer Rodriguez which were in Defendant's possession. Defendant refused to surrender the taxpayer's property. Thereafter, Plaintiff, the United States, initiated this action seeking to impose personal liability on Defendant in the amount of Rodriguez' deposits in Defendant-bank's possession at the time of the levy, pursuant to 26 U. S. C. 6332(e)(1), plus the penalty imposed pursuant to 26 U. S. C. 6332(c)(2) for failure to surrender property without reasonable cause.

In support of the motion for summary judgment, Plaintiff asserts that, pursuant to 26 U. S. C. 6332(a), Defendant is required to pay to the United States all property or rights to property of the taxpayer in the bank's possession in order to avoid personal liability. This has not been done. Plaintiff contends that there are no material facts in issue which would prevent the grant of summary judgment.

There are only two defenses possible for a failure or refusal to surrender property belonging to a taxpayer upon which a notice of levy has been served: 1) that the defendant is not in possession of the taxpayer's property, and 2) that the taxpayer's property is subject to a prior judicial attachment. See United States v. Manufacturers Trust Co. [52-2 USTC 9417], 198 F. 2d 366, 369 (2d. Cir. 1952); see also United States v. Sterling National Bank and Trust Co. of New York [73-2 USTC 9494], 360 F. Supp. 917, 923 (S. D. N. Y. 1973), aff'd in part, rev'd in part on other grounds [74-1 USTC 9336], 494 F. 2d. 919 (2d. Cir. 1974). Defendant has asserted neither of these defenses. Rather, Defendant alleges that summary judgment is inappropriate because Plaintiff has failed to establish that Rodriguez owes any unpaid taxes. Further, Defendant asserts that Plaintiff has produced no evidence as to the validity of the assessments. Finally, Defendant claims that Plaintiff is not entitled to recover the statutory penalty because Defendant had reasonable cause for its refusal to comply with the notice of levy.

With respect to Defendant's first two allegations, the effectiveness of the notice of levy and seizure under 6332 does not depend on a prior judicial determination of the taxpayer's liability to the Government for unpaid taxes. The right of the United States to collect its internal revenue by summary administrative proceedings is well established. See Philips v. Commissioner [2 USTC 743], 283 U. S. 589 (1931) and United States v. New England Merchants National Bank [79-1 USTC 9250], 465 F. Supp. 83 (D. Mass. 1979). As long as there is an adequate opportunity for a later judicial determination of legal rights, the summary proceedings to secure prompt performance of pecuniary obligations to the Government have been consistently upheld. See Phillips, supra, at 595. Moreover, the only prerequisites to levy are assessment, notice and demand to pay the tax, and failure to pay the tax within ten days after notice and demand. See American Acceptance Corp. v. Glendora Better Builders, Inc. [77-1 USTC 9348], 550 F. 2d 1220 (9th Cir. 1977).

It is undisputed that the Government made the required assessments and gave notice and demand for payment to the taxpayer. It is undisputed that Defendant-bank was in possession of Rodriguez' property at the time of the notice of levy, and it is further undisputed that Defendant, for whatever reasons, refused to surrender the taxpayer's property in its possession.

It has been recognized that the process for enforcing the collection of taxes is independent of the judicial determination of the validity of the assessment, and that to allow a challenge to the validity of the assessment as a defense to an action under 6332 would undermine the tax enforcement process. See U. S. v. Augspurger [79-2 USTC 9622], 508 F. Supp. 327, 328 (W. D. N. Y. 1981). In the case at hand, Defendant does not challenge the effectiveness of the Government's levy, nor does Defendant assert that the amount of the deficiency due the Government is incorrect. Instead, Defendant attempts to justify its failure to surrender Rodriguez's property by asserting the invalidity of the assessment. In light of Defendant's failure to assert either of the two allowable defenses to an action under 6332, and Defendant's futile attempt to challenge the legitimacy of a facially valid assessment, the Court hereby concludes that summary judgment in Plaintiff's favor is warranted.

The next question to be determined concerns Defendant's liability for the penalty for failing to surrender the taxpayer's property, pursuant to 26 U. S. C. 6332(d). Defendant asserts that "reasonable cause" existed for its failure to comply with the Government's notice of levy. More specifically, Defendant contends that a bona fide dispute existed between Rodriguez and the Government concerning Rodriguez' actual liability for unpaid income taxes. Therefore, Defendant asserts, the refusal to surrender the property was based on Defendant's fear of liability to the taxpayer in the event that the levy was wrongful. In response, Plaintiff submits that a dispute between the taxpayer and the Government as to whether taxes are owed is insufficient "reasonable cause" to prevent the imposition of the statutory penalty.

It has been held that an unsettled question of law concerning the rights and obligations with respect to the property held constitutes "reasonable cause" to avoid the imposition of the penalty provision. See Sterling National Bank and Trust Co. of New York, supra, 494 F. 2d at 923. Defendant has cited several cases which allegedly support the proposition that the existence of a bona fide dispute constitutes "reasonable cause" which would prevent the imposition of the penalty against the property holder. However, the cases cited by Defendant are so factually dissimilar as to render them inapplicable to the case at hand. The Second Circuit found "reasonable cause" to exist where there was a dispute between the property holder and the taxpayer concerning the amount owed to the taxpayer by the property holder. Id. The Fifth Circuit found that "reasonable cause" existed where there was a bona fide dispute as to whether the property levied upon was actually the property of the taxpayer. See United States v. Citizens and Southern Bank [76-2 USTC 9665], 538 F. 2d 1101 (5th Cir. 1976). Finally, "reasonable cause" has been found where there was a dispute as to the existence and the amount of property subject to levy. See United States v. Guittard Chocolate Co., 81-2 USTC 9805 (N. D. Cal. 1981).

Defendant has not cited any case law which would support the proposition that a dispute between the taxpayer and the Government as to whether taxes are owed constitutes "reasonable cause" which would prevent the imposition of the penalty clause. Indeed, such a dispute is quite common to situations such as this one. Moreover, Defendant's reason for refusing to surrender the taxpayer's property is based on the threat of potential liability to the taxpayer. 6332(d) discharges the property holder from any liability to the taxpayer for compliance with the notice of levy. If Defendant's interpretation of "reasonable cause" is adopted, it would render the protection provided by subsection (d) of 6332 superfluous.

On July 8, 1983, Defendant-bank filed an interpleader against Juan Rodriguez, Inc. Rodriguez has not responded to the interpleader. However, a response is not necessary, as this is not a proper action for an interpleader.

Rule 22 of the Federal Rules of Civil Procedure authorizes an interpleader where 1) two or more persons have claims against the interpleading party, and 2) as a result, the interpleading party is or may be exposed to multiple liability. See Dunbar v. United States [74-2 USTC 9744], 502 F. 2d 506 (5th Cir. 1974); See also Xerox Corp. v. Nashua Corp., 314 F. Supp. 1187 (S. D. N. Y. 1970). The burden is on the party seeking the interpleader to demonstrate that he is entitled to it. Dunbar, 502 F. 2d at 511.

Defendant-bank has failed to carry that burden of proof. In view of 26 U. S. C. 6332(d), which absolves the property-holder of liability to the taxpayer for the release of the taxpayer's property to the Government, it cannot be said that Defendant has demonstrated that it is subject to the risk of multiple adverse claims.

Accordingly, it is hereby ORDERED that Plaintiff's motion for summary judgment is GRANTED. Defendant is ORDERED to relinquish to Plaintiff the sum of one thousand four hundred and sixty-seven and 13/100 dollars ($1,467.13) plus interest from August 24, 1981 at the rate of eleven percent (11%) per annum.

It is further ORDERED that Plaintiff recover from Defendant the penalty for non-compliance with the notice of levy, in the amount of seven hundred and thirty-three and 56/100 dollars ($733.56).

 

[81-2 USTC 9805]United States of America, Plaintiff v. Guittard Chocolate Company, Defendant

U. S. District Court, No. Dist. Calif., No. C 81-1860 TEH, 11/5/81

[Code Secs. 6331 and 6332]

Levy and distraint: Action to enforce IRS levy: Debt owed to taxpayer: Failure to surrender property subject to levy: Reasonable cause.--An individual was subject to an IRS levy on a debt he owed to a taxpayer who had failed to pay taxes because an outstanding debt owed to a taxpayer is considered property belonging to the taxpayer. The debtor's claim that he had a right of set-off against his debt to the taxpayer prior to the service of the notice of levy did not negate the existence of the debt because federal tax liens attach on the date of the tax assessment, which, in this case, occurred prior to the claimed set-off. However, the debtor was not liable for a penalty for failure to surrender property subject to a levy without reasonable cause because his set-off claim gave rise to a bona fide dispute as to the existence of property subject to a levy.

Michael J. Yamaguchi, Assistant United States Attorney, San Francisco, Calif. 94102, for plaintiff. Kenneth E. Goodin, Jay P. Wertheim, Dinkelspiel & Dinkelspiel, One Market Plaza, San Francisco, Calif. 94105, for defendant.

Opinion

HENDERSON, District Judge:

The government filed this suit to enforce an IRS levy. The series of events giving rise to the levy are undisputed, and are as follows:

On November 27, 1978, the IRS assessed Norton Trucking (hereafter "Norton"), the taxpayer, for $102,881.99 in unpaid taxes. Payment in full has still not been made, and Norton is now out of business.

Norton performed trucking services for Guittard Chocolate Co. (hereafter "Guittard"), the defendant in this levy enforcement action.

In late 1978, Norton factored its accounts to a company called Transport Clearings (hereafter "Transport"). As a result, Transport came into possession of certain invoices billed by Norton to Guittard.

In December, 1978, Transport made a claim against Guittard for $40,400 on factored invoices billed from Norton to Guittard. Guittard denied liability on the invoices, contending that they had already paid the amount claimed by Transport directly to Norton. At the time that Transport made its claim against Guittard, Guittard had also received services from Norton on non-factored, unpaid invoices totalling $12,240. Guittard advised Norton that if it (Guittard) was forced to pay Transport on the disputed $40,400 claim, any amount paid to Transport would be used as an offset against the $12,240 in non-factored invoices then owing to Norton.

The Government filed notices of a federal tax lien in Indiana on the following dates in 1979: January 1, January 11, April 9, and October 30.

On January 31, 1979, in a suit to which Guittard was not a party, an Indiana court decreed that Transport was entitled to payment on any Norton invoices billed on or before December 5, 1978. Under the Indiana court's order, any Norton invoices billed on or after December 6, 1978 entitled Norton to payment. The total amount of the pre-December 6, 1978 invoices billed to Guittard, and thus the total on invoices owed by Guittard to Transport under the Indiana court decree terms, was $40,400.

The problem with this from Guittard's point of view was that, prior to the entry of judgment by the Indiana court, Guittard had paid directly to Norton some $30,584 on invoices dated prior to December 6, 1978. The dispute that had arisen in December of 1978 concerning Guittard's liability to Transport continued despite the Indiana court's decree, with Guittard claiming that payments made directly to Norton on the pre-December 6 invoices were made on the basis of authorization from Transport. Also, Guittard continued to assert to Norton that if Guittard were required to make any payments to Transport on the disputed invoices, such payments would be offset against post-December 6 invoices owed by Guittard to Norton.

On July 3, 1979, the government served a notice of levy on defendant Guittard based on the unpaid assessment against Norton.

On August 15, 1979, the IRS served Guittard with a final demand on its notice of levy. No payment was made by Guittard to the IRS pursuant to the notice of levy and final demand.

On March 24, 1981, Transport and Guittard entered into a settlement agreement resolving Transport's claim for $40,400 first made in December, 1978. Under the terms of the agreement, Guittard is to pay Transport $20,000 in full settlement of the claim for invoices totalling $40,400. This settlement agreement is subject to the approval of the Bankruptcy Court, due to the fact that Transport is now in bankruptcy. The approval of the Bankruptcy Court apparently has not yet been received, and none of the $20,000 settlement has been paid to Transport or its trustee in bankruptcy.

On May 12, 1981, the government filed the instant suit to enforce an IRS levy. In the complaint, the government alleged that Guittard is liable to the government for $16,320, plus interest and costs from the date of the levy (July 3, 1979). In papers in support of its motion for partial summary judgment the government contended that Guittard acknowledges a debt owed to Norton, and thus due the government on its lvey, in the amount of $12,240. The government also sought to recover a penalty from Guittard totalling 50% of the amount required to be surrendered by Guittard under the levy. The claim for a penalty was based on 26 U. S. C. 6332(c)(2) in that Guittard's failure to surrender property under the levy was allegedly without reasonable cause.

On October 21, 1981, an Order was entered denying defendant Guittard's motion to dismiss, granting the government's motion for partial summary judgment on the levy, and denying the government's motion for partial summary judgment as to the penalty.

The Levy

Though the defendant raised several contentions in support of its motion to dismiss, we note that in an action by the government to enforce an IRS levy, the available defenses are strictly limited. The only defenses that can be raised by the party that has failed to comply with a levy are that (1) the person against whom the levy is made is not in possession of the taxpayer's property, or (2) the taxpayer's property is subject to a prior judicial attachment or execution. United States v. Trans-World Bank [74-2 USTC 9632], 382 F. Supp. 1100, 1105 (C. D. Cal. 1974) and cases cited therein. The rationale for this limitation is that the process of levy and distraint authorized by 28 U. S. C. 6331 is the government's last resort for collecting taxes due. Accordingly, such an extraordinary procedure is not an appropriate one for raising a multitude of challenges to the government's claim, particularly in light of the numerous other procedures available to the party levied against as means of raising challenges to the government's claim. See United States v. Sterling National Bank [73-2 USTC 9494], 360 F. Supp. 917, 922-923 (S. D. N. Y. 1973), aff'd in part and rev'd in part on other grounds [74-1 USTC 9336], 494 F. 2d 919 (2nd Cir. 1974).

Thus, of the arguments raised by Guittard in support of its motion to dismiss, the only one properly before the Court was the claim that, at the time of the levy, Guittard had no property belonging to the taxpayer Norton. This contention was based on the premise that Guittard had a setoff against its debt to Norton at the time that Transport made its $40,400 claim against Guittard in December of 1978. The notice of levy was not served until July 3, 1979, seven months after the setoff allegedly came into existence, negating any debt owed to Norton by Guittard.

On the question of whether a party is in possession of the taxpayer's property for purposes of the validity of an IRS levy, state law is controlling. Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509, 512-513 (1960). Thus, whether a party against whom enforcement of a levy is sought has a defense based on non-possession of property depends upon whether, as a matter of state law, the taxpayer has a right to property held by the party levied against. American Fidelity Fire Ins. Co. v. United States [75-2 USTC 9636], 385 F. Supp. 1075, 1077 (N. D. Cal. 1974). If the taxpayer has a right to the property held by the party levied against, the government's tax lien attaches to that right.

Thus, defendant's motion to dismiss required a determination of whether, under California law, Guittard was in possession of property belonging to the taxpayer at the time of the levy. Under the facts of this case, that determination involved a two-step process. First, under California law, is a debt owed to a taxpayer a right to property belonging to the taxpayer, and therefore subject to levy under 26 U. S. C. 6331? If so, does the California law regarding setoff negate the existence of such a debt under the facts of this case?

Under California law, an outstanding debt owed to a taxpayer is considered property or a right to property belonging to the taxpayer. United States v. Graham [51-1 USTC 9218], 96 F. Supp. 318, 320 (S. D. Cal. 1951), aff'd per curiam sub nom. State of Calif., et al. v. United States [52-2 USTC 9425], 195 F. 2d 530 (9th Cir. 1952), cert. denied, 344 U. S. 831 (1952). Accordingly, a debt as such is subject to levy based on the taxpayer's failure to pay taxes. Id. Thus, if no setoff claim were asserted here, Guittard would be subject to levy on the $12,240 in invoices owing to the taxpayer Norton, in light of the fact that they are Norton's property under California law.

Guittard, however, claims that because it had a right of setoff against the debt to Norton that arose in December of 1978 when Transport made its claim, it had no property belonging to Norton at the time of the levy in July of 1979. Again we must look to California law on the question of the existence of a setoff. See Aquilino v. United States, supra, 363 U. S. at 512-514.

Under the law of California, a setoff is the right of a judgment debtor, who has become the owner of a judgment or claim against his judgment creditor, to go into the court that entered the judgment against him/her (the judgment debtor) and have his/her judgment or claim set off against his/her creditor's judgment. Highsmith v. Lair, 44 Cal. 2d 298, 302, 281 P. 2d 865 (1955); Harrison v. Adams, 20 Cal. 2d 646, 649, 128 P. 2d 9 (1942); 15 Cal. Jur. 3d Counterclaim and Setoff 3.

Guittard was not at any time relevant to this enforcement action a judgment debtor of taxpayer Norton. Thus, under California law, the doctrine of setoff is inapplicable. This leaves Guittard holding a debt owed to Norton at the time of the levy, and thus subject to a levy of the property.

Up until the settlement agreement with Transport, Guittard insisted that it was not liable on the claim by Transport for $40,400. If Guittard was not liable to Transport, no setoff against taxpayer Norton would ever arise. At best, what Guittard appears to have had in December of 1978 when Transport made its claim is a potential defense to a claim that might one day be filed by Norton. Guittard cited no California authority to support its contention that such rights against Norton as of December 1978 negated the debt it owed to Norton as of that date.

Guittard could have argued, of course, that by entering into a settlement agreement with Transport that required Guittard to make payments to Transport, the claimed setoff against Norton was just as effective as if some payment had in fact been paid to Transport. Even accepting this argument, the settlement agreement was not entered into until March 24, 1981, close to two years after the government served its notice of levy on Guittard.

Thus at all times relevant to this enforcement action, Guittard was in possession of taxpayer Norton's property in the form of a debt in the amount of $12,240.

Guittard contended that the date of the levy, not the date of the tax lien, determines whether the party levied against had any property belonging to the taxpayer. Logically, of course, if the party levied against owed money to the taxpayer on the date of the lien, but paid that amount over to the taxpayer prior to the service of notice of levy, the levy would be invalid because the party levied against would have no property belonging to the taxpayer. Guittard claims that its right to setoff effectively negated any interest that Norton had in the money at issue, and that that right to setoff was effective before Guittard received notice of the levy. The contention made by Guittard is really one concerning the priority of the federal tax lien as against the priority of the interest claimed under state law by the party levied against.

As noted above, the defense of lien priority cannot be raised in an action to enforce a levy. United States v. Sterling National Bank, supra, 360 F. Supp. at 922-923. Nonetheless, for the edification of counsel, we make the following observations on the issue of lien priority.

Even assuming for the purpose of argument that Norton [Guittard] had some right negating its debt to Norton, it is federal law that determines whether a state-recognized property interest has become so perfected as to defeat a federal tax lien. United States v. Pioneer American Ins. [63-2 USTC 9532], 374 U. S. 84, 88 (1963). Furthermore, federal law determines the priority of competing claims to property sought by the government to satisfy tax obligations. Aquilino v. United States, supra, 363 U. S. at 512-513. Only choate state interests take priority over federal tax liens. United States v. Pioneer American Ins., supra, 374 U. S. at 88. And federal tax liens attach on the date of the federal tax assessment. Id. Thus, even if the interest claimed by Guittard was sufficiently perfected, under federal law, to defeat a federal tax lien, it could only do so if it came into existence prior to the date of the tax assessment against Norton.

The assessment against the taxpayer was made in November of 1978. Guittard contended that its right to setoff arose in December of 1978. Even if Guittard were correct in its contention that the right to setoff was established in December, 1978, the federal tax lien attached to the debt first and thus takes priority over Guittard's claimed interest.

The Penalty

The government in its motion for partial summary judgment sought a penalty equal to 50% of Guittard's liability on the tax levy.

Under 26 U. S. C. 6332(c)(2), the penalty for failure to surrender property subject to a tax levy "shall be" assessed if the person required to surrender the property fails or refuses to do so "without reasonable cause." According to Treas. Reg. 301.6332-1(b)(2), the imposition of a penalty is inappropriate where a bona fide dispute exists as to the amount of property subject to the levy.

Though Guittard was incorrect in its contention that it had no property belonging to taxpayer Norton at the time of the levy, the existence vel non of a bona fide dispute is not determined by reference to which party prevails on the merits of the underlying claim. See United States v. Sterling National Bank, supra, 494 F. 2d at 923. Guittard's setoff claim was made in good faith, thus giving rise to a bona fide dispute as to the existence, and therefore the amount, of property subject to the levy.

Furthermore, under the circumstances of this case, failure to impose a penalty will not detract from the Congressional purpose of requiring compliance with tax livies. Id. Accordingly, the government's motion for partial summary judgment as to the penalty was denied.

Conclusion

Under the foregoing analysis, at the time of the levy, Guittard was in possession of a $12,240 debt belonging to taxpayer Norton. Guittard's motion to dismiss, treated as a motion for summary judgment, was therefore denied as no ground in defense of the government's enforcement action was established. Accordingly, the government's motion for partial summary judgment in the amount of $12,240 plus interest and costs from the date of the levy was granted.

A bona fide contention as to the existence of property subject to the levy having been raised by Guittard, the government's motion for partial summary judgment in the amount of a 50% penalty was denied.

 

[74-2 USTC 9565]United States of America, Plaintiff v. Gene Grupposo, Property Clerk, New York City Police Department, Defendant, and Arnaldo Comas, New York State Tax Commission, and Finance Administrator of the City of New York, Interpleaded Defendants

U. S. District Court, So. Dist. N. Y., 72 Civ. 5150, 6/26/74

[Code Sec. 6323]

Lien for taxes: Levy: Priority of creditors: Interpleader.--A U. S. tax lien had priority over the claims of the New York State Tax Commission and the delinquent taxpayer to property deposited with the property clerk of the New York City Police Department. At the time the government's notices of levy were served and final demands for surrender of the property were served, the other claimants had not manifested any interest or rights in the property to justify the clerk's refusal to turn the property over to the U. S.

Paul J. Curran, United States Attorney, David P. Land, Assistant United States Attorney, New York, N. Y., for plaintiff. Adrian Burke, C. Himmelman, Corporation Counsel, City of New York, Municipal Bldg., Chambers and Centre Sts., New York, N. Y. for defendant and interpleaded-defendant Finance Administrator of the City of N. Y. Henry L. Zweig, 261 Broadway, New York, N. Y., for interpleaded-defendant Arnaldo Comas. Louis J. Lefkowitz, Attorney General of New York, 80 Centre St., New York, N. Y., for interpleaded-defendant New York State Tax Commission.

The Status of the Controversy

CARTER, District Judge:

The basic facts in this controversy are virtually uncontroverted and follow. In the course of fighting a fire on the premises of 721 Dean Street, Brooklyn, New York, on December 27, 1969, the New York City Fire Department came into possession of $106,492.43 in United States currency, $466 of which was partially burnt and mutilated, some jewelry and personal papers. Arnaldo Comas resided at the 721 Dean Street residence, and the personal property in question belonged to him. The currency and jewelry were deposited with the property clerk of the New York City Police Department.

[Assessments Levied]

On December 30, 1969, the Internal Revenue Service levied income tax assessments against Comas for 1967, 1968, and 1969, for $20,639.40, $27,363.14 and $98,871.25 respectively for a total assessment of $46,873.79. That same day a notice of levy for the 1967 and 1968 assessments and a separate notice of levy for the 1969 assessment were served on the property clerk. Each notice of levy stated the amount of the tax assessments covered by the levy and advised the clerk that "all property" in his possession belonging to Arnaldo and Zulema Comas "are hereby levied upon and seized for the satisfaction of the aforesaid tax." On January 30, 1970, a final demand was served on the clerk "for the surrender to the [Internal Revenue Service] of all property and rights to property belonging to . . . Comas" in the amount of $48,008.54, and a similar final demand was served the same day for the surrender to the Internal Revenue Service of Comas' property in the amount of $98,877.25, plus lien fees. The clerk refused and failed to surrender the property pursuant to the aforesaid notices of levy and final demands.

[State's Assessment]

On April 30, 1970, the New York State Tax Commission served on the clerk a warrant agent's levy and execution based on warrants issued against Comas for delinquent New York State income taxes for 1967, 1968 and 1969 in the sum of $25,982.13.

On November 20, 1970, a further tax assessment (IRS) for the year 1969 in the sum of $54,037.32 was made, bringing the total tax assessment against Comas to $200,905.11, and notice of levy in respect to this additional assessment was served on the property clerk on August 18, 1971.

[Notice of Levy]

An execution and notice of levy was served on the property clerk on July 21, 1972, by the Finance Administration of the City of New York pursuant to a warrant issued against Comas for delinquent personal income taxes in the sum of $3,019.15. On December 12, 1972, the New York State Tax Commission served a warrant agent's levy and execution on the property clerk pursuant to a warrant issued against Comas for 1969 additional delinquent state income taxes.

[Compromise of Assessments]

The claims of the United States based upon the tax assessments of $200,905.11 were subsequently compromised, as follows, pursuant to a report of the Internal Revenue Service dated March 1, 1973: In respect of the December 30, 1969, assessments, for the year 1967, $4,707.44 in taxes; for the year 1968, $5,856.21 in taxes; and for the year 1969, $14,594.89; and $54,031.32 for the year 1969 pursuant to the November 20, 1970, assessment; the total amount including penalties and interest to April 15, 1973, was $99,981.53 consisting of $78,189.86 in taxes, $7,824.41 in penalties, $12,105.54 of accrued interest through April 15, 1973, and $36 in lien fees. The interest accrues at the rate of $21.47 per day from April 15, 1973, and thus the tax liability to the United States exceeds the $106,026.48 held by the clerk of this court.

The assessments of the New York State Commission in respect of its April 30, 1970, warrants agent's levy and execution was revised downward to $1,131.91 for the 1967 and 1968 tax delinquency and $3,782.60 for the 1969 tax delinquency plus interest.

On October 16, 1972, Comas brought an action in the New York State Supreme Court seeking a return of the property held by the property clerk to him. The State Tax Commission moved to intervene in the state proceedings in December, 1972. On December 5, 1972, this proceeding was commenced by the United States.

[Interpleader]

On April 20, 1973, the property clerk moved in this court for an order interpleading Comas, the New York State Tax Commission and the Finance Adminstration of the City of New York, amending the title of the action by adding the aforesaid parties as interpleaded defendants, enjoining Comas from proceeding further with the action pending in the New York State Supreme Court and enjoining Comas, the New York State Tax Commission and the New York City Finance Administration from instituting any other action against the property clerk in respect of the property in question. In addition, the clerk moved to be discharged from all further liability with respect to the currency and jewelry upon its delivery to the registry of this court.

On June 8, 1973, this court in a memorandum opinion granted the motion in all respects. It was subsequently determined that the clerk of this court had no means of holding the mutilated currency and jewelry, and Comas' attorney agreed to hold the jewelry and mutilated currency. An order was signed on September 26, 1973, directing that $106,026.43 in currency be delivered to the clerk of this court and the $466 in mutilated currency and the jewelry be delivered to Henry L. Zweig, attorney for Comas. Zweig had up to this point not taken possession of the property. It remains with the property clerk.

Instant Proceedings

The United States moves for summary judgment pursuant to Rule 56, Federal Rules of Civil Procedure (FRCP), and for an order directing the clerk of this court to remit to the United States the $106,026.43 cash interpleaded and deposited in this court, and directing the property clerk to remit to the United States the $466 mutilated currency and jewelry belonging to Comas for evaluation by the United States, and directing the United States, after application of the property in satisfaction of the federal tax liability of Comas, to deposit the balance, if any, with the registry of this court for distribution by this court.

The State of New York cross-moves for summary judgment pursuant to Rule 56, FRCP, and for an order directing the property clerk to remit to the New York State Tax Commission the sum of $4,914.51, plus accrued interest from the cash sum of $106,026.43 interpleaded and deposited with the registry of this court.

The property clerk moves for summary judgment to Rule 56, FRCP, and for an order directing the property clerk to remit the mutilated currency and jewelry still in his possession to the appropriate party and dismissing the complaint against the defendant, property clerk, and relieving him of further liability in respect of said property after its delivery to the appropriate party.

Determination

The motion of the United States is granted. At the outset, it should be stated that the court now regards its memorandum opinion of June 8, 1973, and the September 26, 1973, order issued pursuant thereto relieving the property clerk of liability in respect of the Comas property in his possession as error. The rationale of the earlier disposition was that the property clerk was an innocent stakeholder unable to determine which of four contending parties was entitled to the Comas property in his possession. The uncontroverted facts agreed upon by all parties as set out in the papers in support of their various motions prove conclusively that the property clerk was in clear violation of the requirements of 26 U. S. C. 6332(c), 1 as of December 30, 1969, when he was served two notices of levy by the Internal Revenue Service on the Comas property in his possession in respect of tax assessments totalling $146,873.79, plus $12 for lien fees. Moreover, the property clerk concedes the final demands for surrender of the property to satisfy the $146,873.93 assessments were served on him on January 30, 1970, by the Internal Revenue Service, and he continued in his refusal to surrender the property.

By virtue of the tax assessment a lien in favor of the United States attached to the property, and after the notices of levy had been served on the property clerk in respect of these assessments on Comas' property in his possession, his refusal to surrender the property on demand rendered him personally liable. See United States v. First National City Bank [64-1 USTC 9231], 321 F. 2d 14, 17, 18 (2d Cir. 1963).

Both at the time the December 30, 1969, notices of levy were served and the January 30, 1970, final demands for surrender of the property were served, no other claimant had manifested any interest or rights in the property to justify the clerk's refusal to turn the property over to the United States. The Sate Tax Commission did not assert its claim to the property until April 30, 1970, when it served a warrant agent's levy on the property clerk. The Finance Administration did not serve a levy on the property clerk until July 21, 1972, and Comas did not assert any claim to the property until he instituted proceedings in the New York State Supreme Court on October 16, 1972.

Thus, the property clerk in inexcusable definance of federal law held on to the property for four months affter the United States had properly asserted its right to possess the property in question and occupied thereby a priority in right to the property to the exclusion of all others. 2 United States v. Cox [54-1 USTC 9136], 119 F. Supp. 147 (N. D. Ga. 1953); Stadelman v. Hornell Woodworking Corp. [59-1 USTC 9296], 172 F. Supp. 156 (W. D. N. Y. 1958); Oxford Distributing Co. v. Famous Robert's, Inc., 5 A. D. 2d 507, 173 N. Y. S. 2d 468 (1958). These uncontroverted facts were either misconceived by me or not clearly set forth in the prior proceedings. The court was led to believe that the claims were simultaneously asserted leaving the property clerk in doubt as to what proper course to take. Therefore, he appeared to be an innocent bystander. However, in light of the conceded facts as presently adduced, he was clearly a wrongdoer and has no justifiable defense for his refusal to surrender the property. United States v. Sterling National Bank & Trust Co. [74-1 USTC 9336], 494 F. 2d 919, Slip. Op. Nos. 472-3 at 2396, 2397 (2d Cir. March 29, 1974) and cases cited therein.

The claim that he did not know to whom the property belonged until Comas instituted litigation in October, 1972, to recover the property is totally without merit. The property was taken from the residence of Comas by the Fire Department and deposited with the property clerk. When the United States filed its notices of levy, no adverse claims had been asserted. The property clerk had no basis to doubt that this property which he knew had been taken from 721 Dean Street, the indicated address of Comas on the fact of the notices of levy, belonged to Comas. Moreover, even if he had cause to doubt ownership of the property, he was obligated to comply with the mandate of Section 6332, United States v. Sterling Bank & Trust Co. of New York [73-2 USTC 9494], 360 F. Supp. 917 (S. D. N. Y. 1973). If at some future time error was discovered, the property clerk could not be held subject to liability for complying in good faith with the law's requirements. Indeed, 26 U. S. C. 6332(d) 3 expressly discharges the clerk from liability under those circumstances.

The December 30, 1969, notices of levy effectively seized all the Comas property in the hands of the property clerk, United States v. Manufacturers Trust Co. [52-2 USTC 9417], 198 F. 2d 366 (2d Cir. 1952), and constituted an effective transfer of the property to the United States. United States v. Pittman [71-2 USTC 9650], 449 F. 2d 623 (7th Cir. 1971); Rosenblum v. United States [62-1 USTC 9384], 300 F. 2d 843 (1st Cir. 1962); United States v. Eiland, 223 F. 2d 118 (4th Cir. 1955); American Honda Motor Co., Inc. v. United States [73-2 USTC 9670], 363 F. Supp. 988 (S. D. N. Y. 1973). Once notice had been filed, the lien was superior to any perfected subsequently.

Both the property clerk and the State Tax Commission contend that the United States does not have priority in respect to all the Comas property held by the property clerk. They argue that because the 1967, 1968 and 1969 assessments, pursuant to which the December 30, 1969, notices of levy were served, were subsequently compromised, reducing the taxes due from assessments totalling $146,873.79 to a final tax figure of $25,158.54 plus accrued interest, that the December 30 notices of levy can attach only to the amount of property sufficient to satisfy the tax liability as compromised. Moreover, it is contended that since the State Tax Commission filed a warrant agents levy on the property clerk on April 30, 1970, prior to the serving of the third notice of levy by the United States for an additional tax assessment for 1969 of $54,031.32 plus interest, it has a lien on the property subsequent to the December 30 assessments as compromised but prior to the assessment of the Internal Revenue Service on November 20, 1970. The State relies on Commercial Credit Corp. v. Schwartz [55-2 USTC 9589], 130 F. Supp. 524 (E. D. Ark. 1955), "the first in time, first in right" rule. That reliance is misplaced.

The levise of December 30, 1969, were based on a total tax assessment of $146,873.93. Had the property clerk complied with federal requirements, he would have turned over the undamaged cash, mutilated cash and jewelry to the United States at that time. The fact that the tax was subsequently compromised cannot displace or defeat the United States prior asserted lien up to $146,873.93. When that lien was attached, there were no intervening liens which would warrant application of the "first in time, first in line" principle. If the United States were now asserting a claim in excess of the December 30, 1969, assessments and levies, the State Tax Commission position would have merit. See, United States v. Pollack [67-1 USTC 9325], 370 F. 2d 79 (2d Cir. 1966). The state claim is unsupportable on the merits.

The United States argues that the court need not reach the merits because it lacks jurisdiction in that the state lacks standing to controvert the claims of the United States. The United States has foreclosed its tax lien by levy on December 30, 1969, based on the assessments in excess of the amount now claimed. 26 U. S. C. 7426(a)(1) 4 provides for suits by third parties for a wrongful levy but the litigation must be commenced within the time frame set forth in 26 U. S. C. 6532(c)(1), 5 requiring that the action be brought within nine months from the date of levy. In the alternative, if a request for a return of the levied property is filed with the Internal Revenue Service, the time set for the commencement of litigation is twelve months from the date the request was filed or six months from the date notice of disallowance was mailed, whichever is shorter. 26 U. S. C. 6532(c)(2). 6

This right to contest such wrongful levies is accorded without regard to whether the property has been surrendered or sold to the United States (26 U. S. C. 7426(a)(1)), and in such adjudication the tax assessment on which the United States lien is based "should be conclusively presumed to be valid." 26 U. S. C. 7426(c). 7 Compliance with these provisions has been held by this court to be a prerequisite to the exercise of subject matter jurisdiction in respect of a 7426 claim. American Honda Motor Co., Inc. v. United States [73-2 USTC 9670], 363 F. Supp. 988 (S. D. N. Y. 1973). There can be no contention that the state followed the statutory procedures which could evoke this court to exercise jurisdiction in this controversy.

Accordingly, summary judgment must be awarded the United States both on jurisdictional grounds and on the merits, and the memorandum opinion of June 8, 1973, and the September 26, 1973, order insofar as they relieve the property clerk of liability and dismiss the action as to him are recalled and vacated.

1 This provision reads:

"(c) Enforcement of levy.--

"(1) Extent of personal liability.--Any person who fails or refuses to surrender any property or rights to property, subject to levy, upon demand by the Secretary or his delegate, shall be liable in his own person and estate to the United States in a sum equal to the value of the property or rights not so surrended, but not exceeding the amount of taxes for the collection of which such levy has been made, together with costs and interest on such sum at the rate of 6 percent per annum from the date of such levy. Any amount (other than costs) recovered under this paragraph shall be credited against the tax liability for the collection of which such levy was made.

"(2) Penalty for violation.--In addition to the personal liability imposed by paragraph (1), if any person required to surrender property or rights to property fails or refuses to surrender such property or rights to property without reasonable cause, such person shall be liable for a penalty equal to 50 percent of the amount recoverable under paragraph (1). No part of such penalty shall be credited against the tax liability for the collection of which such levy was made."

2 Apparently, the Internal Revenue Service failed to file with the Register of Kings County a notice of federal tax lien in respect of the 1969 tax assessments made on December 30, 1969. The lien is valid, though not recorded, and would have priority over the state or city in any event. United States v. Union Central Life Insurance Co. [62-1 USTC 9103], 368 U. S. 291 (1961); Rosenblum v. United States [62-1 USTC 9384], 300 F. 2d 843 (1st Cir. 1962); United States v. Rasmuson [58-1 USTC 9399], 253 F. 2d 944 (8th Cir. 1958); United States v. Manufacturers National Bank [61-2 USTC 9701], 198 F. Supp. 157 (N. D. N. Y. 1961). Moreover, neither the property clerk nor the State Tax Commission has asserted in its submissions for summary judgment that the technical oversight gives rise to any defenses to or claims opposing the right of the United States to the property. Therefore, any such defenses or claims are deemed waived. See Systems, Inc. v. Bridge Electronics Co., 335 F. 2d 465 (3d Cir. 1964); Wright & Miller, Federal Practice and Procedure: Civil 1394. See also, Lehigh Portland Cement Co. v. United States [39-2 USTC 9798], 30 F. Supp. 217, 228 (Ct. Cl. 1939).

3 Section 6332(d) reads as follows:

"(d) Effect of honoring levy. 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 who, upon demand by the Secretary or his delegate, surrenders such property or rights to property (or discharges such obligation) to the Secretary or his delegate (or who pays a liability under subsection (c)(1)) shall be discharged from any obligation or liability to the delinquent taxpayer with respect to such property or rights to property arising from such surrender or payment. In the case of a levy which is satisfied pursuant to subsection (b), such organization shall also be discharged from any obligation or liability to any beneficiary arising from such surrender or payment."

By not turning the money over to the United States, as he was obliged to do, the property clerk has cost Comas, the taxpayer, considerably more in interest and possible penalties than the government would have been entitled to if it had possessed the property as of December 30, 1969.

4 "7426. Civil actions by persons other than taxpayers

(a) Actions permitted.--

(1) Wrongful levy.--If a levy has been made on property or property has been sold pursuant to a levy, any person (other than the person against who is assessed the tax out of which such levy arose) who claims an interest in or lien on such property and that such property was wrongfully levied upon may bring a civil action against the United States in a district court of the United States. Such action may be brought without regard to whether such property has been surrendered to or sold by the Secretary or his delegate.

5 6532(c)(1) reads as follows:

"Suits by persons other than taxpayers.--

(1) General rule. Except as provided by paragraph (a), no suit or proceeding under section 7426 shall be begun after the expiration of 9 months from the date of the levy or agreement giving rise to such action."

6 26 U. S. C. 6532(c)(2) reads as follows:

"(2) Period when claim is filed.--If a request is made for the return of property described in section 6343(b), the 9-month period prescribed in paragraph (1) shall be extended for a period of 12 months from the date of filing of such request or for a period of 6 months from the date of mailing by registered or certified mail by the Secretary or his delegate to the person making such request of a notice of disallowance of the part of the request to which the action relates, whichever is shorter."

7 26 U. S. C. 7426(c) reads as follows:

"(c) Validity of assessment.--For purposes of an adjudication under this section, the assessment of tax upon which the interest or lien of the United States is based shall be conclusively presument to be valid."

 

[83-2 USTC 9685]United States of America, Plaintiff v. Yonkers Child Care Association, Inc., Hudson Valley National Bank, Westchester County Department of Social Services, Westchester County Sheriff's office, Vincent K. Murtha, and Paul D. Jaffe, Defendants

U. S. District Court, So. Dist. N. Y., 82 Civ. 8416, 566 FSupp 1509, 7/25/83

[Code Secs. 6323 and 6332]

Tax liens: Priority: Judgment creditor: Liability of sheriff.--Since a federal tax lien arose two years prior to the entry of a creditor's default judgment against the taxpayer, the tax lien was entitled to priority. Moreover, because the tax lien had priority, the government was entitled to a judgment against the sheriff to recover the funds which he had obtained pursuant to a levy against the taxpayer's bank account upon the creditor's default judgment.

Rudolph W. Giuliani, United States Attorney, William J. Brennan, Assistant United States Attorney, New York, N. Y. 10007, for plaintiff. Paul D. Jaffe, Greenspan & Jaffe, 180 East Post Road, White Plains, N. Y. 10601, for Vincent K. Murtha and Paul D. Jaffe. Samuel S. Yasgur, Peter J. Holmes, 148 Martine Ave., White Plains, N. Y. 10601, for defendnat Sheriff's Office. Griffin, Fanelli, Letsen & Coogan, 51 Pondfield Rd., Bronxville, N. Y. 10708, for Hudson Valley National Bank.

Opinion

WEINFELD, District Judge:

The United States and the defendant Vincent Murtha cross-move for summary judgment in this action brought by the government to enforce federal tax liens against a delinquent taxpayer, Yonkers Child Care Center ("YCCC"), which has defaulted. Two other defendants, the Hudson Valley National Bank and the Westchester Department of Social Services, hold funds of YCCC that both the government and Murtha claim, but these defendants assert no interest of their own in those funds. The government seeks judgment against the Westchester County Sheriff, also a defendant herein, 1 who transferred funds to Murtha pursuant to a levy on YCCC's bank account under a judgment entered in favor of Murtha, discussed hereafter.

Since approximately early 1976, YCCC had failed to pay its FICA taxes. Assessments, notices and demands were served on YCCC on December 20 and 21, 1976, and April 18, June 27, October 17 and December 5, 1977. By December 5, the total unpaid assessed balance had reached $35,450.55. On March 1, May 17, August 18 and December 20, 1977, notices of the tax liens were filed with the New York Secretary of State. On September 19, 1980, the government served a notice of levy on the Sheriff.

Murtha, a forner YCCC employee, after extensive litigation in state trial and appellate courts, recovered a default judgment against it for wrongful discharge. The judgment was entered in Supreme Court, Westchester County, on October 23, 1979. Executions were issued and pursuant thereto the Sheriff levied on YCCC's bank account, and two days later (November 11, 1979) received $11,239. The following month the default was vacated, however, but the judgment remained in effect as security. On Marcy 26, 1981, after trial, a final judgment was entered in Murtha's favor for $18,500. Thereafter, on July 8, 1981, the funds (less poundage fees) which the Sheriff had previously recorded were turned over to Murtha.

Under 26 U. S. C., section 6322, when any person neglects or refuses to pay any federal tax upon demand, a federal tax lien arises "at the time the assessment is made and . . . continue[s] until the liability for the amount so assessed . . . is satisfied or becomes unenforceably by reason of lapse of time." The federal lien here thus arose, at the latest, on December 20, 1977--two years prior to the entry of Murtha's default judgment on October 23, 1979, which was vacated and subsequently re-entered on March 26, 1981. Accordingly, the federal lien is entitled to priority over the Murtha judgment. 2

Murtha's arguments to the contrary are unavailing. His claim that the federal lien had to be served on the clerk of Westchester County is contrary to the New York Lien Law, section 240(2)(a), which provides that service on the Secretary of State is sufficient. The federal bankruptcy priority rules are irrelevant since no petition has been filed, and Murtha's mechanic's lien theory is inapposite. 3 Murtha's laches defense fails in view of the government's filing of its lien in 1977, and its subsequent acts with respect thereto. Finally, Murtha urges the Court to exercise its general equity authority in view of the nature of his litigation and his persistent effort to enforce his claim is to which he finally prevailed. But the statutory command controls.

Since the government has priority, it moves for judgment against the Sheriff to recover the $11,239 which he obtained pursuant to a levy against YCCC's bank account upon Murtha's 1979 judgment. After the government's notice of levy had been served on the Sheriff, Murtha's 1981 judgment was entered. It provided that "the sum presently held by the Sheriff of the County of Westchester obtained pursuant to an execution previously issued may now be remitted to [Murtha] or his attorney together with appropriate interest and less the appropriate fees and expenses of that office, subject to the lien rights of the United States." Despite the underscored and explicit language in the judgment regarding the federal lien, the Sheriff transferred the funds to Murtha's counsel. Under 26 U. S. C., section 6332(c)(1), such conduct renders the Sheriff liable "in his own person."

In defense, the Sheriff raises two arguments: (1) that Murtha's rights are superior to the government's--which the Court has already rejected, and (2) that the Sheriff was compelled to turn over the funds by reason of the 1981 judgment. He further argues that because the funds were transferred "subject to the lien rights of the United States," the government's lien was preserved. However, this disregards the government's notice of levy entered six months previously. Moreover, the 1981 judgment itself was clear notice to the Sheriff of the government's existing lien. At a minimum, the Sheriff should have sought a judicial determination of the proper disposition of the funds. 4 His failure to do so was at his own peril. The government is entitled to judgment in its favor against the Sheriff for the amount improperly turned over to Murtha. It is also clear from the foregoing that since the government's lien has priority, it is also entitled to the funds held by the Westchester County Department of Social Services and the Hudson Valley National Bank.

In sum, the government's motion for summary judgment is granted, and Murtha's cross-motion is denied.

So ordered.

1 Also named as a defendant is Murtha's counsel, Paul D. Jaffe. The government has represented to the Court, however, that it asserts no claim against him.

2 United States v. Pioneer American Insurance Co. [63-2 USTC 9532], 374 U. S. 84 (1963); United States v. New Britain [54-1 USTC 9191], 347 U. S. 81 (1954).

3 See, e.g., 26 U. S. C. 6323(h)(2).

4 See, e.g., CPLR 5234(b)(c).

 

[75-2 USTC 9555]United States of America, Plaintiff v. Vincent J. Cuti, Jr., Defendant

U. S. District Court, East., Dist. N. Y., 74 C 887, 395 FSupp 1064, 6/6/75

[Code Sec. 6332]

Surrender of property subject to levy: Property in possession of third party: Escrow fund: Reasonable cause.--The holder of funds in escrow was ordered to pay over the sum which was subject to a lien for taxes. The escrow fund was not subject to prior judicial attachment or execution and the court concluded that the holder was in possession of the property or had rights to the property so as to be able to turn over the fund. However, the court concluded that the holder was not subject to the penalty provided by law for dishonoring the government's lien because he had been presented with an unsettled question of law--who bore the burden of paying for a lien record search.

Lloyd H. Baker, Assistant United States Attorney, Brooklyn, N. Y., for plaintiff. Vincent J. Cuti, 464 New York Ave., Huntington, N. Y., for defendant.

Memorandum and Order

BRAMWELL, District Judge:

This is a motion by the government for summary judgment. The defendant has interposed a cross-motion for summary judgment. Fed. R. Civ. P. 56. The material facts in the case are not in controversy.

This case involves a dispute regarding the obligations of the defendant, Vincent J. Cuti, an attorney of the State of New York, as escrow agent, resulting from a tax levy affecting his principal, the Bivona Vista Restaurant, Inc.

The government brought this action against Vincent J. Cuti, Jr. after he failed to honor a tax levy imposed by the Internal Revenue Service (I. R. S.) upon moneys held by him which originally came into his possession as escrow agent for Bivona Vista Restaurant, Inc.

[Levy on Escrowed Funds]

Since the chronology of events is crucial to the disposition of the motions before this Court, it is set forth below.

On August 27, 1971, the taxpayer, Bivona Vista Restaurant, Inc., sold the assets of its business, and placed the proceeds of sale, amounting to $4,555.20, in escrow with its attorney, Vincent J. Cuti, Jr. 1

The government's complaint and supporting affidavit indicate that on October 28, 1971, January 28, 1972, December 18, 1972, and February 2, 1973, a delegate of the Secretary of the Treasury of the United States issued and served upon Mr. Cuti, notices of levy on all property and rights to property in his possession belonging to the taxpayer, on which liens had attached in favor of the United States of America. Such liens included any sums of money held in escrow by the defendant to or for the account of the taxpayer to the extent that such property and rights to property were necessary to satisfy the amounts due from the taxpayer. Final demands were issued and served upon Mr. Cuti on January 28, 1972, July 18, 1972, and October 11, 1973.

[Fund Holder's Challenge]

In his affidavit in support of his notice of cross-motion the defendant expressly conceded: that he has no standing to and does not challenge either the validity or the amounts of the assessments made against the taxpayer; and that he does not contest or dispute either the validity or the amounts of the levies served upon him, or that the same were valid and accurate.

Section 6332(a) of Title 26 of the United States Code (Internal Revenue Code) provides in pertinent part:

"[A]ny 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."

[Two Defenses]

Section 6332(a) gives the possessor of property upon which a levy has been made only two defenses: first, that such person was not in possession of property which was subject to levy; and second, that the property was subject to prior judicial attachment or execution. The statute provides no other defenses. See United States v. Manufacturer's Trust Co. [52-2 USTC 9417], 198 F. 2d 366 (2d Cir. 1952); United States v. Third National Bank & Trust Co., Scranton, Pa., 111 F. Supp. 152 (D. C. M. D. Pa. 1953).

Section 6332(c)(1) provides that when one dishonors a tax levy, he is personally liable to the United States for the value of the property not surrendered, together with costs and interest. At the outset of this action, the amount sued for by the government was $4,555.20, plus interest and costs. The defendant does not dispute the value of the property not surrendered, that is $4,555.20. The government is also seeking to exact a penalty from the defendant pursuant to Section 6332(c)(2) for his failure to turn over the corpus of the escrow account.

The defendant has cross-moved for summary judgment. His supporting papers do not establish that the property which the government seeks to recover was subject to prior judicial attachment or execution. Therefore, that defense is not available to the defendant. The basis upon which the defendant has predicated his refusal to pay over the escrow fund to the government is that the same does not constitute "property or rights to property" of the taxpayer made subject to levy by the provisions of Section 6332 of the United States Code. Defendant contends that where an escrow account may be subject to the claims of other creditors whose claims have not been the object of prior judicial attachment or execution, the property in the escrow account is not the property of the taxpayer. However, the defendant has failed to provide any authority for this proposition. After exhaustive research, the Court has been unable to find any authority for the defendant's argument. One must ask rhetorically then, if Mr. Cuti was not in possession of property or rights to property of the taxpayer, then who was in possession of such property? Who had rights to such property? Clearly, it was not the property of creditors who had not reduced their claims to judgment or who had not levied upon their judgments. Therefore, such moneys in the defendant's possession are payable to the government.

[Subject to Penalty?]

The remaining issue to be confronted by this Court is whether the defendant having dishonored the government's tax levy is liable for a penalty under Section 6332(c)(2). Subsection (c)(2) provides that in addition to the personal liability imposed by subsection (c)(1):

[I]f any person required to surrender property or rights to property fails or refuses to surrender such property or right to property without reasonable cause, such person shall be liable for a penalty equal to 50 percent of the amount recoverable under [subsection (c)(1)]. No part of such penalty shall be credited against the tax liability for the collection of which such levy was made.

26 U. S. C. 6332(c)(2) [emphasis added].

In United States v. Sterling National Bank & Trust Company of New York [74-1 USTC 9336], 494 F. 2d 919 (2d Cir. 1974), the Second Circuit addressed itself to an interpretation of the term "reasonable cause" as it is used in the subject statute. There the Court emphasized that "[n]o penalty can be imposed if the [defendant] acted with 'reasonable cause' in resisting the levy." 494 F. 2d at 923. Further, the Court expressly indicated that it rejected the view that for the purposes of this statute "reasonable cause" could not as a matter of law be an adherence to "a non-frivolous, but erroneous, argument of law . . ." Moreover, the Court set forth the principle that a holder of property which is levied upon has "reasonable cause" to resist the levy if he is presented with an unsettled question of law concerning the rights and obligations with respect to such property held:

"The question here is whether we should penalize the [defendant] for forcing the government to litigate an unsettled question of law. There is no reason to believe that Congress would wish to penalize the holder of the property levied upon for litigating a test case. Nor do we believe that failing to impose the 50% penalty in situations like this will detract from the congressional purpose of requiring compliance with tax liens." Id. at 923.

Applying the Sterling standard to the facts of this case, we find that the defendant, Mr. Cuti, was a mere stakeholder who was ready, willing and able to disburse the funds in his possession in accordance with the Order of a Court of competent jurisdiction. He engaged in a continuous dialogue and course of correspondence with the I. R. S. in an attempt to comply with the statutory requirements of the Internal Revenue Code. He continuously indicated to the I. R. S. that he was only trying to insulate himself from potential liability to adverse claimants to the funds he held in escrow. Defendant correctly asserted that under the circumstances of this case he is afforded no statutory protection from liability to beneficiaries of the escrow fund.

[Holder Cooperative]

Mr. Cuti made every effort to cooperate with the government to the extent that he agreed to assume the role of a Court of competent jurisdiction and make the determination as to priority of liens, if the government would agree to authorize deduction of the cost of a search for the liens of record from the escrow fund. This offer the government declined.

Thus, the issue before this Court has ultimately narrowed to this: who bears the burden of making and paying for a search for the liens of record in the circumstances presented? Neither of the parties has set forth authority for their contentions that the burden of search and payment for such search rests upon the other. The Court is aware of American Honda Motor Co., Inc. v. United States [73-2 USTC 9670], 363 F. Supp. 988 (S. D. N. Y. 1973), where in dictum the burden was placed upon the possessor of taxpayer's property. However, Honda, supra, is factually dissimilar from the instant case. Moreover, in that case, no authority is cited for that view.

[Unsettled Legal Question]

The test for reasonable cause set forth in Sterling, supra, is whether or not a unsettled question of law exists. This Court finds that the question of whether the government or the attorney-escrow agent bears the burden of making and paying for a search for the liens of record in the circumstances presented is such an unsettled question. The dictum in Honda, supra, does not lead this Court to a contrary conclusion. Therefore, the demand for the 50% statutory penalty is denied.

Accordingly, partial summary judgment is granted to the government to the extent that Mr. Cuti is directed to pay over the corpus of the escrow account, $4,555.20 to the government, plus interest; and partial summary judgment is granted to Mr. Cuti to the extent that he is held not liable to the United States for the 50% statutory penalty.

SO ORDERED.

1 The portion of the contract dealing with the escrow account reads as follows:

"EIGHT: The parties agree to comply with the provisions of the Uniform Commercial Code relative to Sale in Bulk and Bivona Vista Restaurant, Inc., agrees to provide at least FIFTEEN (15) DAYS prior to the closing, a list of its existing business creditors and that all existing taxes pertaining thereto and all creditors shall be paid on or before closing of title. The seller shall provide the buyer with a release as to taxes. A tax credit and escrow shall be held by seller's attorney in the minimum of 5000 to a maximum of 7500 to be determined at closing for a period of 90 days and applied to the payment of the aforesaid."

 

[83-2 USTC 9585]United States of America, Plaintiff v. Capital Savings Association, Successor to First State Savings Association, Defendant

U. S. District Court, No. Dist. Ind., Hammond Div., Civil No. H 80-692, 576 FSupp 790, 7/27/83

[Code Sec. 6332]

Levy and distraint: Bank accounts: Failure to surrender property: Reasonable belief.--A saving association's reasonable belief that all of the funds within a joint savings account belonged to an innocent spouse, and not to her and her husband, did not excuse it from liability to the government for one-half of the funds when it released all of the funds to her and did not place a hold on the account until the IRS could determine exactly which portion or how much of the account should have been paid over in satisfaction of a levy. The saving association, however, was not liable for an additional 50-percent penalty pursuant to Code Sec. 6332(c)(2) because there had been a bona fide dispute as to the ownership of the funds in question.

United States Attorney, Charles B. Miller, Assistant United States Attorney, Hammond, Indiana 46320, T. Kazan Ray, Department of Justice, Washington, D. C. 20530, for plaintiff. James A. Holcomb, Lucas, Clifford & Holcomb, 1000 E. 80th Place, Merrillville, Indiana 46410, David Capp, 8585 Broadway, Merrillville, Indiana 46410, for Mary T. Bianco, for defendant.

Memorandum, Opinion and Order

MOODY, District Judge:

This cause came on for trial without intervention of a jury upon Plaintiff's Complaint and the Defendant's Answer and affirmative defenses only on the 23rd day of May, 1983, and the Court, having heard and considered the evidence, finds the facts and states the conclusions of law as follows:

Findings of Fact

1. The Defendant, Capital Savings Association, formerly known as First State Savings Association, is a savings and loan association having its principal offices at 100 West Ridge Road, Gary, Indiana.

2. That on November 16, 1978 Pete Bianco a/k/a Peter J. Bianco owed delinquent income taxes to the United States government for the years 1968 through 1971. That this tax liability was his alone and that his wife, Mary T. Bianco, had been granted "innocent spouse" status.

3. On November 16, 1978 David M. Moss, a Revenue Agent with the Internal Revenue Service, served a "Notice of Levy" upon the defendant at its offices at 100 West Ridge Road, Gary, Indiana, requiring the defendant to pay over to the Internal Revenue Service any property or rights to property belonging to the taxpayer, Peter J. Bianco. The Revenue Officer indicated that only those funds belonging to Peter J. Bianco were to be turned over pursuant to the Notice of Levy.

4. That on said date and at the time of the serving of the Notice of Levy there existed a savings account at First State Savings Association, now known as Capital Savings Association, Account No. B-495 in the joint names of Pete Bianco and Mary T. Bianco which account was opened on July 16, 1975 and which was rolled over from a previous account that the parties held in joint names, and which prior to that time belonged to Mary Bianco alone.

5. That on the same date, namely, November 16, 1978, one of the attorneys for the Defendant discussed with the Revenue Agent in charge of the collection the subject of Indiana law with respect to ownership of joint savings accounts, the procedures for determining same and inquired as to his or the authority of the IRS for levying upon a joint account when the liability is only that of one taxpayer rather than the joint tenants. The Revenue agent indicated that he would look into the question and get back to her in that regard.

6. That at no time from November 16, 1978 through April 25, 1979 did the Internal Revenue Service or any of its agents or employees ever furnish to the defendant or its attorneys, as requested, any authority for its levying on a joint savings account to satisfy the tax deficiency of one of the signators only to that joint account.

7. Further, on November 16, 1978, and after discussing the matter with defendant's counsel, the Revenue officer informed John Sikora, President of Capital Savings Association, that he did not expect payment that day but rather he should put a hold on the account until the Internal Revenue Service could determine exactly which portion or how much of the account should be paid over to the Internal Revenue Service in satisfaction of the levy.

8. On January 26, 1979, Mary Bianco, wishing to purchase a new home, entered Capital Savings Association for the purpose of obtaining a mortgage until such time as she could sell her home. John Sikora informed her that it was impossible to obtain a mortgage in the three to five day period which she indicated. Sikora then suggested to Mrs. Bianco that she withdraw the money from her savings account, No. B-495, and replace that money once her present home had been sold. It was at this time that Mr. Sikora informed Mrs. Bianco of the levy against the account and once again placed a call to the attorneys for Capital Savings Association indicating that Mrs. Bianco wanted to withdraw the funds from the savings account upon which the levy had been placed.

9. Upon being informed of the levy, Mrs. Bianco indicated to Mr. Sikora that the money in Account No. B-495 was her money, a claim which she maintains in this litigation and of which she had previously informed the Internal Revenue Service through her attorney.

10. That upon receiving the inquiry from the defendant concerning the request of Mary Bianco to withdraw the funds from the account in question, the attorneys for the defendant attempted to reach the Revenue agent and others at the Internal Revenue Service concerning this action, but were unsuccessful in their attempts. Unable to reach the Revenue Agent in charge and not having heard from him on January 29, 1979, and not having any word from the Internal Revenue Service or any of its agents or employees concerning the ownership question of the account or what specific funds, it any, were to be turned over to the Internal Revenue Service, Mary Bianco was allowed to withdraw the sum of $18,518.21 from Account No. B-495 on January 29, 1979.

11. Those funds were then used as payment for the home in which Mary Bianco and Peter Bianco presently reside and which was purchased shortly after the withdrawal of funds from the account in question on January 29, 1979.

12. On April 24, 1979, the Revenue agent contacted the attorneys for the defendant inquiring as to whether or not the funds in the account had been released and the following day, April 25, 1979, served a Final Demand upon the defendant.

13. From November 16, 1978 until April 25, 1979 the only action taken by the Internal Revenue Service to determine ownership interest in the account in question was to serve a summons upon First State Savings Association through which summons they obtained the signature card for the account and the card showing the transactions with respect to the account, namely, deposits, withdrawals and adding of dividends or interest.

14. That the signature card for the account in question contains the following language:

"It is agreed by the signatory parties with each other and by the parties with you that any funds placed in or added to the account by any one of the parties are and shall be conclusively intended to be a gift and delivery at that time of such funds to the other signatory party or parties to the extent of his or their pro rata interest in the account. (Emphasis in original.)

15. While the taxpayer, Peter Bianco, was in the service during the early '40s in World War II, Mary Bianco worked at U. S. Steel in Gary, Indiana and lived with her mother, saving all of her money. This money was deposited in the predecessor account to the one in question. After Peter Bianco returned from the service, Peter and Mary Bianco entered into the restaurant business at which they both worked seven days a week, a minimum of 12 hours a day.

16. After returning home from the service, Peter Bianco began losing money by way of betting or gambling and an agreement was reached between he and Mary Bianco that he would turn over all of his money to her. She cashed his paychecks, gave him an allowance, paid all the household bills, purchased the food and clothing and ran the entire household while he was employed.

17. From that time to the present, Mary Bianco handled all of the family finances; did all the banking; made all deposits in Account No. B-495; made all withdrawals in that account; did all the saving; and was the only one to deal with the savings account at First State Savings Association.

18. That Mary Bianco had complete control over the monies and the checks once turned over to her and further at all relevant times had control and possession of the pass book to savings Account No. B-495 and its predecessor accounts.

19. At the time that Peter Bianco turned over his checks and monies to Mary Bianco it was not his intention to make a gift of those sums to her at that time and prior to her depositing any of those sums in savings account No. B-495 or its predecessors. Rather, the agreement was a matter of convenience.

20. That at no time did Peter Bianco make any deposits or withdrawals to Account No. B-495 or any other account within the knowledge of First State Savings Association and Mr. Sikora never saw Peter Bianco transacting business in First State Savings Association.

[Reasonable Belief]

21. That based upon Mary Bianco's handling of and dealing with the accounts and monies placed into and withdrawn from the accounts and further based upon statements made by Mary Bianco both immediately prior to withdrawal on January 26th and for the time she was a depositor, the defendant reasonably believed that the funds in Account No. B-495, belonged to Mary Bianco and not Peter Bianco.

[Reasonable Cause]

22. That based upon the evidence, or reasonable inferences that can be drawn therefrom and under the circumstances with which it was confronted, the Defendant, First State Savings Association, had reasonable cause to release the funds in Account No. B-495 to Mary Bianco and to refuse to surrender such funds to the Government.

23. That Mary Bianco and Peter Bianco each owned one-half of the funds in the bank account at issue at the time of the levy.

24. That at the time of the levy, the bank account at issue contained a balance of $18,665.57.

Conclusions of Law and Discussion

The Government brought this case against Capital Savings Association, successor to First State Savings Association (Capital) to recover money withdrawn from a joint savings account held by Capital in the names of Peter and Mary Bianco. The Government served a notice of levy on Capital on November 16, 1978 in relation to any "property or rights to property" belonging to one Peter J. Bianco a/k/a Peter J. Pianco, Jr. On January 29, 1979, Capital permitted one Mary T. Bianco, wife of Peter Bianco to withdraw money from the joint account. The Government argues that this action violated the levy and that Capital is personally liable for the money withdrawn under 26 U. S. C. 6332(c).

Section 6332(c)(1) provides in relevant part that:

Any person who fails or refuses to surrender any property, subject to levy, upon demand by the Secretary, shall be liable in his own person and estate 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 taxes for the collection of which such levy has been made.

Section 6332(c)(2) further provides for a penalty equal to fifty percent of the amount recoverable under paragraph (1) where the refusal is "without reasonable cause." In the present case the Government seeks to recover both the amount withdrawn from the Bianco account and a penalty.

A defendant in an action brought under section 6332(c) has only two alternative defenses: (a) the property at issue is subject to prior judicial execution or attachment, and (b) the defendant is not in possession of property owned by the taxpayer. See United States v. Weintraub [80-1 USTC 9172], 613 F. 2d 612 (6th Cir. 1979); United States v. Sterling National Bank, [74-1 USTC 9336], 494 F. 2d 919 (2d Cir. 1974). There is no indication of any kind that the bank account at issue here was subject to a prior judicial execution or attachment. Rather, Capital bases its case on the claim that the funds in the subject account belonged solely to Mary Bianco at the time of the levy and not to the delinquent taxpayer.

A determination of the relevant property interests in a tax levy case is a matter of state law. Aquilino v. United States [60-2 USTC 9538], 363 U. S. 509 (1960). Some cases have held that the burden of proving a taxpayer's interest in property subject to levy rests on the Government. See, e.g., United States v. Stock Yards Bank of Louisville [56-1 USTC 9418], 231 F. 2d 628 (6th Cir. 1956). More recent cases, however, have held that the burden rests on the party opposing the levy to show that the taxpayer does not have an interest in the property at issue. See, e.g., Flores v. United States [77-1 USTC 9380], 551 F. 2d 1169 (9th Cir. 1977); United States v. National Bank of Commerce [83-2 USTC 9568], 554 F. Supp. 110 (E. D. Ark. 1982). The reasoning for the latter holdings is the belief that it is more appropriate to place the burden of showing nonownership by the taxpayer on the party challenging the levy "because the purpose of the statute is a coercive one which seeks to foster a swift tender of property which has been levied upon." Flores, 551 F. 2d at 1174. In summary, although there are good arguments for placing the burden of proof on either party here, the Court concurs with the more recent case holdings above and concludes that the burden of proof is on the defendant in this case to show nonownership by the taxpayer in the joint account at issue.

Capital bases its defense in this case on the argument that the money in the account at issue belonged to Mary Bianco rather Peter Bianco. The ownership of a joint bank account in Indiana is determined by the contributions of the parties to that account "unless there is clear and convincing evidence of a different intent." West's Ind. Code Ann. 32-4-1.5-3(a). The evidence at trial reveals that most, if not all, of the money in the account at the time of the levy consisted of Peter Bianco's earnings. Although Mary Bianco testified that the account originally belonged to her and that some of the money deposited in the account prior to 1955 was contributed by her, she conceded that after 1955 all of the money deposited in the account at issue originated from Peter Bianco. Thus, if ownership of the account is based solely on contributions, the Court would find that most if not all of the funds in the account belonged to Peter Bianco. The decision on the ownership of the account does not end with analysis of the contributions, however, since Capital contends that it has "evidence of a different intent." This "evidence of a different intent" consists of two somewhat related arguments.

Capital's first argument is based on the third party donee-beneficiary theory first recognized by the Indiana Supreme Court in Estate of Fanning, -- Ind. --, 333 N. E. 2d 80 (1975). In that case, the donor purchased a certificate of deposit from a bank. The certificate was issued to the donor and the donee "either or to the survivor." The Court found that the certificate constituted a contract between the donor and the bank to which the donee was a third party donee-beneficiary. As such, the donee received a present gift of a contingent contractual right to the funds in the account. The contractual right was contingent because it could have been extinguished during the lifetime of the donor.

The Fanning case and the cases generally dealing with the third party donee-beneficiary theory involve disputes over decedent's estates and whether the decedent actually intended the entire proceeds of the account to vest in the donee-beneficiary upon his death. Estate of Fanning, supra; Moore v. Bowyer, Ind. App. 388 N. E. 2d 611, (1979); Robison v. Fickle, Ind. App. 340 N. E. 2d 824 (1976). Consequently, it is somewhat difficult to apply the third party donee-beneficiary theory to a case like the present where both the donor and donee are living and the Court is required to carve out their respective interests in a joint account. Even though these cases may not directly apply in the present situation they are analogous and they teach that a determination by this Court as to the effect of any contract herein on the interest of Peter and Mary Bianco in the joint account at issue must be based, as in the cases above, on the clear language of the contract itself. See, e.g., Robinson, supra.

Capital would apply the theory discussed in the Fanning case to the present situation by arguing that Mary Bianco was a third party donee-beneficiary of the contract between Capital and Peter Bianco. The contract here is the signature card signed by both Mary and Peter Bianco and which provides that all deposits in the account by either of the parties "are and shall be conclusively intended to be a gift and delivery at that time of such funds to the other signatory party . . . to the extent of his . . . pro rata interest in the account." As applied in the present case, then, the theory urged by Capital would only provide Mary Bianco with a one-half interest in the joint account. The reason for this is that the plain language of the contract states that the noncontributing party in a joint account receiving a gift of funds deposited to that account only "to the extent of his . . . pro rata interest in the account." As there are two parties to the account at issue, Mary Bianco's pro rata interest in the account is one-half and, as per the terms of the contract between Peter Bianco and Capital, she is the owner of no more than one-half of the account.

[Intra-spousal Agreement v. Depositary Agreement]

Capital disagrees that Mary Bianco only owned one-helf of the account. Rather, Capital contends that an agreement existed between Mary and Peter Bianco in which Peter completed a gift inter vivos to Mary of all his money, prior to it being deposited in the joint account. This is, in effect, an attempt by Capital to vary the terms of a third party donee-beneficiary contract by the use of parol evidence. This is generally impermissible where, as here, the meaning of the contract is plain and unambiguous. Robison v. Fickle, 340 N. E. 2d at 828-9. Even so, assuming arguendo that such evidence could be admitted to vary the terms of the contract, the Court does not find that they would do so.

Capital bases its argument that Mary Bianco was a gift recipient of all Peter's money on the following facts: Mary Bianco opened the account at issue prior to her marriage to Peter Bianco; shortly after their marriage Mary added Peter's name to the account because, in her words, "in case something should happen to her"; Peter Bianco served in the military during World War II and returned home with a gambling problem; Peter and Mary reached an agreement that from thence forth Mary would have complete control over the family finances; that from the time of their agreement to the present Peter Bianco turned over his paychecks to Mary, who would cash them, give Peter an allowance, pay the bills and bank the remainder; and finally, that Mary handled all of the deposits and the withdrawals in the account at issue. Capital argues that these facts show that Peter made an inter vivos gift to Mary of all his earnings. The Court does not agree.

A valid gift inter vivos must be the result of a donative intent borne by the free will of the donor. Kraus v. Kraus, Ind., 132 N. E. 2d 608 (1956); Bulen v. Pendleton Banking Co., Ind. App., 78 N. E. 2d 449 (1948). Mary Bianco testified on direct that she insisted that Peter Bianco allow her to manage his money or else she would leave him. Certainly this belies a free will or a donative intent on the part of Peter Bianco to give up all his rights to the money. Furthermore, the Court finds that the agreement between Peter and Mary Bianco was more in the nature of a convenience than a gift. As with an incompetent person who permits another to sign checks on his account for the purpose of paying his expenses and so forth, Peter Bianco permitted his wife to handle the family financial affairs because he was unable to do so in a manner that would keep his family intact. Such an arrangement does not constitute a gift. Cf. Gary National Bank v. Sabo, 279 N. E. 2d 248, 252 (1972). Based on the Court's interpretation of the agreement between Peter and Mary Bianco, then, the Court does not find that the agreement varied the clear and unambiguous contractual terms of the signature card in any way. Based on those terms, the Court concludes that Mary and Peter Bianco each owned one-half of the funds in the joint account.

As the Court has concluded that Mary and Peter Bianco each owned one-half interest in the joint account at Capital, it follow that the Government's levy was effective against one-half of the account. A joint account may be subject to claims to the extent of the debtor-party's interest therein. Cf. West's Ind. Code Ann. 32-4-1.5-7 (a surviving party to a joint account is liable to the decedent's personal representative for the amount of the account which the decedent owned beneficially in order to discharge unpaid claims against the decedent's estate); 32-4-1.5-13 (where a party to a joint account is indebted to a financial institution, the financial institution has a right to a set-off on that portion of the account to which the debtor was beneficially entitled). At the time of the levy on November 16, 1978, the account contained a balance of $18,665.57, one-half of which belonged to Peter Bianco and was subject to the levy. Section 6332(c)(1) provides that the bank is liable for "a sum equal to the value of the property [subject to levy] not so surrendered." Accordingly, the bank is liable for one-half of $18,665.57, which equals $9,332.79.

[Enforceability of IRS Levy]

Capital presents three remaining arguments in its favor which the Court now rejects. Capital argues that the levy here is unenforceable because the Government failed to show that it met three prerequisites to levy: assessment; notice to taxpayer of deficiency and demand for payment; and failure of the taxpayer to pay the deficiency within ten days. See Martinez v. United States, 669 F. 2d 568 (9th Cir. 1981). Capital maintains that the Government failed to present evidence at trial of its compliance with these prerequisites. This is incorrect. The Government submitted its Exhibit A into evidence which shows the assessments made, the notices sent to Peter Bianco and the subsequent partial payments. By implication, then, this exhibit also shows the failure of Peter Bianco to pay his tax arrearages within ten days. The exhibit was admitted into evidence without objection by Capital. Capital's counsel points out that he stipulated to the admission of the exhibit stating that he assumed the exhibit was apparently being admitted merely to show the assessments and payments. Capital now argues that it did not agree for the document to be admitted to show the Government's compliance with the levy prerequisites. Where a party seeks to limit the purpose for which evidence is admitted at trial, it is incumbent upon the party to make an explicit request for such a limitation. Fed. R. Evid., Rule 105; 1 Louisell and Mueller, Federal Evidence 45 (1977). This request was not made and cannot be implied based on counsel's comment at the time of admission of what the opposing party's evidence was apparently being admitted for. Furthermore, this Court will not nullify a legitimate Internal Revenue Service levy for unpaid taxes where it clearly appears on the face of the record that the statutory prerequisites for that levy were satisfied.

[Potential Double Liability]

Capital next argues that it should not be held personally liable because the levy placed Capital in a position of potential double liability. Presumably Capital feels that if it had given the money in the joint account to the Government pursuant to the levy, it would have been subject to a claim by Mary Bianco that the money had belonged to her. Capital further points out that section 6332(d) protects it only from liability to the delinquent taxpayer. The short answer to Capital's argument is that it has failed to point out any authority showing that the possibility of multiple liability serves as a defense in an action for personal liability under section 6332(c). Callous as this response may seem, it is not the Court that enacted the Internal Revenue Code. The Court recognizes that Mary Bianco was a longtime valued customer of Capital Savings and certainly Capital wanted to please her when she wished to withdraw the money. Even so, there was a levy on the account. Had Capital released the money in the account to the Government in accordance with the levy, the proper procedure would have been for Mary Bianco to bring a refund action under 26 U. S. C. 7426. Cf. United States v. Rodgers [83-1 USTC 9139], No. 81-1476 (Slip op. May 31, 1983). In such an action, the burden would have been on the Government to prove that the property belonged to the taxpayer. Flores, supra. Of course, this may not bar Mary Bianco from also bringing an action against Capital for releasing the money to the Government. Without deciding what Capital's interest in the money was, it might be possible in such case for Capital to bring the Government in as a third-party defendant under section 7426.

[Estoppel]

Capital's final argument is that the Government should be estopped from asserting the personal liability of Capital here because of its inaction in informing Capital as to how the ownership of the account should be determined. The simple answer to this contention is that the facts of this case do not present a situation where estoppel would apply. Generally, "one who by his deed or conduct has induced another to act in a particular manner will not be permitted to adopt an inconsistent position . . . and thereby cause loss or injury to another." 31 C. J. S. Estoppel 1 (1964). Mere silence will operate as an estoppel only where there is a duty to speak and where the silence has led the adverse party to do something which he would not have done but for such silence. Id. at 87. Capital cannot argue that it permitted Mary Bianco to withdraw the money because the Government failed to inform Capital of its position on the ownership of the account. Granted, the Government did promise to make such a determination, but its failure to do so cannot be construed as prior approval of Capital's action. Capital's estoppel argument is without merit.

[Additional Penalty]

One more issue is as yet to be determined here regarding whether Capital is subject to the fifty percent penalty provision of section 6332(c)(2). Section 6332(c)(2) provides for a penalty where a defendant's refusal to surrender property subject to levy is without reasonable cause. A "reasonable cause" to resist the levy exists where there is a bona fide dispute over the amount of property owned by the taxpayer. United States v. Sterling National Bank and Trust [74-1 USTC 9336], 494 F. 2d 919, 923 (2nd Cir. 1974). The Court finds that there was a bona fide dispute as to the ownership of the property in question in this case and that no penalty should be imposed.

Judgment

It is therefore ORDERED that:

(1) the plaintiff has prevailed in this action and the defendant therefore is liable to the plaintiff in the amount of $9,332.79, plus any interest which may be applicable by law;

(2) the defendant had reasonable cause to refuse to surrender the funds at issue and therefore will not be subject to the penalty provisions of 26 U. S. C. 6332(c)(2); and

(3) each party shall bear its own costs.

 

[85-2 USTC 9833]Sea-Land Service, Inc., Plaintiff v. United States of America, Commissioner, Internal Revenue Service, G. Glendenning, Kenneth Kramlich and Nelson Sala, Defendants

U.S. District Court, N.J., Civil Action No. 85-825, 622 FSupp 769, 11/21/85

[Code Secs. 6332 and 6334, 28 USC 2201, and 42 USC 11109]

Levy and distraint: Surrender of property subject to: Seamen's wages: Penalty under shipping laws: Declaratory Judgment Act.--An employer was required to honor IRS levies on the wages of seamen despite a provision in the shipping laws, 46 U.S.C. 11109, that exempts seamen's wages from attachment. Congress did not intend the shipping laws to prohibit the execution of federal tax levies against seamen's wages. Code Sec. 6334 provides an exclusive list of property exempt from federal tax levies and does not include seamen's wages. The court also declared that under Code Sec. 6332 the employer would not be liable for the double wage penalty under the shipping laws with respect to the wages paid over to the IRS. The Declaratory Judgment Act did not bar the employer's suit

Jeffrey L. Reiner, Geralyn A. Boccher, Meyner and Landis, Gateway One, Newark, N.J. 07102, for plaintiff. W. Hunt Dumont, United States Attorney, Edward G. Spell, Assistant United States Attorney, Newark, N.J. 07102, for plaintiff. Robert L. Handros, Department of Justice, Washington, D.C. 20530, for defendants.

STERN, District Judge:

The Court is presented with a suit for declaratory judgment, brought under the Declaratory Judgment Act, 28 U.S.C. 2201, and the Shipping Laws of the United States, 46 U.S.C. 1 et seq. Plaintiff seeks to prevent the Internal Revenue Service (the "IRS") from attaching the wages of three of its employees, seamen G. Glendenning, Kenneth Kramlich and Nelson Sala.

Plaintiff and defendants the United States and the IRS Commissioner (the "government") cross-moved for summary judgment, raising the issue of whether the IRS may garnish the wages of seamen to satisfy the seamen's tax liabilities in spite of a provision in the shipping laws exempting seamen's wages from "attachment or arrestment from any court." 46 U.S.C. 11109. The government also moved, as a threshold matter, to dismiss for lack of jurisdiction. 1

The Court heard oral argument on July 22, 1985. We now deny the government's motion to dismiss for lack of jurisdiction and grant summary judgment upholding the IRS's garnishment power. We also grant plaintiff's motion for summary judgment freeing it from liability for honoring such levies. Our decision on these issues renders moot the remaining issue concerning the Court's power to enjoin the IRS's attachment powers.

Plaintiff Sea-Land Service, Inc. ("Sea-Land") operates vessels in foreign and interstate commerce, maintaining approximately 5,000 seamen on its U.S. vessel payroll. Defendants Glendenning, Kramlich and Sala have been employed as seamen aboard Sea-Land's ships.

Beginning on April 2, 1984, the IRS served Sea-Land with notices of levy on the wages of defendants Glendenning, Kramlich and Sala for taxes, penalties and interest owed to the federal government by the seamen. In each case Sea-Land informed the IRS that it could not honor the levies because the shipping laws precluded the withholding of seamen's wages. Sea-Land further noted its belief that, in the event it paid over the wages to the IRS, it would be liable for the double wage penalty described in the shipping laws at 46 U.S.C. 10313(g). When the IRS persisted in its demands, Sea-Land filed this action to ascertain whether it must respect the IRS levies.

The complaint contains three counts. Count one seeks a judgment declaring whether Sea-Land must honor the IRS levies. Count two asks the Court to enjoin the IRS from levying on the wages of Sea-Land's seamen and from enforcing the levies, pursuant to 26 U.S.C. 6332(c). Count three seeks a declaration that if Sea-Land must comply with the levies, it will neither violate Title 46, United States Code, Section 11109, nor incur double wage liability under section 10313(g).

The government first moves to dismiss for lack of jurisdiction on counts one and two. Alternatively, it urges the Court to dismiss count one for failure to state a claim upon which relief can be granted. Plaintiff cross-moves for summary judgment, arguing that the levies are invalid under the shipping laws. In the alternative, it seeks summary judgment on count three to bar liability if it is obligated to respect the levies.

DISCUSSION

I. The Government's Motion to Dismiss for Lack of Jurisdiction.

The government offers the threshold argument that plaintiff's claim in count one is barred by the Declaratory Judgment Act, 28 U.S.C. 2201. That statute restricts the court's power to grant declaratory relief by providing that federal courts shall issue declaratory judgments "except with respect to Federal taxes . . .." 28 U.S.C. 2201(a).

It is, however, well-settled that the exception for federal taxes does not bar actions by nontaxpayers who seek neither to restrain the assessment of taxes nor to dispute the taxpayer's ultimate tax liability. Kentucky Welfare Rights Organization v. Simon, 506 F.2d 1278, 1284 (D.C. Cir. 1975), rev'd on other grounds, 426 U.S. 26 (1976); Church of Scientology of Celebrity Centre v. Egger [82-1 USTC 9386], 539 F. Supp. 491, 494 (D.D.C. 1982); Henshel v. Guilden [69-1 USTC 9255], 330 F. Supp. 470, 472 (S.D.N.Y. 1969); Hoye v. United States, 109 F. Supp. 685, 686 (S.D. Cal. 1953). In Hoye, for example, a city comptroller sought a judgment declaring whether he was required to honor an IRS levy on the wages or pension of a city employee. 109 F.Supp. at 686. The Hoye court recognized that the comptroller faced an intractable conflict between two sets of laws:

[T]he city of Los Angeles merely holds as a trustee the money which is due to the defendant taxpayer, Champion. Furthermore, under the law of the State of California, Sec. 710, Cal. C.C.P., the plaintiff Hoye as City Controller cannot pay money owed by the city of Los Angeles to anyone other then the one to whom the money is due unless and until there is filed with him an authenticated abstract of judgment of a court showing that the person is entitled thereto. If the plaintiff, Hoye, recognized the demand and levy by the Collector and paid the sum of $121.71 therein demanded, the plaintiff, Hoye, would still be liable to pay that same amount to Champion under the terms of Section 710 of the California Code of Civil Procedure.

Id.

The parallel between the Hoye case and the present action is unmistakable. Sea-Land like comptroller Hoye, is not the taxpayer. Like him, Sea-Land does not ask the Court to declare whether any tax is due the United States, or if so, how much, but only whether it must turn over the unchallenged assessment to the IRS.

Moreover, Sea-Land finds itself, like comptroller Hoye, confronted with two laws that makes observance of both impossible. The Internal Revenue Code requires Sea-Land to obey the IRS orders attaching its employees wages, 26 U.S.C. 6332(c), and does not specifically exempt seamen's wages from such levy, 26 U.S.C. 6334(a). But the shipping laws state that Sea-Land may not withhold from seamen any portion of their full wages, excepting only court-ordered spouse and child support payments. 46 U.S.C. 11109(a). Furthermore, if an employer wrongfully delays paying a seaman's wages it faces the imminent threat of double wage liability under 46 U.S.C. 10313(g). Like comptroller Hoye, therefore, Sea-Land is entitled to a declaration proclaiming whether it must honor the IRS levies. We hold that the relief sought in count one is available under Title 28, United States Code, Section 2201. 2

II. The Motions for Summary Judgment.

A. Count One

Although the government styled its motion as one to dismiss for failure to state a claim, we treat the motions on count one as cross-motions for summary judgment because they raise the identical legal issue, and the parties appear to agree that no material facts are in dispute. See Fed. R. Civ. P. 56(c).

Sea-Land has refused to honor the IRS levies as a result of 46 U.S.C. 11109(a), which provides:

Wages due or accruing to a master or seaman are not subject to attachment or arrestment from any court, except for an order of a court about the payment by a master or seamen of any part of the master's or seaman's wages for the support and maintenance of the spouse of minor children of the master or seaman, or both. A payment of wages to a master or seaman is valid, notwithstanding any prior sale or assignment of wages or any attachment, encumbrance, or arrestment of the wages.

The government contends, however, that provisions of the Internal Revenue Code, 26 U.S.C. 6334(a) and (c), take precedence over the Shipping Laws provisions. Subsection (a) lists property exempt from federal levies. Seamen's wages are not included. Subsection (c) states that:

Notwithstanding any other law of the United States (including section 207 of the Social Security Act), no property or right to property shall be exempt from levy other than the property specifically made exempt by subsection (a).

26 U.S.C. 6334(c) (emphasis added).

The cross-motions for summary judgment ask this Court to resolve the apparent conflict between these two laws.

At the outset we note that we find only one case where this issue has been addressed directly: United States v. Offshore Logistics International, Inc. [80-1 USTC 9154], 483 F. Supp. 1055 (W.D. La. 1979). The Offshore court held that section 6334 of the Internal Revenue Code must prevail over the predecessor to section 11109 of the shipping laws. 483 F. Supp. at 1057. It grounded this conclusion in three considerations: (1) as both statutes as "special" statutes, the rule of statutory construction giving "special" statutes priority over "general" statutes does not apply; (2) the plain language of the introductory phrase in section 6334(c)--"notwithstanding any other laws of the United States"--suggests that the list of exempt property enumerated in subsection (a) was intended to be exhaustive; and (3) Congress in 1966 expanded the list of exempt property in subsection (a), but, again, did not include seamen's wages.

Sea-Land urges us to reject this holding, contending that the Offshore court found an inconsistency in the law where none exists. Section 6334(a), argues Sea-Land, enumerates the types of property exempt from IRS levies; section 11109, on the other hand, exempts from such levies a category of person--seamen. The exemption of seamen's wages from the attachment power of the IRS, it is argued, thus does not fun afoul of the exhaustive list of property exemptions contained in section 6334.

The argument is attractive, but it is based on an untenable distinction. Both section 11109 and section 6334 describe their subject matter as a mixture of both person and property. Section 11109 concerns seamen and their wages. Similarly, section 6334 exempts various sorts of persons--Medal of Honor winners, railroad annuity recipients, any unemployed persons, to name a few--and their property--pension, annuities, and unemployment benefits. The conflict between the statutes cannot be resolved by an unconvincing logical distinction between person and property.

Plaintiff asserts that the treatment of state withholding taxes under the shipping laws shows that even tax claims cannot touch seamen's wages. We note, however, that the legislative history of the shipping laws reveals no intention to extend the protection of section 11109 to federal tax assessments.

In 1948, a district court held that defendant state commissioners could not enforce state laws requiring income tax withholding from seamen's wages because the withholding was an "attachment" prohibited by the shipping laws. American Hawaiian S.S. Co. v. Fisher, 82 F. Supp. 193, 196 (D. Or. 1948). A year later, a court in Alaska reached the opposite conclusion. Alaska S.S. Co. v. Mullaney, 84 F. Supp. 561, 567 (D. Alaska 1949), aff'd, 180 F.2d 805 (9th Cir. 1950). Subsequently Congress amended Title 46 to clarify that section 601, the predecessor to section 11109, prohibited withholding state income taxes from seamen's wages.

Describing the need for the amendment, Congress cited the conflict between the federal shipping law and the state tax provisions--a conflict exactly analogous to the conflict before the Court today--which left shipowners "faced with a staggering potential legal and financial liability if they do not withhold as apparently required under state tax law." S. Rep. No. 433, 86th Cong., 1st Sess. 2, reprinted in 1959 U.S. Code Cong. & Ad. News 2531. But Congress did not apply the same reasoning to federal income taxes. As the Senate Report noted:

S. 1958 would relieve the seamen and the steamship companies of the accounting burden enumerated above; it would also clarify the legal conflict between State and Federal law.

It is to be noted, however, that this legislation will not relieve the seaman of his liability to pay taxes properly due, will not effect [sic] the Federal withholding taxes, and will not in any way impair the general tax authority of the States.

Id. at 2532 (emphasis added). Thus Congress adopted the view that withholding wages for state taxes was a type of attachment which encroached on the traditional protection afforded seamen's wages under federal law. 3 But it chose not to prohibit withholding of federal taxes from seamen's wages.

We believe this distinction is significant for the federal tax levies at issue here. An IRS levy, like the withholding of taxes, is a type of attachment which at first blush appears to conflict with the prohibitions of section 11109. The legislative history of this section, however, provides reason to think that Congress did not mean those prohibitions to extend to federal tax collection.

We conclude that Congress did not intend Title 46, United States Code, Section 11109 to prohibit the execution of federal tax levies against seamen's wages. Furthermore, we agree with the Offshore court's conclusion that section 6334(a) of the Internal Revenue Code provides an exclusive list of property exempt from federal tax levies.

The accumulation of these reasons leads the Court to grant the government's motion for summary judgment on count one.

B. Count Three

Plaintiff maintains that, should the government prevail on count one, Sea-Land is entitled to summary judgment on count three declaring that it will not violate the shipping laws, nor be subject to the double wage penalty under 46 U.S.C. 10313(g), nor incur any other obligations with respect to the seamen's wages paid over to the IRS. The government does not oppose this motion, commenting that section 6332(d) of the Internal Revenue Code protects plaintiff against liability. That section provides:

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 who, upon demand by the Secretary or his delegate, surrenders such property or rights to property (or discharges such obligation) to the Secretary or his delegate (or who pays a liability under subsection (c)(1)) shall be discharged from any obligation or liability to the delinquent taxpayer with respect to such property or rights to property arising from such surrender or payment. . . .

26 U.S.C. 6332(d).

We agree that the language of section 6332(d) relieves Sea-Land of further obligations with respect to the wages it pays over to the IRS due to the notices of levy. Further, it follows from our resolution of count one that Sea-Land does not violate Section 11109 of Title 46 by honoring the levies.

Accordingly, plaintiff's motion for summary judgment on count three is granted.

Order

For the reasons set forth in the Court's opinion filed herewith;

It is on this 21 day of November, 1985,

ORDERED that the motion of defendants United States of America and Commissioner, Internal Revenue Service for summary judgment on count one be, and it hereby is, granted; and it is further

ORDERED that plaintiff's motion for summary judgment on count three be, and it hereby is, granted; and it is further

ORDERED that the Court's ruling on count one renders count two of plaintiff's complaint moot.

1 The three seamen are not represented on these motions. Defendants Kramlich and Sala have defaulted and defendant Glendenning cannot be found for service.

2 We do not need to address the jurisdictional issue the government raises concerning this Court's power to enjoin the IRS from levying on the seamen's wages. Given our disposition of the issues before us, this issue is moot.

3 Currently, a separate provision of the shipping laws, Section 11108 of Title 46, explicitly prevents states from withholding taxes from seamen's wages.

 

[90-1 USTC 50,155] Texas Commerce Bank-Fort Worth, N.A., Plaintiff-Appellee/Cross-Appellant v. United States of America, Defendant-Appellant/Cross-Appellee

(CA-5), U.S. Court of Appeals, 5th Circuit, 88-1809, 3/16/90, 896 F2d 152, 896 F2d 152. Affirming a District Court decision, 89-2 USTC 9655 , 703 F.Supp. 592

[Code Secs. 6332 and 7426 ]

Suits by nontaxpayers: Property owner: Lien for taxes: Surrender of property subject to levy and distraint: Reasonable cause.--A bank justifiably instituted a wrongful levy action before surrendering a joint-payee check to the IRS, and the bank had reasonable cause to dishonor the levy for the purposes of the 50% penalty clause under Code Sec. 6332 . The bank properly followed the procedural scheme of Code Sec. 7426 , which is the exclusive remedy for banks to assert their claims of priority against the IRS, "without regard to whether property has been surrendered." The IRS was not permitted to file a Code Sec. 6332 counterclaim in order to defeat the bank's rights under Code Sec. 7426 . The "surrender-then-litigate" position was not the only permissible response to an IRS levy, especially in a case where the bank had a clear priority over the disputed asset.

[Code Secs. 6321 and 6323 ]

Lien for taxes: Property subject to: Bank deposits: Priority: Security interest holder.--A bank did not hold a security interest in a corporation's bank accounts which primed the IRS's interest because the bank's interest in the accounts could only arise post-deposit. Since a tax lien attaches to all property or rights in property held by a delinquent taxpayer, any deposits made after the IRS files its tax lien notices would be deposited in the bank already impressed with the tax lien.

Thomas Nezworski, McDonald, Sanders, Ginsburg, Maddox, Newkirk & Day, 1300 Continental Plaza, Fort Worth, Tex. 76102, for plaintiff-appellee/cross-appellant. Marvin Collins, United States Attorney, Fort Worth, Tex. 76102, William S. Estabrood, Assistant Attorney General, Gary R. Allen, Steven W. Parks, Department of Justice, Washington, D.C. 20530, for defendant-appellant/cross-appellee.

Before GOLDBERG, POLITZ, and JONES, Circuit Judges.

JONES, Circuit Judge:

The United States and Texas Commerce Bank, Fort Worth ("TCB") cross-appeal from the district court's summary judgment resolving the parties' conflicting interests in funds held by TCB for the benefit of C.I. Construction Inc. ("CIC"). The district court found that the IRS held a superior lien over CIC's $40,233.91 bank account ("account"), while TCB possessed a prior interest in the $83,907.00 check ("check") made payable jointly to TCB and CIC. On appeal, the parties dispute the court's decision regarding priority over the bank account, and the court's reluctance to impose a 50% penalty against TCB for wrongful dishonor of the levy. Significantly, however, the IRS now concedes that TCB's lien in the $83,907 check primed the IRS's interest in those funds. We affirm the district court's summary judgment order. We hold that TCB had the right to institute a wrongful levy action concerning property in which it claimed a lien superior to that of the IRS, where (1) the IRS had not yet filed a lawsuit to enforce its levy and (2) TCB in good faith honored the levy concerning property in which the relative priority of its lien claim was dubious.

I.

BACKGROUND

CIC obtained business loans from Texas Commerce Bank in November, 1982 for $325,000, and on November 12, 1985 for $121,585.14. CIC secured these loans in two ways. First, it executed promissory notes which provided TCB with a "lien and contractual right of set-off in and to all money now in or at any time hereafter coming within payee's [TCB's] custody and control." At all times during this transaction, CIC maintained two general deposit accounts with TCB.

Second, on November 30, 1982, CIC signed a security agreement giving TCB an interest in "all of debtor's accounts now owned or hereafter acquired." TCB properly perfected this security interest by filing a timely financing statement. CIC executed another security agreement in favor of TCB in February, 1985, giving the bank an interest "in all accounts and accounts receivable . . . of whatever nature now owned by debtor or existing or hereafter acquired . . . and all proceeds of the collateral." These security interests extended to all future advances by TCB and so covered the November 1985 loan.

During 1985 and 1986, CIC's business liabilities exceeded its revenue. In August, 1985, CIC contracted with Par Properties No. 1 ("Par") to construct a shopping center. Par would pay CIC in installments as CIC completed portions of the project, for a total anticipated revenue of $504,787. This income could not satisfy CIC's mounting debts. CIC had already failed to pay its federal employment taxes for the first two quarters of 1985. The IRS filed Notices of Tax Lien with the Texas Secretary of State for $33,417 (August 3, 1985) and $93,404.53 (September 24, 1985). CIC disregarded these notices.

Additionally, CIC defaulted on its loan from TCB. Sometime before January 1986, TCB placed an administrative hold on CIC's bank accounts, allowing TCB to decide whether it would honor individual checks presented for payment. This procedure enabled TCB closely to monitor the cash flow in these accounts. TCB also requested that Par make all checks for CIC's completed work jointly payable to CIC and TCB. This dispute involves one of these co-owned checks.

On January 8, 1986, between 8:30 and 9:00 a.m., an employee of CIC presented to TCB and $83,907.00 Par Properties check payable jointly to CIC and TCB and endorsed "FOR DEPOSIT ONLY". This check represented payment for work completed through January 2, 1986. Later that morning, the IRS served a notice of tax levy against all CIC property in TCB's hands for a total of $87,522.02. TCB surrendered the $40,233.91 contained in CIC's bank accounts but did not release the Par check. On or before January 10, TCB accelerated repayment of CIC's loans and applied the Par check against that indebtedness. 1 The IRS served a second notice of levy on January 14, 1986 in the amount of $43,353.43.

II.

SUMMARY JUDGMENT

On January 22, 1986, TCB instituted a wrongful levy action under 26 U.S.C. 7426 , requesting a declaration of the parties' rights in Par's check and a return of the bank account balance. The IRS counterclaimed under 26 U.S.C. 6332(c)(2) for wrongful dishonor of the levy, seeking a 50% penalty against TCB for its failure to surrender the check. The district court granted cross motions for summary judgment in part. Finding that TCB was not the "holder of a security interest" in the bank accounts as required by 6323(a) , and that the administrative hold did not divest CIC of its property interest in the funds, the court adjudged the IRS's tax lien on the bank account superior to TCB's interest. Conversely, TCB held a superior interest in Par's check as the proceeds of accounts receivable. The district court declined to impose the 50% penalty against TCB. Both parties appeal from this decision.

When an appeal is taken from summary judgment, we review the district court's actions de novo, applying the same standards used by the district court. Degan v. Ford Motor Company, 869 F.2d 889, 892 (5th Cir. 1989). Where, as here, questions of law control the disposition on summary judgment, we must subject the controverted issues to full appellate review. Barrett Computer Services Inc. v. PDA, Inc., 884 F.2d 214, 215-16 (5th Cir. 1989); Netto v. Amtrak, 863 F.2d 1210, 1212 (5th Cir. 1989); Brooks, Tarlton, Gilbert v. United States Fire Insurance, 832 F.2d 1358, 1364 (5th Cir. 1987). Summary judgment may be affirmed, regardless of the correctness of the district court's rulings, when we find an adequate and independent basis for that result in the record. Schuster v. Martin, 861 F.2d 1369, 1371 (5th Cir. 1988).

III.

WRONGFUL LEVY ACTION

The IRS alleges that TCB responded improperly to the government's Notices of Tax Levy by filing a wrongful levy action under 26 U.S.C. 7426 . According to the IRS, TCB should have surrendered both the bank account and Par's check before pursuing TCB's statutory remedies against the United States . 26 U.S.C. 6331 -6332. The IRS seeks to impose a 50% penalty against TCB under 26 U.S.C. 6332(c)(2) for wrongful dishonor of the levy. 2 Since TCB surrendered the proceeds of CIC's bank account, this argument concerns only TCB's retention of Par Properties' check.

Section 7426(a)(1) , Civil Action By Persons Other than Taxpayers, 3 affords the exclusive remedy for an innocent third party whose property is confiscated by the IRS to satisfy another person's tax liability. United Sand and Gravel Contractors v. United States [80-2 USTC 9626 ], 624 F.2d 733, 739 (5th Cir. 1980). See Trust Company of Columbus v. United States [84-2 USTC 9614 ], 735 F.2d 447, 449 (11th Cir. 1984); Valley Finance, Inc. v. United States [80-2 USTC 9554 ], 203 U.S.App.D.C. 128, 629 F.2d 162, 168 (1980) cert. den. sub. nom. Pacific Development Inc. v. United States, 451 U.S. 1018, 101 S.Ct. 3007, 69 L.Ed.2d 389 (1981); Rosenblum v. United States [77-1 USTC 9177 ], 549 F.2d 1140, 1145 (8th Cir. 1977) cert. den. 434 U.S. 818, 98 S.Ct. 58, 54 L.Ed.2d 74 (1977). In order to state a cause of action under this provision, the plaintiff must show: (1) that a levy has been filed against property in plaintiff's hands, (2) that plaintiff has an interest in or a lien on the property which is senior to the interest of the United States , and (3) that the levy was wrongful. Security Counselors, Inc. v. United States [88-2 USTC 9584 ], 860 F.2d 867, 869 (8th Cir. 1988); Flores v. United States [77-1 USTC 9380 ], 551 F.2d 1169, 1171 (9th Cir. 1977). See Treasury Regulations 301.7426-1 (1988). A levy is "wrongful" if it seizes property that does not belong, in whole or in part, to the taxpayer. Arth v. United States [84-2 USTC 9601 ], 735 F.2d 1190, 1193 (9th Cir. 1984)); Trust Company of Columbus, 735 F.2d at 448; Al-Kim Inc. v. United States [81-2 USTC 9573 ], 650 F.2d 944, 947 (9th Cir. 1979). See Treasury Regulations 301.7426-1 (1988); Senate Report No. 1708, 89th Congress, 2d Session, reprinted in 1966 U.S. Code Congressional & Administrative News, 3722, 3751.

Although the plaintiff must prove that the government has levied against the property at issue, 4 the plaintiff need not demonstrate that the property has actually been surrendered in response to the levy. Section 7426(a)(1) states:

Such action may be brought without regard to whether such property has been surrendered to or sold by the Secretary.

In this way, Congress sought to balance the primary lienholder's interests in the property against the government's interest in collecting tax revenue. 1966 U.S.Code Congressional & Administrative News at 3724. When the levied property provides the only realistic source from which the senior lienholder can realize collection, or when the levy effectively destroys or otherwise irreparably injures the lienholder's superior interest, the tax levy is "wrongful" as against that lienholder, even if the lienholder's legal rights to enforce its interests survive the levy. Treasury Regulations 301.7426-1 (1988). Section 7426 permits the lienholder to safeguard its superior rights in the property without surrendering the collateral.

The remedial provisions of section 7426 support this interpretation. Section 7426(b)(1) permits a court to enjoin enforcement of the levy, "[i]f a levy . . . would irreparably injure rights in property which the court determines to be superior to rights of the United States in such property." Inferentially, if a court may remedy a wrongful levy by enjoining enforcement, the lienholder need not have honored the levy before filing suit. Myers v. United States [81-2 USTC 9490 ], 647 F.2d 591, 602 (5th Cir. Unit A 1981) (7426 guarantees immediate access to the courts and the right to seek injunctive relief). See Al-Kim Inc., 650 F.2d at 948; Valley Finance, 629 F.2d at 171 and n. 19. (Recognizing that 7426 permits pre-surrender injunctive relief). By contending that section 7426 requires compliance with the levy as a prerequisite to suit, the IRS renders this injunction provision a nullity. We must avoid statutory constructions which render parts of the statute inoperative or superfluous. Mountain States Telephone and Telegraph v. Pueblo of Santa Ana, 472 U.S. 237, 249, 105 S.Ct. 2587, 2594, 86 L.Ed.2d 168 (1985); Duke v. University of Texas-El Paso, 663 F.2d 522, 526 (5th Cir. 1981), cert. den. 469 U.S. 982, 105 S.Ct. 386, 83 L.Ed.2d 320 (1984).

Both the prescriptive and the remedial portions of section 7426 permit third party lienholders to file wrongful levy actions against the United States before complying with the levy. Despite this express statutory language, the IRS contends that once the Secretary has demanded surrender of the levied property, the individual holding the property must relinquish it to the United States , or face the statutory penalties. 26 U.S.C. 6332 . We reject this conclusion.

Section 6332(a) states:

[A]ny 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, surrender such property or rights (or discharge such obligation) to the Secretary, 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.

Subsequent sections of this provision impose personal liability for the levied property's value on any person who fails or refuses to honor the levy, plus a 50% penalty if the refusal occurs without reasonable cause. 26 U.S.C. 6332(c) .

In United States v. National Bank of Commerce [85-2 USTC 9482 ], 472 U.S. 713, 105 S.Ct. 2919, 86 L.Ed.2d 565 (1985), the Supreme Court enumerated the procedures which a bank should follow when faced with an IRS demand for the surrender of levied property under 6332 . The Court observed that "a bank served with a notice of levy has two, and only two, possible defenses for failure to comply with the demand: that it is not in possession of property of the taxpayer, or that the property is subject to a prior judicial attachment or execution." 472 U.S. at 727, 105 S.Ct. at 2928. See United States v. Bell Credit Union [88-2 USTC 9564 ], 860 F.2d 365, 367 (10th Cir. 1988); United States v. Sterling National Bank & Trust [74-1 USTC 9336 ], 494 F.2d 919, 921 (2d Cir. 1974).

Where these defenses do not apply, the Government's interest in the speedy collection of taxes trumps other claimants' interests in the property, permitting the IRS to levy on the assets at once and to resolve ownership disputes in a post-seizure administrative or judicial proceeding. National Bank of Commerce, 472 U.S. at 729, 105 S.Ct. at 2929. The Court cautions that levy procedures do not determine ownership rights, and that third parties whose assets are "wrongfully" seized may apply to the government for return of that property. 472 U.S. at 731, 105 S.Ct. at 2930. The administrative levy merely protects the Government from diversion or loss of funds while courts resolve these competing claims. 472 U.S. at 719-20, 105 S.Ct. at 2923-24. See State Bank of Fraser v. United States [88-2 USTC 9592 ], 861 F.2d 954, 959 (6th Cir. 1988).

Appellate Courts have applied these principles to situations in which banks have alleged a lien interest in the funds on deposit. In United States v. Citizens and Southern National Bank [76-2 USTC 9665 ], 538 F.2d 1101, 1106 (5th Cir. 1976) cert. den. 430 U.S. 945, 97 S.Ct. 1579, 51 L.Ed.2d 792 (1977), our court held that "the claim of a prior lien may not be interposed as a defense to an action to enforce a tax levy." Instead, "[t]he banks may litigate the priority of liens issue in an action under 26 U.S.C. 7426 ." Id. at 1106. Accord Bell Credit Union, 860 F.2d at 367; Sterling National Bank, 494 F.2d at 921.

The 11th Circuit extended the Citizens and Southern National Bank holding to wrongful levy actions under 7426 . In Trust Company of Columbus, 735 F.2d at 447, the bank held a perfected security interest in bank accounts that was superior to the IRS's claim to the funds. Nevertheless, the bank elected to surrender the funds and to litigate the priority questions at a later date. In dictum, the 11th Circuit ratified the bank's decision, explaining, "the proper procedure in contesting a levy is to surrender the funds and then litigate the priority of liens." Id. at 449. Based upon these decisions, the IRS contends that TCB violated the enforcement scheme established by the Internal Revenue Code when it filed the wrongful levy action without first surrendering the Par Properties check.

None of the cases presented by the IRS in support of its position directly governs TCB's lawsuit. In most of these cases, the underlying circumstances and the attendant policy considerations differ materially from TCB's situation.

The majority of these cases concern the proper procedure to be followed by a third party who faces a government-initiated 6332 lawsuit to enforce the levy. 5 Although the parties to these cases refused to surrender the property, they took no legally enforceable measures to assert their property interests prior to the government's suit. Many of the banks involved did set-off the taxpayer's deposits against debts which the taxpayer owed to the bank. See State Bank of Fraser, 861 F.2d at 954; Bell Credit Union, 860 F.2d at 365; United States v. Central Bank of Denver [88-1 USTC 9256 ], 843 F.2d 1300 (10th Cir. 1988); Citizens and Southern National Bank, 538 F.2d at 1101. However, these set-offs uniformly occurred after the IRS served the banks with Notices of Levy. See United States v. Bank of Celina [83-2 USTC 9688 ], 721 F.2d 163, 167 (6th Cir. 1983) and cases cited therein. Post-levy set-offs are usually ineffective to protect any interest which the bank might have held in the levied funds. J.A. Wynne Co., Inc. v. R.D. Phillips Construction Co. [81-1 USTC 9305 ], 641 F.2d 205, 208 (5th Cir. 1981); Citizens and Southern National Bank, 538 F.2d at 1101; Sterling National Bank and Trust Co., 494 F.2d at 921-23.

Nevertheless, these institutions set off the funds, compelled the IRS to institute a levy enforcement action, and then interposed the priority of their spurious liens as a defense to the lawsuit. State Bank of Fraser, 861 F.2d at 954; Bell Credit Union, 860 F.2d at 365; Central Bank of Denver [88-1 USTC 9256 ], 843 F.2d 1300; Citizens and Southern National Bank, 538 F.2d at 1101. In at least one instance, the lienholder asserted a lien priority defense in the enforcement action simply because the 9 month statute of limitations had already expired on its 7426 claim. Bell Credit Union, 860 F.2d at 365. See United Sand and Gravel Contractors, 624 F.2d at 739 (7426 provides exclusive remedy against IRS for lienholders even when action is time-barred).

Faced with these dilatory tactics, the circuit courts have required third parties to surrender the levied property in response to the enforcement action, and then to assert lien priorities in a suit for wrongful levy under 7426 . Citizens and Southern National Bank, 538 F.2d at 1106. Accord State Bank of Fraser, 861 F.2d at 954; Central Bank of Denver [88-1 USTC 9256 ], 843 F.2d 1300; Sterling National Bank, 494 F.2d at 921. Even the Supreme Court acknowledged that the bank's unwarranted delay, and the government's need to collect tax revenue promptly, motivated its decision in National Bank of Commerce, 105 S.Ct. at 2924. See United States v. Rodgers [83-1 USTC 9374 ], 461 U.S. 677, 699, 103 S.Ct. 2132, 2145, 76 L.Ed.2d 236 (1983). Finally, the government's brief in this case justifies the surrender-then-litigate rule on the grounds that a party may not ignore the levy "on the assumption that, if pressed, it could establish its senior claim to the fund." (emphasis added). None of these considerations apply to TCB.

When confronted by the Notices of Levy, TCB pursued two courses of action. Although TCB possessed a contractual right of set-off over CIC's bank accounts similar to those exercised by the banks in the above cases, TCB surrendered the funds in these accounts. On the other hand, TCB's interest in the Par Properties check primed the IRS tax lien, as the government concedes on appeal. TCB withheld the check and, within eight days of the second Notice of Levy, filed a wrongful levy suit to adjudicate the parties' respective rights in this property.

We have expressly held that banks should assert their claims of lien priority in a 7426 action. Citizens and Southern National Bank, 538 F.2d at 1106. This statute permits third parties to file suit "without regard to whether such property has been surrendered." By promptly filing its 7426 Wrongful Levy Suit, TCB offered to prove its meritorious claim of lien priority outright, before the government "pressed it" into establishing its senior interest in a 6332 suit. We will not permit the IRS to file a 6332 counter-claim in response to TCB's wrongful levy action, and then to assert that its claim defeats TCB's rights under 7426 . State Bank of Fraser, 861 F.2d at 960. (Recognizing the procedural distinction between a levy enforcement action and a wrongful levy action). Since, unlike the parties to the above actions, TCB followed the procedural scheme established by 7426 to assert its superior interests in the check, TCB should have its claim adjudicated on the merits.

Besides following the correct procedure, TCB was also the proper plaintiff to assert a section 7426 claim. The same was not true of parties to these other suits. In National Bank of Commerce, 105 S.Ct. at 2928, the bank refused to surrender assets in the levied accounts because other depositors might possess an interest in those funds. Section 7426 permits only those parties with an interest in the funds to institute a wrongful levy action. Consequently, as the Supreme Court held, the bank could not contravene the IRS levy by asserting some other party's interests. Unlike National Bank of Commerce, TCB presented its own superior lien in the 7426 suit. 6

Even the one factually similar case offered by the IRS is distinguishable from this case. As explained above, the 11th Circuit found that a bank which possessed a superior security interest to the IRS acted properly when it surrendered the funds in response to the levy, and then instituted a wrongful levy action. Trust Company of Columbus, 735 F.2d at 449. We agree that the statutes allow parties to elect that alternative procedure. However, the 11th Circuit went on to imply that "surrender-then-litigate" is the only permissible response to an IRS levy. Id. at 449. We question this assertion. The case itself did not present the question of a bank that litigated before surrendering the property. The court never discussed the specific language of 7426 . Instead, the court based its conclusions upon its reading of our decision in Citizens and Southern National Bank, 538 F.2d at 1101. That case involved an enforcement action under 6332 rather than a wrongful levy action under 7426 . Id. at 1106. As we indicated above, this procedural distinction alters the outcome of the analysis.

Later proceedings in the Trust Company case undermine the wisdom of the court's prior pronouncement. Trust Company of Columbus v. United States [85-2 USTC 9824 ], 776 F.2d 270, 272 (11th Cir. 1985). After prevailing on the merits, the bank sought an award of attorney's fees under the Equal Access to Justice Act. The appellate court upheld the fee award, because the position advanced by the United States in the wrongful levy suit was not "substantially justified":

[T]he conduct of the IRS prior to the bank's filing suit . . . left the bank with no alternative save to seek judicial relief. . . . [A]fter the levy the bank endeavored to explain to the IRS the priority of its lien over the tax lien . . .

As stated in the District Court's opinion: . . . '[The IRS] did not respond to Plaintiff's written explanation, leaving Plaintiff no recourse but to file suit in this Court.'

Id. at 272.

The procedure established by these two decisions seems anomalous. Under the first opinion, the bank must surrender even those assets over which it has clear priority, and then litigate priority issues in a wrongful levy action. If the IRS controverts the bank's priority position, it might incur the bank's costs and attorney's fees when the bank prevails. As a result, the IRS must not only surrender the assets which it seized, but must also expend dual litigation expenses.

This is precisely the result that the Supreme Court attempted to avoid in National Bank of Commerce, 105 S.Ct. at 2931, when it compared levy procedures to lien foreclosure actions:

If the IRS were required to bring a lien foreclosure suit each time it wished to execute a tax lien on funds in a joint bank account, it would be uneconomical as a practical matter, to do so on small sums of money as those at issue here.

Id. at 2931. With regard to the costs incurred by the IRS, a levy procedure followed by a wrongful levy action in which the third party prevails and receives a fee award, is equivalent to a lien foreclosure action. Consequently, the benefits of speed and efficiency attributable to the levy procedure do not apply in a case like TCB's where the bank has clear priority over the disputed asset.

Given the permissive language of Section 7426 , the distinctions between TCB's case and similar precedents, and the IRS's concession that TCB satisfied the prima facie requirements under 7426 , we find that TCB justifiably instituted a wrongful levy action before surrendering the check. See Security Counselors, Inc. v. United States [88-2 USTC 9584 ], 860 F.2d 867, 869 (8th Cir. 1988); Flores v. United States [77-1 USTC 9380 ], 551 F.2d 1169, 1171 (9th Cir. 1977). See also Treasury Regulations 301.7426-1 (1988). 7 Furthermore, we find that a meritorious wrongful levy action instituted prior to the surrender of the levied property constitutes "reasonable cause" to dishonor the levy for purposes of the 50% penalty clause under 6332(c)(2) . Thus, we affirm the district court's determination not to penalize TCB for its actions. Even if our construction of 7426 is in error, however, it seems to us that this case is sufficiently novel to justify the conclusion that TCB had a "reasonable cause" to dishonor the levy and cannot suffer a 50% penalty for asserting valid, superior property rights in the check. See United States v. Sterling National Bank & Trust, supra.

IV.

LIEN PRIORITIES IN THE BANK ACCOUNTS

TCB also contends that it held a "security interest" in CIC's bank accounts which primed the IRS's interest. We reject this contention.

Section 6321 of the tax code gives the IRS a lien "upon all property and rights to property" belonging to a delinquent taxpayer. Aquilino v. United States [60-2 USTC 9538 ], 363 U.S. 509, 512, 80 S.Ct. 1277, 1280, 4 L.Ed.2d 1365 (1960). The lien arises on the date that the IRS assesses unpaid taxes, applies to currently owned as well as after-acquired property, and continues until the taxpayer satisfies the debt, or the statute of limitations runs. 26 U.S.C. 6322 . See Glass City Bank v. United States [45-2 USTC 9449 ], 326 U.S. 265, 267, 66 S.Ct. 108, 110, 90 L.Ed. 56 (1945); United States v. Cache Valley Bank [89-1 USTC 9157 ], 866 F.2d 1242, 1244 (10th Cir. 1989); Prewitt v. United States [86-2 USTC 9513 ], 792 F.2d 1353, 1355 (5th Cir. 1986).

Where a third party also claims a lien interest in the taxpayer's property, the basic priority rule of "first in time, first in right" controls, unless Congress has created a different priority rule to govern the particular situation. 8 Rice Investment Company v. United States [80-2 USTC 9654 ], 625 F.2d 565, 568 (5th Cir. 1980). See United States v. Wingfield [88-1 USTC 9367 ], 822 F.2d 1466, (10th Cir. 1987) cert. den. sub. nom. County of Boulder v. United States, 486 U.S. 1019, 108 S.Ct. 1762, 100 L.Ed.2d 222 (1988). In this case, TCB relies on the special priority rules under 6323(a) to contend that it is the "holder of a security interest" in the bank accounts, which primes the IRS's tax lien.

Section 6323(a) provides:

The lien imposed by section 6321 shall not be valid against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor until notice thereof which meets the requirements of subsection (f) has been filed . . . (emphasis added)

For purposes of this section, the term "security interest" means "any interest in property acquired by contract for the purpose of securing payment or performance of an obligation or indemnifying against loss or liability." 26 U.S.C. 6323(h)(1) . A security interest exists only when the lienholder satisfies two requirements:

(A) the property must be in existence at the time of the filing, and the interest must be protected under local law against a subsequent judgment lien arising out of an unsecured obligation, and

(b) the holder must have parted with money or money's worth.

Id. Assuming that TCB's contractual rights to place an administrative hold on, or to set-off against, the bank accounts are intended to secure TCB's interests, TCB fails to satisfy the first requirement for lien priority.

TCB failed to prove that the $40,233.91 contained in CIC's bank accounts on January 8, 1986 at the time of the tax levy constituted "property in existence" before the IRS filed its Notices of Tax Lien on August 3 and September 24, 1985. Since bank accounts come into existence only after a customer deposits his funds, TCB's interest in CIC's bank accounts can only arise post-deposit. See Sears v. Continental Bank and Trust, 562 S.W.2d 843 (Tex. 1977). However, a tax lien attaches to all property or rights in property held by the delinquent taxpayer. Aquilino, 363 U.S. at 512, 80 S.Ct. at 1280; Bell Credit Union, 860 F.2d at 369. Thus, any deposits made after the IRS filed its tax lien notices would have entered CIC's, and thus TCB's hands already impressed with the tax lien. 9 See United States v. Bess [58-2 USTC 9595 ], 357 U.S. 51, 57, 78 S.Ct. 1054, 1058, 2 L.Ed.2d 1135 (1958); Cache Valley Bank, 866 F.2d at 1245; Bank of Celina, 721 F.2d at 169. Since TCB did not prove that CIC deposited any portion of the $40,233.91 before the tax lien filing, TCB failed to meet this first requirement. Accordingly, we need not address the parties' interesting arguments concerning the Texas common law of pledge.

For the foregoing reasons, the judgment of the district court is AFFIRMED.

1 The record does not indicate whether TCB actually deposited these funds into CIC's account and then exercised its contractual set-off rights, or merely endorsed the check, presented it to Par's bank for payment, and then applied the money against CIC's debt. Since the IRS agrees that TCB had a superior interest in these funds, we need not resolve this question.

2 Section 6332(c)(2) provides:

In addition to the personal liability imposed by paragraph (1), if any person required to surrender such property or rights to property fails or refuses to surrender such property or rights to property without reasonable cause, such person shall be liable for a penalty equal to 50 percent of the amount recoverable under paragraph (1).

3 Section 7426(a) provides:

If a levy is made on property . . ., any person (other than the person against whom is assessed the tax out of which such levy arose) who claims an interest in or lien on such property and that such property was wrongfully levied upon may bring a civil action against the United States . . .

4 Several courts have held that 7426 does not permit a third party who anticipates that the IRS will levy against property to file for a declaration of the parties' interests in the assets. Interfirst Bank Dallas, N.A. v. United States [85-2 USTC 9635 ], 769 F.2d 299, 304 (5th Cir. 1985) cert. den. 475 U.S. 1081, 106 S.Ct. 1458, 89 L.Ed.2d 716 (1986); Nickerson v. United States [75-1 USTC 9336 ], 513 F.2d 31, 33 (1st Cir. 1975).

5 See, for example, National Bank of Commerce [85-2 USTC 9482 ], 472 U.S. 713, 105 S.Ct. 2919, 86 L.Ed.2d 565 (1985); State Bank of Fraser v. United States [88-2 USTC 9592 ], 861 F.2d 954, 960 (6th Cir. 1988); Bell Credit Union, 860 F.2d at 365; United States v. Central Bank of Denver [88-1 USTC 9256 ], 843 F.2d 1300, 1303 (10th Cir. 1988); Citizens and Southern National Bank, 538 F.2d at 1101.

6 In addition to these procedural differences, TCB's action invokes distinct substantive concerns. Many of the cases relied upon by the IRS involve fraudulent behavior and the dissipation of collectible assets. For instance, the bank, in National Bank of Commerce, 105 S.Ct. at 2919, claimed that it could not ascertain what proportion of the assets in two jointly-held bank accounts constituted "property" of the taxpayer. Id. at 2922. Concerned that this rationale for defying the levy would permit "a delinquent taxpayer to evade . . . his obligations by placing funds in joint bank accounts", the Supreme Court required the bank to surrender the money, allowing third parties to litigate over property rights in a subsequent proceeding. Id. at 2931. See also Arth, 735 F.2d at 1193 (Funds in "assigned" bank account attributed to delinquent corporation rather than to "independent contractor" who 'saved' company); Valley Finance, Inc., 629 F.2d at 162 (Seizure of Pacific Development Co. assets upheld after IRS characterizes company as the "alter ego" of delinquent taxpayer). While affirming the surrender-first rule in these situations, the courts stress "the apparent exigencies of the situation", and the need for the IRS to secure tax collection. See National Bank of Commerce, 105 S.Ct. at 2931; Valley Finance, Inc., 629 F.2d at 167.

By contrast, as the IRS concedes, TCB held a superior lien over the Par Properties check. TCB could not defraud the IRS by withholding those assets from the levy. Even if the IRS had held a superior claim, concerns over dissipation still would not apply. TCB had allegedly set-off the check against the taxpayer's bank debt. As a result, the IRS would retain a cause of action against TCB for surrender of those funds. Unlike a taxpayer who could conceal or dissipate the money, the bank would have all of its assets available to satisfy the IRS's claim. Therefore, TCB's wrongful levy action would not impair prompt collection of tax revenue.

7 The government suggests that we have opened a gaping hole through which tax lien avoiders will stream. We doubt it. First, our holding is limited to assertion of a meritorious lien claim under 7426 . Second, IRS will nearly always counterclaim for enforcement of the levy when it faces a 7426 lawsuit by the party who withheld compliance. The IRS could seek its own injunctive relief to protect the disputed property pending litigation, in addition to seeking a 6332 penalty where warranted.

8 To determine whether those liens not covered by a special priority rule are "first in time" as against a federal tax lien, courts rely on the judicially-created "choateness" doctrine. See United States v. Kimbell Foods, Inc., 440 U.S. 715, 733-35, 99 S.Ct. 1448, 1461-62, 59 L.Ed.2d 711 (1979); United States v. Pioneer American Ins. Co. [63-2 USTC 9532 ], 374 U.S. 84, 83 S.Ct. 1651, 10 L.Ed.2d 770 (1963); United States v. New Britain [54-1 USTC 9191 ], 347 U.S. 81, 84, 74 S.Ct. 367, 370, 98 L.Ed. 520 (1953); United States v. Security Trust & Savings Bank [50-2 USTC 9492 ], 340 U.S. 47, 71 S.Ct. 111, 113-14, 95 L.Ed. 53 (1950). See 14 Merten's 54A.013. In order to assert priority over the government, a lienholder must demonstrate that his lien became choate before the tax lien filing. A lien becomes choate when (a) the lienor is identified, (b) the property subject to the lien is established, and (c) the amount of the lien is fixed. New Britain, 74 S.Ct. at 371.

Several circuits, including two panels of this court, have imported the "choateness" requirement into 6323 . Rice Investment Co. v. United States [80-2 USTC 9654 ], 625 F.2d 565, 571 (5th Cir. 1980); Texas Oil & Gas Corp. v. United States [72-2 USTC 9653 ], 466 F.2d 1040, 1053 (5th Cir. 1972) cert. den. sub. nom. Pecos County State Bank v. United States, 410 U.S. 929, 93 S.Ct. 1367, 35 L.Ed.2d 591 (1973). See J.D. Court Inc. v. United States [83-2 USTC 9454 ], 712 F.2d 258, 263 (7th Cir. 1983) cert. den. 466 U.S. 927, 104 S.Ct. 1708, 80 L.Ed.2d 182 (1984); Sgro v. United States [79-2 USTC 9733 ], 609 F.2d 1259, 1261 (7th Cir. 1979). A different panel of this court specifically rejected this reliance on choateness under 6323 in situations clearly covered by the statute. Aetna Insurance Co. v. Texas Thermal Industries Inc. [79-1 USTC 9287 ], 591 F.2d 1035, 1038 (5th Cir. 1979). See Slodov v. United States [78-1 USTC 9447 ], 436 U.S. 238, 98 S.Ct. 1778, 1790 n. 22, 56 L.Ed.2d 251 (1978); Atlantic States Construction Inc. v. Hand, Arendall, Bedsole, Greaves, and Johnston, 892 F.2d 1530 (11th Cir. 1990). In view of the above resolution of the issues, we need not resolve this apparent conflict.

9 The bank does not contend that its lien extended to a pre-deposit period, e.g. in the form of a security interest in accounts receivable, whose proceeds were paid into the TCB account.

 

[96-2 USTC 50,589] United States of America, Plaintiff v. AmSouth Bank of Florida, Defendant

U.S. District Court, Mid. Dist. Fla., Ocala Div., 95-75-Civ-Oc-10, 9/13/96, 947 FSupp 459

[Code Sec. 6332 ]

Liens and levies: Compliance: Enforcement: Bank account: Defenses: Priority claims: Penalty: Failure to surrender property.--A bank failed to turn over all the funds in an individual's bank account to the IRS pursuant to a levy when it retained a portion of the funds to pay its attorneys' fees and costs incurred during the litigation of an unrelated matter. The bank's claim that it had a perfected security interest in the funds that had priority over the tax lien was not an appropriate defense to the IRS's enforcement action. Further, since no wrongful levy claim was pending, the court was without authority to decide whether the claim was barred by the limitations period. Reg. 301.6323b-1(j) did not require the bank to remit to the IRS only the amount in excess of that to which it was entitled pursuant to its security interest in the account because priority issues are not litigable in enforcement actions. The penalty for failure to surrender property was imposed on the bank because it refused to comply with the levy without reasonable cause.
ORDER

HODGES, District Judge:

This action to enforce a tax levy is before the Court on the parties' cross-motions for summary judgment (Docs. 12, 18). Each party has responded to the motion of the other. For the reasons that follow, Plaintiff's motion for summary judgment will be granted and Defendant's motion will be denied.

BACKGROUND

Because the Court's resolution of the case does not turn on the complex priority issues forming the bulk of the parties' argument, a short statement of undisputed facts will suffice.

In 1988 and 1989, taxpayer, Mr. James T. Greene, contracted for four loans from Defendant's predecessor, Mid-State Federal Savings Bank. Mr. Greene also maintained a time deposit account in Mid-State; and, pursuant to assignments, Mid-State held the account as security for the loans. Mr. Greene's account was also subject to an administrative hold which prevented him from withdrawing funds from the account.

In July 1989, the United States Department of Agriculture filed suit against Mr. Greene and Mid-State under the Perishable Agricultural Commodities Act. The USDA claimed that Greene made payments on the first loan 1 issued by Mid-State out of funds that were subject to a trust created by the Act. The complaint, therefore, sought recovery of many of the funds paid to Mid-State under the first of the four loans. Mid-State believed that the lawsuit placed the completion of Mr. Greene's obligations under the first loan in question and that, under the terms of the first loan or pursuant to dragnet clauses in the other three loans, it was entitled to payment, out of the Greene account, of attorney's fees and costs incurred in defending the action.

On May 30, 1990, while the USDA litigation was pending, the Internal Revenue Service filed a tax lien in the amount of $276,246.36 against Mr. Greene. In an effort to collect Mr. Greene's unpaid tax debt, the IRS, on June 28, 1990, filed a notice of levy with Mid-State Savings Bank. Mr. Greene's account with Mid-State had an approximate balance, at the time of the levy, of $65,000.

On February 26, 1991, the IRS served Mid-State with a final demand for the funds Mid- State held in Greene's account. On March 5, Mid-State's attorney wrote a letter to the IRS informing it of Mid-State's intent to retain the funds in the account pending the outcome of the litigation with the USDA.

On June 29, 1992, the U.S. District Court for the Middle District of Florida granted summary judgment in Mid-State's favor in the USDA litigation. On June 15, Mid-State used the funds in the Greene account to pay $37,750.26 worth of attorney's fees and costs incurred during the litigation. On February 15, 1993, Mid-State remitted the remaining $34,400.13 to the IRS.

On July 13, 1993, the IRS wrote Mid-State informing Mid-State of its belief that the February 15 remittance was insufficient and of its contention that it was entitled to the funds disbursed by Mid-State subsequent to the USDA litigation. On July 26, Mid-State's attorney wrote the IRS explaining its belief that it was entitled to the funds in question and that the February 15 remittance constituted the extent of Mid-State's obligation under the levy.

On December 12, 1993, Mid-State merged into AmSouth bank of Florida. Pursuant to the terms of the merger, AmSouth assumed all liabilities of Mid-State, including any liability it might have had in connection with the tax levy.

This lawsuit to enforce the levy pursuant to 26 U.S.C. 6332 was filed by the United States on April 19, 1995 (Doc. 1). The complaint alleges an entitlement to all of the funds in the Greene account as of the date of the levy, which, for practical purposes, means the $37,750.26 paid out of the account prior to the February 15, 1993 remittance. The complaint also demands that a penalty of fifty percent of the recoverable amount be imposed upon AmSouth. 26 U.S.C. 6332(d)(2) .

Both parties have moved for summary judgment. The government argues that the existence of a prior lien interest cannot be raised as a defense to an action to enforce a levy. The parties then concentrate on the issue of whether, as of the date of the levy, Mid-State had an perfected security interest in the funds held in the Greene account with priority over the tax lien. The parties have also argued about whether Mid-State's refusal to honor the levy constituted "reasonable cause" such that the fifty percent penalty should not be imposed.

DISCUSSION

Summary judgment is appropriate only when the Court is satisfied "that there is no issue as to any material fact and that the moving party is entitled to judgment as a matter of law." F.R.Civ.P. 56(c). In making this determination, the Court must "view the evidence in the light most favorable to the non-moving party." Samples on Behalf of Samples v. Atlanta, 846 F.2d 1328, 1330 (11th Cir. 1988). The moving party has the initial burden of establishing the absence of a genuine issue of fact. Celotex Corp. v. Catrett, 477 U.S. 317, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). Next, the "non-moving party ... bears the burden of coming forward with sufficient evidence of every element that he or she must prove." Rollins v. Techsouth, Inc., 833 F.2d 1525, 1528 (11th Cir. 1987). To that end, the non-moving party must "go beyond the pleadings and by her own affidavits, or by the depositions, answers to interrogatories, and admissions on file, designate specific facts showing that there is a genuine issue for trial." Celotex, 477 U.S. at 324, 106 S.Ct. 2553 (citations and internal quotation marks omitted).

A. May AmSouth raise a prior lien interest in defense?

There are only two defenses to an action to enforce a levy pursuant to 26 U.S.C. 6332(d) 2: (1) that the defendant is not in possession of or obligated with respect to the taxpayer's property or rights therein; and (2) the property levied upon was subject to attachment or judicial process at the time the levy was received. United States v. Nat'l Bank of Commerce [85-2 USTC 9482 ], 472 U.S. 713, 722, 105 S.Ct. 2919, 2925, 86 L.Ed.2d 565 (1985). 3 The defenses to an enforcement action are necessarily limited in light of the Congressional purpose to ensure quick and inexpensive compliance with the provisions of the tax code. Id. at 720-22, [85-2 USTC 9482 ] 105 S.Ct. at 2924-25. As a result, claims of security interests with priority over the tax levy may not be raised in a 6332 proceeding; rather, such claims are properly litigated only in an action for wrongful levy under 26 U.S.C. 7426 . Trust Co. of Columbus v. United States [84-2 USTC 9614 ], 735 F.2d 447, 449-450 (11th Cir. 1984); United States v. Citizens and Southern Nat. Bank [76-2 USTC 9665 ], 538 F.2d 1101, 1106 (5th Cir. 1976), cert. denied, 430 U.S. 945, 97 S.Ct. 1579, 51 L.Ed.2d 792 (1977).

Precedent, therefore, clearly commands the result in this case. However, Defendant raises two arguments against the foreclosure of its defenses in this case. First, Defendant argues that, because the government waited so long to bring this action, the nine month limitation on the bringing of an action pursuant to 7426 has run and "principles of equity" should preclude the government from raising this issue now. Absent a pending 7426 claim, the Court is obviously without authority to decide the limitations issue. Further, Defendant cites no authority for such a departure from clearly established precedent.

Defendant's second argument is equally unavailing. Defendant contends that Treas. Reg. 301.6323b-1(j) and the concomitant example establish that Defendant was only required to remit to the IRS the amount in excess of that to which it was entitled pursuant to its security interest in the account. This regulation interprets 26 U.S.C. 6322 which deals with the validity and priority of IRS liens as against certain individuals. 6332 and the cases interpreting it clearly establish that priority issues are not litigable in actions to enforce a tax levy. Consequently, this argument also fails and the government is entitled to summary judgment on its claim to enforce the levy.

B. Is the United States entitled to a penalty?

26 U.S.C. 6332(d)(2) provides that any person who fails to comply with a levy, without reasonable cause, when required to do so shall be liable to the government for a penalty in the amount of fifty percent of the amount recovered. Treas. Reg. 301.6332-1(b)(2) finds reasonable cause where there is a bona fide dispute concerning the amount of property to be surrendered pursuant to the levy or the legal effectiveness of the levy. Although the regulation is unclear as to whether priority issues raise such bona fide disputes, cases interpreting the statute have found reasonable cause when a defendant has brought a wrongful levy action prior to remittance or where there was a dispute over the applicability of the defenses to a 6332 claim. See supra p. 4-5. See United States v. Donahue Indus., Inc. [90-2 USTC 50,343 ], 905 F.2d 1325 (9th Cir. 1990) (holding that bona fide dispute over whether bank actually possessed property belonging to taxpayer is reasonable cause); Texas Commerce Bank-Fort Worth, N.A. v. United States [90-1 USTC 50,155 ], 896 F.2d 152 (5th Cir. 1990) (holding that reasonable cause exists where meritorious wrongful levy action is instituted prior to surrender of levied property); Citizens & Southern [76-2 USTC 9665 ], 538 F.2d 1101 (bona fide dispute over whether deposit represents property is reasonable cause).

Excepting Defendant from the penalty provisions of the statute where it has neither raised a cognizable defense to the enforcement action or instituted a wrongful levy proceeding would undermine the effectiveness of the levy as a remedy. The levy provisions of the Internal Revenue Code contain broad grants of power with narrow exceptions in order to secure the efficiency and cost effectiveness of the levy as a tax collection device. See generally Nat'l Bank of Commerce [85-2 USTC 9482 ], 472 U.S. at 720-23, 105 S.Ct at 2924-25. If every dispute with the IRS over priority to property subject to a levy constituted reasonable cause, persons claiming priority would have no reason to surrender levied property until the government commences an enforcement action, rendering the penalty provision, in substantial part, nugatory. Such a result would destroy the levy's effectiveness as a provisional administrative remedy. See Nat'l Bank of Commerce, [85-2 USTC 9482 ] 472 U.S. at 721, 105 S.Ct. at 2924.

The justification for the imposition of a penalty in this case is strengthened in light of the clarity of the law with regard to the proper procedure in the event of a priority dispute. Controlling law in this Circuit and others unequivocally declines to recognize priority claims as a defense to a levy and makes an action for wrongful levy the exclusive mechanism for pursuit of such claims. Trust Co. of Columbus [84-2 USTC 9614 ], 735 F.2d at 449-50; Citizens & Southern [76-2 USTC 9665 ], 538 F.2d at 1106. See Texas Commerce Bank-Fort Worth [90-1 USTC 50,155 ], 896 F.2d at 157. Defendant has not raised a cognizable defense to a 6332 action and has ignored the appropriate avenue for pursuit of its priority claims. As such, Defendant has not established reasonable cause for its failure to honor the levy.

Accordingly, upon due consideration,

(1) Defendant's motion for summary judgment (Doc. 18) is DENIED; and

(2) Plaintiff's motion for summary judgment (Doc. 12) is GRANTED and the Clerk is directed to enter judgment for Plaintiff in the amount of thirty-seven thousand seven hundred and fifty dollars and twenty-six cents ($37,750.26), representing the principal amount due under the levy, eighteen thousand eight hundred and seventy-five dollars and thirteen cents ($18,875.13), representing the penalty imposed pursuant to 26 U.S.C. 6332(d)(2) , plus interest at the rate prescribed by law, plus costs according to law.

IT IS SO ORDERED.

1 The payment status of the loans is a matter of some dispute. The first loan was paid in full by Mr. Greene in September 1988 and stamped paid by Mid-State. The remaining three loans matured in September 1989 and Mid-State took $111,488.02 from the Greene account to satisfy the debt. These loans, however, were never noted by Mid-State as paid.

2 26 U.S.C. 6332(d)(1) provides:

Any person who fails or refuses to surrender any property or rights to property, subject to levy, upon demand by the Secretary, shall be liable in his own person and estate to the United States in a sum equal to the value of the property or rights not so surrendered. ...

3 Defendant raises neither of these defenses here.

 

[91-1 USTC 50,042] United States of America v. Philadelphia Yearly Meeting of the Religious Society of Friends. United States of America v. Philadelphia Yearly Meeting of the Religious Society of Friends

U.S. District Court. East. Dist. Pa., Civ. 88-6368, Civ. 88-6390, 12/20/90

[U.S. Constitution and Code Sec. 6332 ]

Constitution: First Amendment: Tax protestor: Levies: Salary: Enforcement: Penalty.--A levy on the wages of employees of a religious society was enforceable and did not violate the constitutional rights of the society. However, since the society had reasonable cause for its refusal to honor the levy, it was not liable for an additional penalty. The society contended that its refusal to honor the levies and turn over the wages of its employees was protected by the First Amendment, free exercise of religion clause. The employees failed to pay the military portion of their tax liability on religious grounds. It is a religious tenet of the society not to coerce or aid in the coercion of persons who for religious reasons feel they cannot pay the military portion of their tax liability. Consequently, the society argued that for religious reasons it could not act as the collection agent for the IRS with respect to the levy. Nevertheless, it was determined that requiring the society to enforce the levy did not violate its constitutional rights because the levy enforcement law is a neutral, generally applicable regulatory law that is not specifically directed at regulating the religious practice of the society or its religious beliefs. However, as a bona fide dispute existed concerning the legal effectiveness of the levy, the society was not liable for a penalty for its refusal to enforce the levy.

Valentina G. Biletto, Department of Justice, Washington, D.C. 20530, for plaintiff. Peter Goldberger, Chestnut St. at 9th, Philadelphia, Pa. 19107, for defendant.

MEMORANDUM AND ORDER

SHAPIRO, District Judge:

The United States brought these civil actions in August, 1988, to enforce two Internal Revenue Service levies, authorized by 26 U.S.C. 6332(c)(1), upon the Philadelphia Yearly Meeting of the Religious Society of Friends ("Yearly Meeting"). In each case, the government seeks to impose a 50% penalty, authorized by 26 U.S.C. 6332(c)(2), on the ground that the Yearly Meeting refused to honor the levies without reasonable cause.

I. FACTS

The Yearly Meeting was established in 1681 by William Penn. It presently includes approximately 13,000 members, who are organized into one hundred and one congregations, or Monthly Meetings, located throughout southeastern Pennsylvania, central and southern New Jersey, Delaware and the Eastern Shore of Maryland. The membership gathers in an annual session for worship and business. A body of appointed delegates, known as Representative Meeting, conducts the business of the Yearly Meeting when the full membership is not in session. The Yearly Meeting has about 45 full-time employees, many of whom are also members of the Yearly Meeting. At the time the IRS served the levies at issue in these cases, David A. Falls and William Grassie were employees and members of the Yearly Meeting.

On August 26, 1985, an IRS officer served the Yearly Meeting with a Notice of Levy against the salary of David Falls to collect the unpaid joint federal income taxes of Falls and his wife, Sabrina S. Falls, for the years 1983 and 1984 in the amount of $5,558.21. That notice was followed by a Final Demand served upon defendant on October 2, 1985. On June 26, 1986, an additional Notice of Levy and Final Demand were served on the Yearly Meeting to collect the Falls' unpaid tax liabilities from 1983, 1984 and 1985 in the amount of $9,947.09.

By letter, dated July 21, 1986, the Representative Meeting on behalf of the Yearly Meeting informed the IRS that it knew David and Sabrina Falls were "deeply religious and conscientiously motivated individuals who feel they cannot pay the military portion of their taxes without violating the central tenets of their religious faith." Complaint, Civ. Action No. 88-6390, Ex. F. The letter stated that:

It is the policy of Philadelphia Yearly meeting not to coerce or violate the consciences of such persons, or to act as agents for those who do. We, therefore, advise you that we cannot honor the levy you have served.

Ibid.

On October 24, 1986, the IRS served a Notice of Levy against the salary of William Grassie to collect $1,276.90 in unpaid taxes for the years 1981 and 1982. Defendant, responding on November 7, 1986, stated that it knew Grassie was "conscientiously refusing payment of the military portion of his taxes in accordance with long-established religious principles of the Religious Society of Friends (Quakers), of which he is a member in good standing." Complaint, Civ. Action No. 88-6388, Ex. C. Defendant again advised the IRS that it refused to honor the levy because:

It is the policy of Philadelphia Yearly Meeting of the Religious Society of Friends, as employer, not to coerce or violate the consciences of its employees and members with respect to their religious principles, or to act as an agent for those who do.

Ibid. The IRS responded on November 25, 1986 by serving a Final Demand upon defendant.

The refusal to honor the levies was in accordance with a written policy of the Yearly Meeting adopted in 1975 and reaffirmed in 1983 and 1988. Def. Ex. at D9-D10.

The parties filed cross motions for summary judgment. Following oral argument, supplemental memoranda were submitted by defendant on June 5, 1990 and by the United States on June 22, 1990.

II. DISCUSSION

Under the Federal Rules of Civil Procedure, summary judgment may be granted only if there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c). The parties agree that there are no disputed facts in this case. The legal issues before the court are whether the levies issued by the government may be enforced against the Yearly Meeting and, if so, whether the Yearly Meeting must pay a statutory penalty for refusing to honor the levies.

A. Enforcement of the Levies

Section 6332(c)(1) of the Internal Revenue Code provides:

[A]ny person who fails or refuses to surrender any property or rights to property, subject to levy, upon demand by the Secretary [of the Treasury], shall be liable in his own person and estate to the United States in a sum equal to the value of the property or rights not so surrendered * * *.

26 U.S.C. 6332(c)(1). There is no dispute that the salaries of David Falls and William Grassie were "property" subject to levy, that the Yearly Meeting was in possession or control of the salaries they earned, and that the Yearly Meeting refused to surrender their salaries to the Secretary of the Treasury. The Yearly Meeting defends its refusal to honor the levies on the ground that its action was protected by the Free Exercise Clause of the First Amendment. 1 It argues that enforcement of the levies would deny free exercise of religion by the Religious Society of Friends because it is a fundamental tenet of the Yearly Meeting of the Society of Friends to respect the conscientious actions of its members and Falls and Grassie desired to withhold certain taxes based on their religious convictions. The Yearly Meeting asserts that the government of the United States is constitutionally required to accommodate the religious principles of the Society of Friends by finding another way to collect delinquent taxes from Yearly Meeting employees who are religious pacifists or establishing a means for them to pay taxes only for non-military government programs.

Prior to the decision of the Supreme Court in Employment Division v. Smith, 108 L.Ed 2d 876 (1990), such claims were commonly evaluated under the test set forth in Sherbert v. Verner, 374 U.S. 398 (1963). Under Sherbert, parties whose sincerely held religious beliefs were burdened or infringed by a government practice were entitled to a religious exemption from that practice unless the exemption frustrated a compelling state interest.

In Smith, respondents were fired by a private drug rehabilitation organization because they ingested a hallucinogenic drug, peyote, for sacramental purposes at a ceremony of the Native American church, of which both were members. Respondents then applied for unemployment compensation from the State of Oregon, but were denied benefits because they had been discharged for work related "misconduct." The state agency argued to the Oregon Supreme Court that the denial was permissible because peyote consumption was a crime under Oregon law. That court, citing Sherbert, reasoned that the criminality of peyote use was irrelevant and held that the denial of benefits violated respondents' rights under the Free Exercise Clause. 108 L.Ed. 2d at 883.

In Smith I, 485 U.S. 660, 670 (1988), the Court determined that if the state could constitutionally make criminal the religiously motivated use of peyote, the state could also deny unemployment compensation benefits to persons fired because of peyote use. The Court remanded the case to the Oregon Supreme Court and instructed it to determine whether the state criminal law exempted religiously motivated use of peyote from the general prohibition against use and possession of controlled substances. Id. at 672. The Oregon Supreme Court held that the state law prohibited such use and that the law violated the Free Exercise Clause. Smith II, 108 L.Ed.2d at 883-884. The United States Supreme Court then granted certiorari to consider whether the Free Exercise Clause prohibits a state from barring the use of peyote for religious reasons.

Reversing the state court's decision, the Court rejected the contention that when "prohibitable conduct is accompanied by religious convictions * * * the conduct must be free from governmental regulation." Id. at 888. To the contrary, the Court held that:

[T]he right of free exercise does not relieve an individual of the obligation to comply with a 'valid and neutral law of general applicability on the ground that the law proscribes (or prescribes) conduct that his religion prescribes (or proscribes).'

Id. at 886 (quoting United States v. Lee [82-1 USTC 9205 ], 455 U.S. 252, 263 n.3 (1982)). Under the Smith standard, the Free Exercise Clause is violated by a generally applicable social regulation only, if that regulation is "specifically directed at * * * religious practice," id. at 885, or if it attempts "to regulate religious beliefs, the communication of religious beliefs, or the raising of one's children in those beliefs * * *," id. at 888.

The Court concluded that claims for religious exemptions from criminal prohibitions should not be evaluated under any balancing test. Considering that test "inapplicable to such challenges," the Court stated that:

The government's ability to enforce generally applicable prohibitions of socially harmful conduct * * * cannot depend on measuring the effects of a governmental action on a religious objector's spiritual development. To make an individual's obligation to obey such a law contingent upon the law's coincidence with his religious beliefs, except where the State's interest is "compelling" * * * contradicts both constitutional tradition and common sense.

Id. at 888-889 (quoting Lyng v. Northwest Indian Cemetery Protective Ass'n, 485 U.S. 439, 451 (1988)).

In light of the Court's holding in Smith and the limitation placed on the applicability of the Sherbert test, defendant's constitutional attack on enforcement of the levies in this case fails. Section 6332(c)(1) is a "neutral, generally applicable regulatory law," as was the criminal provision at issue in Smith. The statute is not specifically directed at regulating the religious practice of the Yearly Meeting, nor does it attempt to regulate the Yearly Meetings' religious beliefs. The law is designed to facilitate the collection of delinquent taxes through the procedural device of a third party levy. Under Smith, such a law is enforceable against all individuals and organizations, regardless of whether, or the degree to which, the law interferes with religious conduct.

The Yearly Meeting contends (see Letter of Peter Goldberger, Esq., June 5, 1990) that the new standard announced in Smith does not apply to this case. It distinguishes Smith on the ground that an exemption from a criminal law for religious observance was claimed there while the Yearly Meeting just seeks compliance with civil tax laws in a manner accommodating its religious convictions. But application of the Smith standard does not depend upon whether the law at issue is criminal or civil. Neither does it depend on whether a party is seeking an exemption or an accommodation of its religious views. Smith holds that all neutral laws of general applicability are valid against all claims for special treatment under the Free Exercise Clause.

Defendant's argument that Smith can be confined to criminal law has recently been rejected by the Court of Appeals for the Third Circuit in Salvation Army (The) v. Department of Community Affairs, No. 89-5705, slip op. (3rd Cir. Nov. 5, 1990). The Salvation Army (TSA) sought an exemption from the requirements of the New Jersey Rooming and Boarding House Act of 1979 (the Act) and regulations promulgated thereunder. Like the argument raised by Yearly Meeting in this case, TSA claimed that the Act and regulations interfered with its sincerely held religious beliefs. 2

After defendants granted an exception to some, but not all, the provisions of the Act, the District Court granted summary judgment in favor of defendants. On appeal, TSA contended that the defendants' concessions were insufficient to accommodate its right to free exercise of religion. After considering Smith, and the provisions of the Act and regulations to which the defendants insisted upon compliance by TSA, the Court of Appeals concluded that all of TSA's objections to those provisions based on the free exercise clause should be rejected.

TSA argued that "the Court's holding [in Smith] was limited to free exercise challenges to neutral, generally applicable criminal statutes." The Court of Appeals refused to accept this interpretation of Smith. Recognizing that there are a number of phrases in the Court's opinion that might support such a limited reading, it noted that the opinion makes references that are not so limited as often as it makes reference to generally applicable criminal laws. Slip op. at 26. The Court of Appeals concluded that the Court was not contemplating a distinction between criminal and civil statutes. In light of the Court of Appeals' rejection of this argument, the holding in Smith controls this case.

Finally, this case does not fall within the narrow category of cases to which Sherbert v. Verner may still apply: cases in which the government has established a "system for individualized exemptions" from a general requirement but has failed to provide an exemption based on religious grounds. See Smith, 108 L.Ed.2d at 889. The United States Congress has not yet established a system providing exemptions from the personal liability imposed by 26 U.S.C. 6332(c)(1) for individuals who fail to honor levies. Parties refusing to honor levies may be exempted from the 50% penalty authorized by 26 U.S.C. 6332(c)(2) for reasonable cause. However, that exemption applies strictly to the penalty, not to initial liability for refusal to honor a levy.

For the reasons stated, partial summary judgment is granted to the United States. The levy against the salary of William Grassie for $1,276.90 plus interest will be enforced. The levy against the salary of David Falls originally in the amount of $9,947.09, will be enforced against his wages in the possession of the Yearly Meeting plus interest ($8,882.82). However, the court has been advised that the total tax liability of David and Sabrina Falls has been reduced; the levy cannot exceed the amount of the Falls' tax liability.

B. Penalty

The United States claims a 50% penalty should be imposed on the Yearly Meeting for failing to honor the levies. Under 26 U.S.C. 6332(c)(2) , no penalty can be imposed unless the defendant acted "without reasonable cause." The Treasury Regulation interpreting that statute provides that the penalty is not applicable where a "bona fide dispute exists concerning * * * the legal effectiveness of the levy." Treas. Reg. 301.6332-1(b)(2) . Likewise, the Senate Report on the penalty statute stated that "a bona fide dispute * * * over the legal effectiveness of the levy itself is to constitute reasonable cause under this provision." S.Rep. No. 1708, 89th Cong., 2d Sess., reprinted in 1966 U.S.Cong.Code & Admin. News 3722, 3740.

When the Yearly Meeting refused to honor the government's levies, in June and November 1986, Smith had not yet been decided. The prevailing legal standard at that time was the Sherbert test, requiring the government to put forward a compelling state interest to justify any action that burdened religious activity. Indeed, Sherbert had been reaffirmed as recently as 1982. See Thomas v. Review Board, 450 U.S. 707, 718 (1982). U.S. v. Lee, supra, foreshadowed Smith in deciding that imposition of social security taxes was constitutional as applied to an employer who objected on religious grounds to receipt of insurance benefits and to payment of taxes to support public insurance. But the opinion in Lee, while quoting the 1961 decision in Braunfeld v. Brown as to the difficulty in attempting to accommodate religious beliefs in the area of taxation, expressly recognized that religious beliefs could be accommodated and cited Thomas and Sherbert as retaining vitality. Had Smith not been decided, this court could have balanced the Yearly Meeting's liberty interest against the government's interest in collecting taxes through levies. The Yearly Meeting reasonably believed it could prevail under that standard.

First, the Yearly Meeting convincingly demonstrated that the government's demand to honor the levies was in direct conflict with its religious principles.

Second, the Yearly Meeting suggested that its exercise of religious precepts could easily be accommodated by permitting conscientious objectors to pay whatever taxes were due into a "peace fund" dedicated to non-military government operations. A bill to establish such a fund had been introduced in Congress in 1987. See H.R. 2041, 100th Cong., 1st Sess. (1987).

Third, the Yearly Meeting sincerely disputed that the government's interest in effective and efficient collection of taxes outweighed any burden imposed on First Amendment rights. United States v. Lee [82-1 USTC 9205 ], 455 U.S. 252 (1982), was distinguishable, the Yearly Meeting argued, because employer Lee sought an outright exemption, not only from withholding his employee's taxes but also from paying taxes owed by him. The Yearly Meeting owes no taxes and requires no exemption. It only asks the government to accommodate its religious convictions by not requiring it to withhold taxes of employees as to whom other collection methods were and are available. The distinction has some weight because collection of revenue is more critical to the operation of the government than a particular method of collection.

The Yearly Meeting had reasonable grounds for challenging the "legal effectiveness of the levy" on constitutional grounds. It may not have prevailed, but its creative and forceful arguments raised a "bona fide dispute" and provided "reasonable cause" for the failure to honor the levies. 3 See United States v. Sterling National Bank & Trust Co. [74-1 USTC 9336 ], 494 F.2d 919, 923 (2d Cir. 1974) (penalty inappropriate under 26 U.S.C. 6332(c)(2) when enforcement of levy depends on "an unsettled question of law"). The Yearly Meeting's motion for summary judgment on the penalty sought by the government is therefore granted.

However, Smith has radically altered Free Exercise Clause jurisprudence and practice. Smith acknowledges that government may not punish the expression of religious doctrines it believes to be false, but for now it is clear that religious beliefs do not excuse compliance with otherwise valid federal tax laws.

Claims such as those here asserted by the Yearly Meeting are now foreclosed by current law. Failure in the future to honor a tax levy on the First Amendment grounds asserted herein may be subject to penalty. See Treas. Reg. 301.6332(b)(2) ("[I]f a court in a later enforcement suit sustains the levy, then reasonable cause would usually not exist to refuse to honor a later levy made under similar circumstances.").

* * *

It is ironic that here in Pennsylvania, the woods to which Penn led the Religious Society of Friends to enjoy the blessings of religious liberty, neither the Constitution nor its Bill of Rights protects the policy of that Society not to coerce or violate the consciences of its employees and members with respect to their religious principles, or to act as an agent for our government in doing so. More than three hundred years after their founding of Philadelphia, and almost two hundred years after the adoption of the First Amendment, it would be a "constitutional anomaly" to the Supreme Court, Smith, 108 L.Ed.2d at 890, if the Religious Society of Friends were allowed to respect decisions of its employee-members bearing witness to their faith.

But "[u]nless we wish anarchy to prevail within the federal judicial system, a precedent of [the Supreme] Court must be followed by lower federal courts no matter how misguided the judges of those courts think it to be." Hutto v. Davis, 44 U.S. 370, 375 (1982). "[O]nly [the Supreme] Court may overrule one of its precedents. Until that occurs [Smith ] is the law." Thurston Motor Lines, Inc. v. Jordan K. Rand, Ltd., 460 U.S. 533, 535 (1983) (quoted in Krause v. Consolidated Rail Corp., 899 F.2d 1352, 1364 (3rd Cir. 1990)). The Smith decision determines the outcome of this action.

JUDGMENT ORDER

AND NOW, this 19th day of December, 1990, upon consideration of the parties' cross-motions for summary judgment and following oral argument on the motions, it is ORDERED that:

1. Plaintiff's motion for summary judgment is GRANTED IN PART AND DENIED IN PART.

a. Pursuant to 26 U.S.C. Section 6332(c)(1) judgment is entered in favor of the plaintiff, the United States of America, and against the defendant, the Philadelphia Yearly Meeting of the Religious Society of Friends, in the amount of no more than $1,276.90, plus interest accruing thereon at the rate established by 26 U.S.C. Section 6621 , from October 24, 1985, with said amount to be credited against the amount of unpaid federal tax liabilities of William V. Grassie, if any, for the tax years 1981 and 1982. The judgment shall not exceed the unpaid tax liability of William V. Grassie.

b. Pursuant to 26 U.S.C. Section 6332(c)(1) judgment is entered in favor of the plaintiff, the United States of America, and against the defendant, the Philadelphia Yearly Meeting of the Religious Society of Friends, in the amount of no more than $8,882.82, plus interest accruing thereon at the rate established by 26 U.S.C. Section 6621 , from June 26, 1986, with said amount to be credited against the amount of unpaid federal tax liabilities of David A. Falls and Sabrina S. Falls, if any, for tax years 1983, 1984 and 1985. The judgment shall not exceed the unpaid tax liability of David A. Falls and Sabrina S. Falls.

2. Defendant's motion for summary judgment is GRANTED IN PART AND DENIED IN PART.

Judgment is entered on the claims of the plaintiff, the United States of America, pursuant to 26 U.S.C. Section 6332(c)(2) , in favor of the defendant, the Philadelphia Yearly Meeting of the Religious Society of Friends, and against the plaintiff, the United States of America. The 50% penalty imposed by the government shall be vacated.

1 The First Amendment provides that "Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof." U.S. Const., amend I.

2 The Court of Appeals noted that for TSA, operating a Rehabilitation Center is a sacrament. TSA Rehabilitation Centers are an essential part of TSA's faith and play a role analogous to that of a church in a more traditional Christian faith: "the Centers are the tools whereby Salvation Army Officers practice and preach their basic theology--the regeneration of homeless and socially handicapped men through spiritual teaching, counselling and work therapy." Slip op. at 12, citing Affidavit of Raymond E. Howell, 5.

3 The fact that defendant raised a constitutional defense to Section 6332(c)(1) weighs against imposing the 50% penalty. Effective enforcement of constitutional rights depends upon thoughtful and aggressive litigation. Imposing a penalty on a party for raising a constitutional defense to a tax enforcement action is a step that should not be taken lightly. A penalty should only be applied when a party raises a constitutional claim that is so clearly foreclosed by the law, its assertion is unreasonable, i.e. frivolous.

 

[92-2 USTC 50,566] United States of America, Plaintiff v. Del Matthews, Defendant

U.S. District Court, East. Dist. Wash., Cy-91-3006-RJM, 8/20/92

[Code Secs. 6331 and 6332 ]

Levy and distraint: Taxpayer's property in possession of third party: Notice, sufficiency of.--A third party wrongfully refused to honor an IRS levy on a money judgment in favor of a taxpayer. An alleged post-judgment compromise, whereby the third party promised to transfer property to the taxpayer in lieu of paying the judgment, did not extinguish the judgment prior to the time the levy was served. The evidence established that there was no accord and satisfaction between the taxpayer and the third party. An agreement between the parties was not reached until after the levy was served. Even assuming the agreement pre-existed the levy, additional evidence established that the property was not transferred and the agreement was not performed until after the levy was served. Additionally, the taxpayer's alleged agreement to accept the third party's promise prior to the levy could not be substituted for performance. Such an agreement would be unenforceable under state (Washington) law for lack of new consideration. Accordingly, the judgment remained outstanding and was enforceable. Although the taxpayer was not served with notice of the levy, the third party did not have standing to challenge the procedural irregularity because there was no injury-in-fact. The 50-percent penalty was imposed based on the third party's failure to establish that reasonable cause existed for dishonor of the levy. Whether an unperformed promise constituted an accord and satisfaction was not a novel legal issue. Further, a dispute over the validity of the notice did not exist until the eve of the trial.
ORDER

NIELSEN, District Judge:

Plaintiff seeks an award of $19,320.72 for wrongful refusal to honor an IRS levy. Also sought is $15,431.33 in statutory interest. In addition, the government contends this is a proper case for imposition of a 50% penalty in the amount of $17,367.03 for a total judgment of $52,119.08. Trial to the bench was held on July 21, 1992 at Yakima. The following will constitute the findings and conclusions pursuant to FRCP 52(a). Incorporated by reference is the recitation of agreed facts contained in the stipulated pretrial order.

I. Transactional Events

Johnny Walker incurred significant unpaid tax liability. An assessment made in 1981 remained uncollected when the events giving rise to this action transpired. Del Matthews came into the picture when he purchased an off-road racing vehicle from Walker in 1984 for which he failed to pay. Walker sued and on November 1, 1985 won a judgment for $23,271 including costs. The judgment allowed Matthews the option of either paying in cash or extinguishing $20,000 of liability by returning the vehicle to Walker and paying the balance in cash. Matthews did neither and Walker obtained a modified judgment on June 13, 1986 deleting the option and rendering Matthews liable for the full $23,271. Matthews paid $3,466 leaving an unsatisfied balance of $19,805.

On July 18, 1986 Matthews's counsel, Donald Bundy, contacted IRS. Bundy advised Agent Troutt that he was aware of Walker's tax liability and that his client had a vehicle belonging to Walker which he would gladly turn over. 1 Bundy did not disclose the modified judgment which stripped Matthews of the option of returning the car. Troutt assigned Agent Nolan Clark to handle the matter. That same day Clark filed a lien and served Bundy with a notice of levy. Matthews then delivered the vehicle to IRS. While attempting to clear title so the car could be sold, Clark discovered the modified judgment. That raised a question in his mind since if Matthews no longer had the right to return the car to Walker, neither did he have authority to turn it over to IRS on Walker's behalf and the levy attaching the vehicle was invalid.

Discussions between Bundy and Clark ensued. Bundy indicated that judicial proceedings were ongoing to determine ownership of the vehicle and promised to keep Clark apprised as events unfolded. That is confirmed by Clark's memorandum of August 28, 1986 to his supervisor explaining the delay in processing the vehicle for sale. Plaintiff's Exhibit 17. Matthews' motion for a new trial was denied on October 2, 1986 thereby putting to rest any lingering doubts over ownership. Plaintiff's Exhibit 24. 2 This development was not disclosed to Clark.

On October 16, 1986 Walker called Clark out of the blue and requested a meeting. That was arranged. Clark's recollection of the meeting was hazy, and perhaps he was not asked all the right questions at trial, but presumably he learned the validity of the judgment had been sustained. 3 In any event, by late-October Clark became convinced the vehicle was not subject to levy. He determined to return the car to Matthews and to levy on the judgment. Walker's liability had grown to $19,320.72 which happened to be slightly less than the unsatisfied portion of the judgment. A levy was prepared in that amount on October 30, 1986 and served on Matthews on November 3, 1986. Matthews did not honor it and instead returned the vehicle to Walker who executed a notice of satisfaction on January 30, 1987.

The facts recited at pages 2-6 (but not 7) of plaintiff's trial brief were already before the Court when summary judgment was denied. Based on those asserted facts, Judge McNichols concluded there were material issues of fact as to: (1) the sequence of events on November 3, 1986; i.e., whether Clark released the vehicle before or after serving the notice of levy; (2) to whom Clark released the vehicle; (3) when Matthews and Walker entered into their settlement agreement; i.e., before or after release of the vehicle; and (4) when Matthews and Walker effectuated their settlement agreement; i.e., whether Walker was in possession of the vehicle prior to Matthews being served with the levy. See Order entered March 31, 1992. CR 44.

The facts presented at page 7 of the trial brief are new. The government now asserts the following: (1) on November 3, 1986 at 3:30 p.m. Clark and Agent Booher visited Matthews at his place of business and presented him with a release of levy and receipt for the vehicle which Matthews signed; (2) immediately thereafter and in the course of the same visit Clark served Matthews with a levy on the judgment; and (3) later that same day Clark released the vehicle to Matthews through his agents. For reasons to be addressed further, the Court finds these contentions proven.

II. Analysis

At the close of the evidence, counsel argued the facts and were granted ten days in which to submit additional briefing on the legal questions, one of which arose late in the process. That has now been accomplished. Two central issues appear: (1) whether Matthews owed Walker a valid debt at the time of levy; and (2) whether the levy is void for lack of notice to Walker.

A. Basic Principles:

The applicable law on the core issue of liability is well settled. One who is in possession of property belonging to a taxpayer against whom an assessment is outstanding must release such property to IRS upon service of a levy. 26 U.S.C. 6332(a) . Failure to do so renders the person in possession liable for the value of the property held provided that exposure is limited to the amount of the underlying tax liability. 6332(d)(1) . If a refusal to comply is without reasonable cause, a 50% penalty attaches. 6332(d)(2) . See generally, United States v. Donahue Indus., Inc. [90-2 USTC 50,343 ], 905 F.2d 1325, 1330-31 (9th Cir. 1990) (overview of mechanics of 6332 ).

B. Accord and Satisfaction:

No one challenges the validity of the June 13th decree. What Matthews does contest is its enforceability. The defense position is that if Matthews and Walker entered into an agreement to compromise the judgment, then the judgment was without efficacy as to the parties inter se and if Matthews owed Walker nothing as of November 3, 1986 it follows that he held nothing belonging to Walker which IRS could levy upon.

State law governs the validity of a state court judgment and determines the parties' property rights thereunder. See United States v. Capital Sav. Ass'n [83-2 USTC 9585 ], 576 F.Supp. 790, 794 (N.D. Ind. 1983). The problem with defendant's approach is that under Washington law, an effective accord and satisfaction must satisfy three elements, at least one of which has not been met in this case. These elements are: (1) a bona fide dispute between the parties; (2) an agreement to compromise the dispute; and (3) performance of the agreement. Ward v. Richards & Rossano, Inc., 51 Wn.App. 423, 429, 754 P.2d 120, rev. denied, 111 Wn.2d 1019 (1988). Performance is the catalyst which consummates the transaction. Dept. of Fisheries v. J-Z Sales Corp., 25 Wn.App. 671, 676, 610 P.2d 390 (1980).

The government urges the first prong has not been met for lack of a bona fide dispute. It is argued that a valid obligation for a sum certain may be subject to dispute, but not a good faith dispute (relying on Phillips v. Mukluk, 721 P.2d 1143, 1145-46 (Alaska 1986)). Were that the proposition for which Phillips stands, which it is not, 4 it would seem too inflexible a rule. Post-judgment compromises, work-out arrangements and a host of other transactions frequently contemplate one party surrendering valid liquidated rights in exchange for avoiding potential risks in recovering on those rights. The case law in this jurisdiction recognizes as much. "Any claim, whether disputed, unliquidated, or undisputed and liquidated, may be discharged by an accord and satisfaction." J-Z Sales, supra, 25 Wn.App. at 676. For the sake of analysis, the Court will assume the first prong is satisfied.

There was an agreement. That much is certain based on the satisfaction dated January 30, 1987. The question is whether the agreement predated November 3, 1986. The evidence tilts strongly in favor of finding the agreement arose only after service of the levy. When Clark served Matthews with a final demand on November 26, 1986 Matthews did not protest that the judgment had been satisfied. Rather, he advised Clark that if Walker continued his collection efforts, he would be forced into bankruptcy. This suggests an ongoing dispute between Walker and Matthews. During this same time frame, Walker scheduled a judgment/debtor examination. It was continued on several occasions, the most recent being a resetting from December 18, 1986 to January 29, 1987 by agreement of the parties. Plaintiff's Exhibit 28. The obvious question is why Walker would pursue collection remedies if the judgment had already been satisfied.

Against this backdrop is Matthews' testimony that he recalls entering into a "handshake" agreement with Walker on October 15, 1986 and so advised his attorney. There is a notation in Bundy's file which arguably supports the proposition that Matthews and Walker had some type of agreement by mid-October. Defendant's Exhibit 102. There is also testimony from Walker's counsel, Fred Porter, to the effect that his client believed the matter had been settled by mid-October. 5

These events taken in their totality suggest that while Walker and Matthews may have been negotiating toward a compromise throughout the fall of 1986, no final agreement was reached until some time in December of 1986 or January of 1987. The inference flowing from the pendency of judgment/debtor examination proceedings outweighs testimony to the contrary.

Even if an agreement to settle pre-existed the levy, there could not have been timely performance. Matthews does not concede that he signed a receipt for the vehicle and urges that the car had been physically released directly to Walker prior to November 3, 1986. IRS has no signed copy as release-of-levy files are routinely destroyed two years after return of the property. By destroying a record which might be valuable to IRS in pursuing subsequent legal action, 6 and even more valuable to the system in promoting the goal of ferreting out the truth, the government walks a perilous path. The deliberate destruction of evidential material could weigh heavily in a proper case, and IRS was well aware in November of 1986 that it had a claim against Matthews under 6332(d) . See Plaintiff's Exhibit 20.

In the final analysis, however, this is a "best evidence" problem. There is no hard evidence of the release and receipt, but there is evidence in the form of the agents' testimony. Such testimony is altogether consistent with what a prudent agent would be expected to do.

Clark and Booher each testified that in quick succession the receipt was signed, the substitute levy served, and arrangements made for physical transfer of the vehicle. Matthews provided the agents with the names of two individuals who would take possession. Clark wrote those names on a scrap of paper. The agents then proceeded to the storage facility where the vehicle was situated. About a half-hour later, two men appeared with a truck and trailer. Clark asked the men to identify themselves and verified that the names provided matched those he had written down.

That testimony is accepted at face value. To find otherwise would be to conclude that these two agents are guilty of perjury and either fabricated the visit with Matthews out of whole cloth or used a fictitious date. ID agents may not be entirely immune from coloring the facts when the greater goal of filling the coffers of the United States is at stake, but based on these witnesses' demeanor on the stand, the reasonableness of their version of the events, the unreasonableness of the conduct attributed to them by the defense, and the consistency of their testimony with other evidence in the case, the Court is not prepared to take the profound step of charging them with the criminal act of perjury.

In stark contrast is Matthews' trial and pre-trial testimony. His trial testimony was vague, unfocused and evinced a decidedly selective memory. Matthews repeatedly relied on the passage of time to explain his equivocation. He was positive Walker came into possession of the vehicle at least several weeks prior to service of the levy, but could not say why or how. He was positive neither he nor his employees picked up the vehicle and equally certain that IRS must have released it directly to Walker. He was positive he never again laid eyes on the vehicle after surrendering it to IRS in July of 1986. Earlier in the proceedings, when the passage of time should have had a less dulling effect, he recalled the events quite differently:

Q. Did you pay [Walker] the $20,000?

A. I paid him the race car.

Q. Did you deliver the race car to him?

A. I believe he picked the race car up at my building. And my recollection of it was I was not there when he picked it up, because I believe I was out of town. And I called back to my girlfriend and she had said that John Walker had been there and wanted to pick up the race car. And asked me if it was okay. And I said it was fine. And I believe she let him in at 10:00 at night.

Q. What time did it occur?

A. I believe it was in October to the best of my recollection, that he picked it up.

Q. Could it have been after November 3, 1986?

A. I would say anything is possible. But my recollection of the thing is I was not in town when it was picked up so I don't have a specific date at this point that I can recall. Just my knowledge that it was done in October.

Q. Do you remember what dates you were out of town at that time? I know that's probably tough.

A. It's been five years. The only thing I do specifically recall is Carol asked me if it was okay for John Walker to take the race car.

Deposition of Matthews at pages 30-31 (emphasis added).

Judge McNichols found that pretrial testimony troubling during summary judgment proceedings:

The government's position is well taken that defendant has suddenly gained a more precise (and contrary) recollection of the events than he exhibited during his deposition testimony, and were this the only issue, it would weigh heavily against him. Foster v. Arcata Assocs., Inc., 772 F.2d 1453, 1462 (9th Cir. 1985). Given that IRS was in possession, however, it would seem to be the government's burden to demonstrate to whom [the vehicle] was released. Then too, there are other issues.

Order entered March 31, 1992. CR 44.

The undersigned finds such contradictory testimony equally troubling. The Court has in mind Carol Matthews' testimony that the phone conversation alluded to above involved only Walker's request to pick up a trailer, not the vehicle. By her own concession, this witness knew little of the underlying events. On this discrete point, she seemed facially credible, but for reasons to be addressed further, the testimony will be rejected. Also in mind is the testimony of Wendell Smith, an employee of Matthews', that he would be in a position to know whether the vehicle had ever been returned to Matthews' place of business and he believed it had not. Smith, however, was obviously confused over the timing of various events. Then there is Matthews' affidavit in which he explains that his deposition testimony was based on conjecture and assumptions which he later discovered to be untrue. CR 38. That is not the way the system works. Depositions are taken under oath. When a litigant swears to tell the truth as he knows it and states categorically "The only thing I do specifically recall is Carol asked me if it was okay for John Walker to take the race car," contrary testimony at trial is entitled to scant weight. People forget. That is part of the human condition. There is a difference, however, between a mere fading of memory and whipping a 180 degree turn.

The Court finds the res of the settlement agreement remained in the possession of IRS until after the levy was served. Satisfaction was not yet a fait accompli and the judgment remained outstanding. It thus does not matter that Walker ultimately came into possession of the car nor does it matter that the judgment was in fact satisfied on January 30, 1987. The focus is on the parties' respective legal rights on November 3, 1986. Under these circumstances, accord and satisfaction was a legal impossibility for lack of timely performance.

As a fallback position, Matthews contends the settlement agreement binds the parties inter se (and presumably those who stand in the parties' shoes) and argues that a failure to perform may be cured only through an action to compel performance:

In short, after that new contract was entered into, Walker's sole legal recourse was an action to enforce contract compliance through vehicle delivery, and the superseded money judgment was no longer enforceable by Walker.

Defendant's Trial Brief at page 8 (emphasis original).

Defendant appears to be urging that accord and satisfaction incorporates the concept of substitution. Substitution may theoretically occur simultaneously with accord and satisfaction, but this is not necessarily so. As a practical matter it would rarely be so. The distinction between the two is illustrated in Calamari & Perillo, The Law of Contracts, Sec. 21 -4 (2d ed. 1977). If creditor approaches debtor and offers to immediately discharge an obligation in return for a promise of future performance and if debtor so promises, there has been an accord and satisfaction. The promise itself becomes the performance. There has also been a substituted agreement and the underlying obligation is extinguished. In the event of a breach, creditor may sue only on the new agreement. Id.; see also, Restatement (Second) of Contracts 279 (1981).

On the other hand, if creditor approaches debtor and offers to discharge an obligation upon fulfillment of some substituted future performance and debtor agrees to so perform, then what has been created, in the arcane terminology peculiar to contracts professors, is an "executory bilateral contract of accord." The underlying obligation is temporarily suspended pending performance and will be discharged only upon performance. In the event of a breach, creditor may sue on either the original obligation or the new contract or both if breach of the accord causes additional damages. Calamari & Perillo, supra, at Sec. 21 -4; Restatement (Second) of Contracts 281 (1981). That states the majority rule throughout the country. Polish American Machinery Corp. v. R.D. & D. Corp., 760 F.2d 507, 511 (3rd Cir. 1985) (Pennsylvania law); K-Line Builders, Inc. v. First Federal Sav. & Loan Ass'n, 139 Ariz. 209, 213, 677 P.2d 1317, 1321 (Ariz. App. 1983); Rhea v. Marko Const. Co., 652 S.W.2d 332, 334-35 (Tenn. 1983); Sergeant v. Leonard, 312 N.W.2d 541, 545-46 (Iowa 1981) and authorities cited therein.

As in all contractual undertakings, the key inquiry is the intent of the parties and intent may be inferred from the circumstances attendant to the transaction:

Whether a contract is an accord or a substitute contract is a question of interpretation, subject to the general rules stated in Chapter 9. In resolving doubts in this regard, a court is less likely to conclude that an obligee was willing to accept a mere promise in satisfaction of an original duty that was clear than in satisfaction of one that was doubtful. It is therefore less likely to find a substituted contract and more likely to find an accord if the original duty was one to pay money, if it was undisputed, if it was liquidated and if it was matured.

Restatement (Second) of Contracts 281 (1981) at Comment e.

The judgment was for money and was both liquidated and matured. It may have been disputed in some subjective sense, but the dispute was apparently not of sufficient legal moment to warrant taking an appeal. Moreover, the proof is in the pudding. Walker did not discharge the obligation upon securing Matthews' promise to deliver the vehicle. To the contrary, by all accounts Walker came into possession of the car prior to executing the notice of satisfaction. In sum, the record reflects no basis for concluding that Walker agreed to accept Matthews' bare promise of future performance in substitution of the judgment.

Even if there were such an agreement, it would not be enforceable under Washington law:

The trial court granted a motion to strike this affirmative defense at the beginning of the trial because it failed to state a claim--there being no consideration for an agreement to accept the sum of $40,000 in full settlement of the more than $70,000 then due on the note.

The trial court cited, in support of its ruling, three Washington cases: Berliner v. Greenberg, 37 Wn.2d 308, 223 P.2d 598 (1950); Joyner v. Seattle, 144 Wash. 641, 258 Pac. 479 (1927); Rogers v. City of Spokane, 9 Wash. 168, 37 Pac. 300 (1894).

These cases support the proposition that there can be no accord and satisfaction without a new agreement supported by a new consideration; and an agreement to accept a stated amount in settlement of a larger claim is not such a new consideration until actual payment and acceptance of the stated amount.

Nat'l Bank of Washington v. Myers, 75 Wn.2d 287, 299, 450 P.2d 77, 484-85 (1969).

Finally, there are policy reasons why defendant's premise is unsound. Suppose "A" secures a money judgment against "B" for $20,000. "B" contacts "A" and makes a compelling argument that enforcement of the judgment will precipitate a bankruptcy which will net "A" zero after discharge proceedings. "B" offers to produce an asset worth $15,000 to satisfy the judgment. "A" accepts. Prior to delivery, creditor "C" leaps into the fray and repossesses the asset. "B" can longer perform. Under Matthews' theory, the $20,000 judgment is now past history and "A" is relegated to suing for performance of an unperformable agreement (or perhaps its cash equivalent). "B" is not discouraged and tenders another asset worth $10,000 to settle the $15,000 dispute. This could go on ad infinitum and underscores the policy behind the rule in Washington that satisfaction is achieved only upon fulfillment of an agreed-upon substitute performance. A debtor is not harmed by such a rule. If unable to deliver on his promise, he continues to be liable on the existing obligation. Nor is a creditor harmed. If performance cannot be accomplished, the pre-existing relationship remains in effect.

C. Validity of Levy:

A novel issue surfaced on the eve of trial. The record is inconclusive, but it seems Walker was not served with a notice of levy as required by 26 U.S.C. 6331(d)(1) . Plaintiff could put on no evidence, documentary or otherwise, that notice had been effected. 7 Matthews urges that the failure of notice is a fatal flaw which renders the levy void. The version of the statute which applied to the events at issue reads as follows:

Levy may be made under subsection (a) upon the . . . property of any person with respect to any unpaid tax only after the Secretary has notified such person in writing of his intention to make such levy.

It bears noting that Congress considers pre-seizure notice to be of substantial import. Prior to 1982, the only pre-levy notice required by statute was a demand for payment rather than notice of an imminent levy. L.O.C. Indus., Inc. v. United States [76-2 USTC 9573 ], 423 F.Supp. 265, 273 (M.D. Tenn. 1976). If the taxpayer failed to pay within ten days, a levy could then be made without further notice. 6331(a) . In 1982, 6331(d) was enacted which provided for a ten-day pre-seizure notice of the levy. P.L. 97-248. Now, it is thirty days. P.L. 100-647, Title VI, 6236 (Nov. 10, 1988). Not only was the time extended thus allowing the taxpayer a greater opportunity to take measures to avoid the loss of his property, but the content of the notice has been enhanced to ensure the taxpayer understands the process and his options. 6331(d)(4) . Only when a jeopardy assessment is made (a feature not relevant here) is statutory notice waived. 6331(d)(3) . Even then, due process requires at least some pre-seizure notice. 8 L.O.C. Indus., supra, [76-2 USTC 9573 ] 423 F.Supp. at 273 and authorities cited therein, cited with approval in Martinez v. United States, 669 F.2d 568, 569 (9th Cir. 1981).

The purpose of providing notice is to gave the taxpayer one final opportunity to "pay or fail to pay" prior to suffering a deprivation which may prove more costly than coughing up the tax due. Martinez, supra, 669 F.2d at 569; L.O.C. Indus., supra, 423 F.Supp. at 273. When the property levied upon is cash or its equivalent, the taxpayer receives a dollar-for-dollar reduction in liability. But when the property is illiquid, the taxpayer is at the mercy of the market. Subject only to meeting the upset price (6335(e)(1)(A) ), whatever the market is prepared to pay is what the item is worth, notwithstanding that the property may be of far greater value to the taxpayer. Even when the property is liquid, the taxpayer may face collateral economic consequences upon seizure which he would rather not.

Walker was entitled to notice and if he did not receive it, the levy would be open to challenge. United States v. Potemken [88-1 USTC 13,765 ], 841 F.2d 97, 101-02 (4th Cir. 1988); Matter of Computer Management, Inc., 40 B.R. 201, 203 (Bkrtcy. N.D. Ga. 1984). Even if collection procedures were otherwise regular, he would be entitled to release of the levy and/or return of the property seized. Martinez, supra, 669 F.2d at 569-70; Rodriguez v. United States [86-1 USTC 9289 ], 629 F.Supp. 333, 350 (N.D. Ill. 1986). Moreover, he could sue for damages under 26 U.S.C. 7433 if the failure of notice were intentional or reckless. Gonsalves v. United States [92-1 USTC 50,067 ], 782 F.Supp. 164, 171-72 (D. Me. 1992). The question is whether a third party has standing to challenge procedural irregularity. Stated another way, is a levy made without notice void ab initio, or is it subject to being declared invalid only at the insistence of the taxpayer? The parties cite no authority on direct point, and the Court has found none. It is unlikely that a third party has standing to refuse to honor a levy which is regular on its face but which is defective for lack of notice to the taxpayer. This is so for at least four reasons.

The first is the settled rule that a third party "served with a notice of levy has two, and only two, possible defenses for failure to comply with the demand: that it is not in possession of property of the taxpayer, or that the property is subject to a prior judicial attachment or execution." United States v. National Bank of Commerce [85-2 USTC 9482 ], 472 U.S. 713, 727 (1985). A levy does not transfer title. It only reduces the res to the government's possession while competing interests are sorted out in other proceedings. Id. at 728-29. The stakeholder has no right to assert the potential claims of others. Id. at 727. If here is no right to press facially meritorious claims on behalf of innocent bystanders, as was the case in National Bank of Commerce, it follows that neither does the third party have a right to assert the claims or defenses of the taxpayer.

Second, the stakeholder or any other person (except the taxpayer) with an interest in the outcome may access 26 U.S.C. 7426 to test the validity of a levy. United States v. Weintraub [80-1 USTC 9172 ], 613 F.2d 612, 622 (6th Cir. 1979), cert. denied, 447 U.S. 905 (1980). Significantly, this section provides for injunctive relief precluding enforcement of a levy notwithstanding the Anti-Injunction Act codified at 7421 . 7426(b)(1) . The foregoing should not be read too broadly as jurisdiction under 7426 exists only when the claimant has an interest in the property. William L. Comer Family Equity Trust v. United States [90-1 USTC 50,142 ], 732 F.Supp. 755, 758 (E.D. Mich. 1990). A levy is wrongful as to a third party only when "the property levied upon 'does not, in whole or in part, belong to the taxpayer against whom the levy originated.' " Pottorf v. United States [91-2 USTC 50,487 ], 738 F.Supp. 1365, 1368 (D. Kans. 1990) quoting Arth v. United States [84-2 USTC 9601 ], 735 F.2d 1190, 1193 (9th Cir. 1984). Matthews could have commenced an action pursuant to 7426 to press his claim that the judgment had been satisfied, but this line of authority does not support the premise that a stakeholder may vicariously assert the rights of others.

Third, a stakeholder who complies with a valid levy is shielded from liability for a turnover which later proves wrongful. Johnson v. United States [83-1 USTC 9307 ], 566 F.Supp. 1012, 1014 (M.D. Fla. 1983): 26 U.S.C. 6332(e) . The extent to which protection attaches in the face of an invalid levy is less settled.

Which leads to the fourth consideration. The third party will generally not be aware of a failure of notice. Except for levies on insurance contracts (see 6332(b)(1) ) there is no requirement that the levy contain a declaration that the taxpayer has been served. If a third party had the right to refuse to comply based on procedural defects, some creative attorney would try to convert that right into a duty. The mischief such a duty would visit on innocent stakeholders is apparent as is the potential for delay and uncertainty which would attach to IRS sequestration efforts.

For all of these reasons, Matthews has no defense based on lack of notice to Walker. The failure of notice neither harmed Matthews nor could it have. He thus lacks the sort of injury-in-fact fundamental to notions of standing. See Lujan v. Defenders of Wildlife, -- U.S. --, 112 S.Ct. 2130, 2136 (1992).

The only countervailing consideration is the public interest in encouraging procedural regularity. The notice requirement could hardly be more precise. Congressional concern over proper notice could scarcely be more emphatic. There is something to be said for declining to reward a governmental agency which fails or refuses to abide by the law. It developed during trial that in the normal course Clark did not (and still does not today) furnish notice of levy to the taxpayer. See note 7, supra. It is the government's position that the only duty imposed by 6331 is to provide an initial notice of intent to levy and thereafter IRS is free to issue as many levies against as many different property interests as it cares to without further notice. 9 That is not what the statute says. IRS's practice guarantees that at some future time in some future lawsuit, an aggrieved taxpayer in this district is going to avail himself of 7433 . Having said that much, the proper party to vindicate the wrong is the person who suffered injury. Matthews did not.

Matthews raises a further contention that a levy is ineffective until ten days after notice. This is not a separate issue. It is merely another way of saying a levy is ineffective as to the entire world for lack of notice to the taxpayer, a position which is rejected.

D. 50% Penalty:

The remaining question is whether Walker had "reasonable cause" to dishonor the levy in which case the otherwise-mandatory 50% penalty may be avoided. If there is a bona fide dispute over the amount of property subject to a levy, or the legal efficacy of the levy itself, then reasonable cause may exist. Donahue, supra, [90-2 USTC 50,343 ], 905 F.2d at 1331-33. Whenever the term "reasonable" is used, it is a safe wager that an objective standard applies. It has been settled for many years in Washington that an accord and satisfaction requires performance as well as a promise. Perez v. Pappas, 98 Wn.2d 835, 843, 659 P.2d 475 (1983) and authorities cited therein. Objectively, it is difficult to see how Matthews could argue that he reasonably believed he owed Walker nothing on November 3, 1986. While both Bundy and Matthews considered ownership of the vehicle uncertain, the trial judge's biting commentary at the time of modifying the judgment could leave no doubt over who owned the car or the efficacy of the judgment. Plaintiff's Exhibit 3. There is thus nothing "novel" about the legal issue. United States v. Marine Midland Bank [88-1 USTC 9159 ], 675 F.Supp. 775, 781 (W.D. N.Y. 1987) (existence of novel question may give rise to reasonable cause). Matthews cites no case law supporting the premise that an unperformed promise constitutes an accord and satisfaction. United States v. Sterling Nat. Bank & Trust Co. of New York [74-1 USTC 9336 ], 494 F.2d 919, 923 (2nd Cir. 1974) (stakeholder had at least some case law supporting its position).

Nor is the day saved by pointing to the invalidity of the levy. The levy was invalid as to Walker, but not as to Matthews. Then too, while reasonable cause may exist where there is "a bona fide dispute" over the legal efficacy of a levy, there was no dispute on this point at all, let alone a bona fide one, until the eve of trial. Matthews did not refuse to comply on the basis that Walker had not been given notice. Rather, he claimed only that the judgment was not enforceable due to the purported post-judgment settlement agreement.

E. Equities:

There is something Kafkaesque about the result. Walker eluded IRS collection efforts for five years. Clark never heard of Walker prior to the time Bundy offered to turn over the car. Clark had no idea Walker had assets located in Yakima County. By assisting IRS, albeit for less than righteous motives, 10 Matthews cooked the soup in which he now finds himself. Had Bundy not contacted IRS at his client's behest, the government would not have known about the vehicle. Had Bundy not advised Clark that $3,466 had been paid to Walker's counsel, the government may never have learned of the judgment. Had Matthews acted five weeks earlier and turned the vehicle over to IRS prior to entry of the modified judgment, he would have accomplished all he set out to do: satisfy the judgment, retaliate against Walker, and open up the possibility of purchasing the car at auction for a bargain price. As it is, defendant virtually wrapped a banner around himself emblazoned with the challenge "Levy on me." Thus, Walker walks and Matthews pays his tab.

Perhaps one answer is that it is not equitable to furnish IRS with false information. Another is that the terms of the levy are plain. Although the advice of obligations contained on the face of the levy might be better drafted (Plaintiff's Exhibit 18), no one could read the final demand without gaining an appreciation of the consequences of a continuing failure to comply. Plaintiff's Exhibit 20. The recipient is alerted to the terms of 6332 and persons of normal intelligence are placed on fair notice that failure to effect a turnover will render the stakeholder personally liable. The wiser course when dealing with all government agencies is to play by their rules rather than one's own. That is true in spades when IRS is involved.

There might be some room for equitable maneuvering if the Court could accept the premise that Matthews informed Clark that he and Walker had an agreement and that he intended to return the vehicle to Walker immediately upon release. Clark would probably have no duty to counsel Matthews on the legal effect of his intended actions, but such a finding may have impacted the favorable view which has been taken of the agent's testimony. The propriety of assessing a 50% penalty might also bear closer scrutiny. For reasons adequately stated, the predicate finding cannot be made.

THEREFORE IT IS ORDERED that:

(1) Judgment will be in favor of the United States and against Del Matthews in the sum of $19,320.72 for wrongful refusal to honor the levy; in the sum of $15,431.33 in statutory interest; and in the sum of $17,367.03 in statutory penalties for a total judgment of $52,119.08.

(2) The Clerk shall enter judgment accordingly.

DONE BY THE COURT

1 A week later Bundy also cooperated by advising Clark that $3,466 in settlement proceeds had been paid to Walker's counsel, Fred Porter. By the time Clark contacted Porter, the proceeds had been disbursed. Plaintiff's Exhibit 16.

2 Plaintiff's Exhibit 24 is an unsigned minute entry noting denial of the motion. The state court file does not contain an order memorializing that action and Bundy (who argued the motion) was fuzzy on the outcome in his testimony. It seems clear, however, that had the motion been granted, Bundy would have presented an order for signature in conformity with local practice. That he did not tends to confirm the ruling was adverse.

3 Walker was conspicuous by his absence at trial. Had he been available to testify, this case might have fewer loose ends.

4 Phillips held only that good faith is a necessary element of a valid accord and satisfaction and that sufficient questions of fact had been raised to warrant trial. Because of the mode of disposition, there is no need to consider whether Matthews' displeasure with the judgment was based on "a bona fide belief in the validity of [his] positions with respect to the claim." J-Z Sales, supra, 25 Wn.App. at 676.

5 Trial was notable for the introduction of an inordinate amount of unobjected-to hearsay testimony. No criticism of counsel is intended. In a bench trial, counsel may reasonably assume the Court is capable of sua sponte separating the wheat from the chaff.

6 Not only did the Seattle District Office destroy the document in the normal course, but Clark destroyed a copy he had retained for his own records. It is speculative, perhaps, but the expense of trial may have been avoided had the signed receipt been produced during summary judgment proceedings.

7 Clark testified he had provided no notice to Walker as to either the levy on the vehicle in July or the levy on the judgment in November. Nor did he have knowledge of any other IRS official furnishing notice. He knew only that when such notice was required, it would be issued by the Ogden Service Center. How Ogden would become aware of a field agent's decision to issue a levy was not explored. The government made a tentative motion to reopen in order to ascertain whether any supporting documents existed but withdrew it in reliance on the premise that notice to Walker is irrelevant.

8 While an accurate statement of the law in this Circuit, Matthews reads too much into the rule. A taxpayer must always be given at least some notice of his asserted tax liability prior to levy pursuant to 6631(a) . However, in a jeopardy situation he need not be given notice of a specific levy. 6631(d)(3) . That only makes sense. Due process demands that a taxpayer be placed on notice of the claim against him, but does not require that a taxpayer likely to abscond or secrete assets be forewarned of what assets IRS intends to seize. A recalcitrant taxpayer with such knowledge would predictably enough seek to remove the assets from the custody of the stakeholder.

9 IRS is apparently not enamored with 6331(d) . The implementing regulations expound at length on other provisions of 6331 , but require notice to the taxpayer only when a levy against salary or wages is contemplated. Compare 26 C.F.R. 301.6331-1 with 301.6331-2 . The statute is not so limited and provides for notice when any property is levied upon.

10 Matthews hoped to repurchase the vehicle at the IRS auction for substantially less than $20,000. Plaintiff's Exhibit 32. That explains why Matthews would advise Clark that fair market value was only $12,000. See Plaintiff's Exhibit 8.

 

[95-1 USTC 50,177] United States of America, Plaintiff v. C & A Paving Co., Inc., et al., Defendants

U.S. District Court, So. Dist. Fla., 88-14161-CV-Hoeveler, 2/7/95

[Code Secs. 6331 and 6332 ]

Levy and distraint: Accounts receivable: Custodians: Penalties, civil: Failure of custodian to surrender property: Reasonable cause.--A paving contractor was required to pay to the IRS amounts that it owed to a subcontractor in satisfaction of the subcontractor's tax debts. The contractor was not liable for the full contract price of the subcontracted work because the contractor was required to expend additional amounts in order to properly finish the job and because cost overruns incurred by the subcontractor were not authorized in writing. The penalty for failure by a custodian of a delinquent taxpayer's property to surrender the property to the IRS was not imposed because there was a bona fide dispute regarding the amount owed to the subcontractor.


Findings of Fact and Conclusions of Law

HOEVELER, District Judge:

The court tried this case without a jury on January 27, 1995. After review of the file and the exhibits, and having considered the testimony of the witnesses and the arguments of counsel, the court makes the following findings of fact and conclusions of law pursuant to Federal Rule of Civil Procedure 52(a).

Findings of Fact

1. C & A Paving, Inc. ("C & A Paving"), a Florida corporation, built driveways, parking lots, streets, and drainage improvements from 1985 to 1987. Charles E. Ward was the president, director, chief executive officer, and sole shareholder of the company.

2. In 1985, C & A Paving agreed to excavate and pave the parking lot at the Cumberland Farms convenience store located at 6521 S.E. Federal Highway in Stuart, Florida in return for a contract price of $21,536.11.

3. C & A Paving subcontracted the Cumberland Farms parking lot excavation and paving work to Stuart Supervac, Inc., doing business as Statewide Contracting, ("Stuart Supervac"), in October 1985. C & A Paving and Stuart Supervac executed a written contract (Government's Exhibit 3) wherein C & A Paving agreed to pay Stuart Supervac $16,616.40 in return for the construction and paving work.

4. Stuart Supervac did not complete the Cumberland Farms parking lot, as required by the contract with C & A Paving, and also improperly finished the parking lot asphalt. C & A Paving then completed the Cumberland Farms parking lot at its own expense, at an approximate cost of $2000.00.

5. Pursuant to contract, Cumberland Farms paid C & A Paving $21,536.11 on February 25, 1986 in return for the completed parking lot.

6. On April 14, 1986, Stuart Supervac invoiced C & A Paving for work performed on the Cumberland Farms parking lot. The total invoiced amount is $21,067.15 (Government's Exhibit 4). Stuart Supervac charged more than the original contract price because it claimed to have performed additional work for C & A Paving. While the evidence is not clear (in view of the elapsed time Mr. Ward found his memory somewhat deficient) it appears the added costs may have been, in part at least, the result of Stuart Supervac's error on the job.

7. C & A Paving paid Stuart Supervac the following sums in return for Stuart Supervac's work on the Cumberland Farms parking lot:

April 17, 1986:  $6616.40

May 2, 1986:     $2000.00

June 9, 1986:    $1000.00

July 11, 1986:   $1000.00


The payments made by C & A Paving to Stuart Supervac listed above total $10,616.40. Stuart Supervac did not attempt to collect any additional sums.

8. Stuart Supervac owes unpaid taxes to the Internal Revenue Service ("I.R.S."). The I.R.S. assigned Revenue Agent Raymond Salyer to the collection of Stuart Supervac's delinquent taxes. Agent Salyer sought to collect Stuart Supervac's unpaid taxes by levying upon Stuart Supervac's outstanding accounts receivable. After review of Stuart Supervac's accounts receivable, Agent Salyer determined that C & A Paving might owe Stuart Supervac money under the contract to pave the Cumberland Farms parking lot.

9. As a result of Agent Salyer's determination, a delegate of the Secretary of the Treasury served C & A Paving and Charles Ward with a Form 66-A Notice of Levy on March 26, 1987. A delegate of the Secretary of the Treasury then served a Form 668-C Final Demand upon C & A Paving and Charles E. Ward. The I.R.S. demanded that C & A Paving pay $26,248.81 (the full amount of Stuart Supervac's delinquent tax obligation) to the I.R.S., or such smaller sum as C & A Paving then owed to Stuart Supervac.

10. C & A Paving and Charles E. Ward refused to pay the full amount of the I.R.S. levy. A bona fide dispute existed, however, between the I.R.S. and defendants concerning the amount to be paid pursuant to the levy. Defendants reasonably believed Stuart Supervac was not owed the amount claimed in the I.R.S. levy and defendants therefore acted reasonably in refusing to pay the levy. Defendants also negotiated with Revenue Agent Salyer and Mr. Ward testified that he offered to pay $4000.00 in settlement of the I.R.S. claim. Mr. Ward also testified that Mr. Salyer told him he had no authority to accept that amount.

11. The United States then brought an action against C & A Paving and Mr. Ward in order to collect the full amount of the levy, or such smaller amount as the court would determine that C & A Paving and Mr. Ward were liable to pay.

12. At trial, Charles E. Ward admitted that he owed Stuart Supervac $4000.00 for excavation and paving work on the Cumberland Farms parking lot pursuant to contract.

13. Counsel for the United States argued at trial that C & A Paving and Charles E. Ward owed $6000.00 to Stuart Supervac. C & A Paving and Mr. Ward would therefore owe $6000.00 plus interest to the government. The government asserted that defendants owed Stuart Supervac $6000.00 under the following reasoning: (1) C & A Paving should be held to its written contract with Stuart Supervac which provides for a $16,616.40 payment; (2) C & A Paving already paid Stuart Supervac $10,616.40; (3) charges for additional work performed by Stuart Supervac should cancel out the $2000.00 cost incurred by C & A Paving in properly finishing the Cumberland Farms job. Under this formula, defendants owed the difference between the contract price and the payments made, or $6000.00, to the government. Counsel for the United States also asked the court to impose a 50% penalty on defendants pursuant to Internal Revenue Code Section 6332(c) .

14. The contract executed by Stuart Supervac and C & A Paving provides that "[a]ny alteration or deviation from above specifications involving extra costs will be executed only upon written orders, and will become an extra charge over and above the estimate." (Government's Exhibit 3). C & A Paving did not issue written orders authorizing extra charges. There was no competent evidence that Stuart Supervac's additional charges for work on the Cumberland Farms parking lot were authorized by C & A Paving or Charles E. Ward. Defendants therefore did not owe Stuart Supervac for additional work performed at the Cumberland Farms site and contained in Stuart Supervac's April 14, 1986 invoice.

Conclusions of Law

In pertinent part, Section 6321 of the Internal Revenue Code provides:

If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount . . . 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 6331(a) further provides that the I.R.S. may collect unpaid taxes by administrative levy. 26 U.S.C. 6331(a) . Such administrative tax liens create a custodial relationship between any person who holds property of the delinquent taxpayer and the I.R.S. See United States v. National Bank of Commerce [85-2 ustc 9482 ], 472 U.S. 713, 720 (1985). When held by a person other than the taxpayer, such property comes into the constructive possession of the government pursuant to Section 6331 and the relevant Treasury regulations. Id. The custodian of a delinquent taxpayer's property, however, may refuse to turn property subject to a levy over to the I.R.S. if the custodian does not possess the property or is not obligated to the taxpayer with respect to the property. See, e.g., United States v. Metropolitan Life Insurance [89-1 ustc 9362 ], 874 F.2d 1497, 1499 (11th Cir. 1989).

Internal Revenue Code Section 6332(c)(2) also provides that the custodian of a delinquent taxpayer's property is liable for a penalty equal to 50% of the tax due if that custodian refuses to surrender taxpayer property to the I.R.S. without reasonable cause. Treasury Regulation 301.6332-1(b)(2) further states, however, that the 50% penalty "is not applicable in cases where a bona fide dispute exists concerning the amount of the property to be surrendered pursuant to a levy or concerning the legal effectiveness of the levy."

Conclusion

Based on the facts above, C & A Paving and Charles E. Ward owe Stuart Supervac an additional $4000.00 under the contract to excavate and pave the Cumberland Farms store parking lot. Pursuant to the contract, C & A Paving agreed to pay Stuart Supervac a total of $16,616.40 for the parking lot job. C & A Paving made payments to Stuart Supervac over a period of several months which total $10,616.40. The difference between the contract price and the payments made by C & A Paving is $6000.00. C & A Paving spent approximately an additional $2000.00, however, to complete the parking lot when Stuart Supervac failed to properly finish the job. Subtracting the $2000.00 in costs from the $6000.00 remaining under the contract yields a sum of $4000.00. Mr. Ward also admitted at trial that he owed this amount to Stuart Supervac. Under this formula, the court finds that C & A Paving owed Stuart Supervac an additional $4000.00. Pursuant to Internal Revenue Code Section 6321 and the relevant Treasury regulations, C & A Paving therefore owes the United States $4000.00 in satisfaction of the Notice of Levy.

The court declines to impose a 50% penalty pursuant to Internal Revenue Code Section 6332(c)(2) . C & A Paving refused to pay the I.R.S. tax levy with reasonable cause and had a bona fide dispute regarding the amount owed under the contract with Stuart Supervac.

For these reasons, it is ORDERED AND ADJUDGED that C & A Paving and Mr. Charles E. Ward pay $4000.00 plus interest, to be calculated at the statutory rate from the date of the I.R.S. Notice of Levy, to the United States. A final judgment will be entered by separate order reflecting these findings.

DONE AND ORDERED in chambers in Miami, this 6th day of February 1995.

 

 

 

[94-2 USTC 50,629] United States of America, Plaintiff v. Key Bank, N.A., Defendant

U.S. District Court, No. Dist. N.Y., 94-CV-0016, 11/4/94

[Code Sec. 6332 ]

Levy and distraint: Notice of levy, effect: Surrender of property subject to levy: Bank accounts: Reasonable cause.--A bank was found personally liable for failing to honor a levy imposed on a delinquent taxpayer's checking account where it offset the funds against an outstanding loan it had made to the taxpayer after the notice of levy had been served. The bank could not refuse to honor the levy because it was in possession of the taxpayer's property and the property was not subject to any prior judicial attachments or executions. In addition, the bank's claim that it held a superior lien interest was no defense to its failure to honor the IRS levy. Further, a penalty for failure to comply with the tax levy was imposed because the superior lien interest defense was a settled question of law. Sterling Nat'l Bank & Tr. Co. of N.Y. ((CA-2) 74-1 USTC 9336 ) followed.

Steven E. Cole, Department of Justice, Washington, D.C. 20530, for plaintiff. Anthony Carpinello, Hiscock & Barclay, 30 S. Pearl St., Albany, N.Y. 12207, for defendant.

MEMORANDUM--DECISION AND ORDER

The instant action arises out of defendant Key Bank's (hereinafter "defendant") failure to honor the Internal Revenue Service's (hereinafter "IRS") tax levy served upon the defendant. Presently before the Court is the government's motion for summary judgment made pursuant to Fed. R. Civ. P. 56.

I.

The Bryar Trucking Company (hereinafter "taxpayer") was assessed $178,788.69 and $45,843.78 for unpaid employment taxes for the first taxable quarter of 1988 and the fourth taxable quarter of 1988 respectively. These figures represent tax delinquencies including penalties and interests. The IRS filed with the New York State Secretary of State and also the Albany County Clerk's office a Notice of Federal Tax Lien Under Internal Revenue Laws. Thereafter, on April 4, 1989, the IRS served a Notice of Levy upon the defendant. The Levy gave defendant notice of the above-mentioned liabilities of taxpayer. It also demanded that the defendant surrender to the IRS all of the taxpayer's property and rights to property, including all bank deposits. At the time of the levy, it is alleged that the taxpayer kept a checking account with the defendant with deposits amounting to $28,781.77. It is alleged that the defendant failed to turn over taxpayer's funds in the checking account to the IRS and, on April 13, 1989, defendant offset the funds in the account against an outstanding loan it had made to the taxpayer.

II.

Rule 56(c) provides that the court may grant summary judgment where there are no genuine issues of material fact for trial. Fed. R. Civ. P. 56(c). If there are no genuine issues, the movant is entitled to judgment as a matter of law. When the movant meets this standard, the opposing party must present sufficient facts to demonstrate that there exists some genuine issues of material fact in order to defeat the movant's motion for summary judgment. An issue is genuine if the evidence is such that a reasonable jury could return a verdict for the non-moving party. Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986). The court must view the evidence in light most favorable to the party opposing the motion. See Lopez v. S.B. Thomas, Inc., 831 F.2d 1184, 1187 (2d Cir. 1987).

It is now well settled that a federal tax lien is not self-executing. United States v. National Bank of Commerce [85-2 USTC 9482 ], 472 U.S. 713, 720 (1985). "Affirmative action by the IRS is required to enforce collection of the unpaid taxes." Id. Two principal tools for such action are provided within the Internal Revenue Code. The first of the two deals with lien-foreclosure suits. 26 U.S.C. 7403 . More relevant to our case, however, is the second of the two which deals [with] third party property holders--i.e. when a taxpayer's property is held by another. Under such circumstances, the Internal Revenue Code allows the IRS to serve upon the custodian with a notice of levy. 26 U.S.C. 6332(a) . "This notice gives the IRS the right to all property levied upon, United States v. Eiland [55-1 ustc 9487 ], 223 F.2d 118, 121 (4th Cir. 1955), and creates a custodial relationship between the person holding the property and the IRS so that the property comes into the constructive possession of the Government." National Bank of Commerce [85-2 ustc 9482 ], 472 U.S. at 720 (citing Phelps v. United States [75-1 ustc 9467 ], 421 U.S. 330, 334 (1975)). If the custodian honors the levy, the custodian is "discharged from any obligation or liability to the delinquent taxpayer and any other person with respect to such property or rights to property arising from such surrender or payment." 26 U.S.C. 6332(e) . "If, on the other hand, the custodian refuses to honor a levy, he incurs liability to the Government for his refusal." National Bank of Commerce [85-2 ustc 9482 ], 472 U.S. at 721; see 26 U.S.C. 6332(d) .

The issue then becomes, when can a custodian refuse to honor a levy imposed upon by the Government? The Second Circuit has specifically addressed this issue. In United States v. Sterling National Bank & Trust Co. [74-1 USTC 9336 ], 494 F.2d 919 (2d Cir. 1974), under very similar facts to the case at bar, the Court stated that the custodian may refuse to honor the levy only under two circumstances: (1) the custodian is neither "in possession of" nor "obligated with respect to" the taxpayer's property or rights to property belonging to the delinquent taxpayer; or (2) the property is subject to a prior judicial attachment or execution. Id. at 921; see National Bank of Commerce [85-2 USTC 9482 ], 472 U.S. at 721-22.

The defendant has not raised any of the above-mentioned defenses. From the facts, it is clear that the defendant was indeed in possession of the taxpayer's property. Furthermore, the evidence indicates that the taxpayer's checking account was not subject [to] any prior judicial attachments or executions. Under such circumstances, the Court determines as a matter of law that the defendant has no defense to its failure to honor the Government's levy. Consequently, pursuant to 26 U.S.C. 6332(d)(1) , the defendant is personally liable for the amount of $28,781.77 plus interest from the date of levy. This sum represents the amount present in taxpayer's checking account at the time the levy was served upon the defendant. This conclusion is reached even if the facts are looked at in light most favorable to the defendant. There simply is no material issue of fact to be determined by the fact-finders.

The defendant contends that the levy at issue was not made effective on the proceeds in the taxpayer's checking account because the defendant had a lien which was superior to that of the Government's. The defendant argues that a superior lien is in fact a valid ground under which the Government's levy may be dishonored. This argument is footless and was expressly rejected by the Second Circuit in Sterling National Bank.

In Sterling National Bank, under facts very similar to our own, the Second Circuit rejected the bank's argument that it had a superior lien interest to that of the Government's. The Court stated that superior lien interest was not a defense to the bank's failure to honor the levy imposed by the IRS. Sterling National Bank [74-1 USTC 9336 ], 494 F.2d at 921. The Court noted that there were other procedures under which the bank could have sought to protect its lien interest but, concomitantly, stated that lien priority was not an appropriate argument when dealing with levies imposed pursuant to 26 U.S.C. 6332 . Id. at 921 n. 1.

In the case at bar, the defendant is making an argument which was expressly rejected by Sterling National Bank Court. Accordingly, defendant's defense of superior lien interest is without merit and must be rejected.

It is here noted that the cases cited by the defendant in support of its argument are inapplicable since they are either distinguishable on the facts or inconsistent with the controlling law of this Circuit.

The determination that defendant is personally liable under 26 U.S.C. 6331(d)(1) does not end our inquiry, however. This is because the Government is also seeking a penalty of 50% of the total amount recovered under 26 U.S.C. 6332(d)(1) for defendant's failure, without reasonable cause, to honor the levy imposed.

26 U.S.C. 6331(d)(2) states, in pertinent part,

Penalty for violation.--In addition to the personal liability imposed by paragraph (1), if any person required to surrender property or rights to property without reasonable cause, such person shall be liable for a penalty equal to 50 percent of the amount recoverable under paragraph (1). . . . .

Accordingly, under the statute, no penalty can be imposed on the bank if the bank acted with "reasonable cause" when failing to honor the Government's levy. Sterling National Bank [74-1 USTC 9336 ], 494 F.2d at 923. The test for "reasonable cause" is whether or not a unsettled question of law exists. Id. It is important to note that the Sterling National Bank Court, again, under very similar facts, warned that banks "confronted with levies in similar circumstances after this decision cannot reasonably refuse to comply," since the law has been settled by the Court's decision. Id.

In accordance with the holding of Sterling National Bank, the Court determines that the instant defendant has failed to give reasonable cause for its failure to comply with the levy at issue. As stated earlier, a defense of superior lien interest has been addressed and rejected by the courts and, thus, cannot be considered a unsettled question of law. Thus, defendant has failed to demonstrate to the Court any "reasonable cause" for its failure to comply with the levy, 1 and accordingly, defendant is liable for the 50% penalty imposed by 6332(d)(2) .

III.

For the reasons stated herein, summary judgment is granted for the Government, and judgment is entered for the Government in the amount of $28,781.77 plus interest from the date of levy pursuant to 26 U.S.C. 6332(d)(1) . The Court, furthermore, imposes a penalty on the defendant for failure to comply with the tax levy pursuant to 26 U.S.C. 6332(d)(2) for the amount equaling 50% of the amount awarded under 6332(d)(1) .

IT IS SO ORDERED.

1 It is here noted that defendant's reliance on the United States v. Cuti [75-2 USTC 9555 ], 395 F. Supp. 1064 (E.D.N.Y. 1975), is misplaced since that case is factually distinguishable from the case at bar.

Moreover, defendant's contention that the lapse of time between the Notice of Levy and the commencement of the instant action prejudiced defendant is without merit. Defendant fails to cite to any authority for the proposition that lapse of time plays a factor in cases dealing with tax levies.

 

 

[99-1 USTC 50,271] United States of America, Plaintiff v. Bank of the West, Defendant

U.S. District Court, No. Dist. Calif., San Jose Div., C-98-20086-JF (PVT), 12/18/98

[Code Sec. 6332 ]

Liens and levies: Bank accounts: Failure of bank to honor levy: Self-help: Summary judgment.--No issue of material fact remained regarding a bank's refusal to honor an IRS levy that sought funds in a delinquent taxpayer's checking account. The bank had foreclosed on the account upon receiving notice of the levy based on its belief that it had lien priority against the IRS with respect to the funds. Under National Bank of Commerce (SCt), 85-2 USTC 9482 , however, a bank has only two defenses for failure to comply with such a levy: (1) the bank is not in possession of the funds when served with the notice of levy, and (2) the funds are subject to prior judicial attachment or execution. Here, the bank engaged in "self-help" by foreclosing on the funds strictly on a priority theory and, thus, failed to establish a defense for noncompliance with the levy. 

[Code Sec. 6332 ]

Liens and levies: Bank accounts: Failure of bank to honor levy: Self-help: Penalties, civil: 50% of value of levied property: Reasonable cause not established.--A bank was liable for the 50% penalty on the value of a checking account pursuant to Code Sec. 6332(d) since its failure to honor an IRS levy on the account, based on the its purported superior lien status, was not reasonable. It was also not reasonable for the bank to attempt to arrange satisfaction of the levy out of escrow funds belonging to the account owner and held by a third party since the IRS could have levied that account had it so intended.

Robert S. Mueller III, Thomas Moore, 450 Golden Gate Ave., San Francisco, Calif. 94102, for U.S. Bruce W. Robertson, Robertson, Lewis & Deckard, 60 S. Market St., San Jose, Calif. 95113, for Bank of the West. Cary L. Dictor, 19 Embarcadero Cove, Oakland, Calif. 94606, for Commonwealth. Stephen D. Pahl, Sarahann Shapiro, 160 W. Santa Clara St., San Jose, Calif. 95113-1700, for the Stephensons.

Caution: This court has designated this opinion as NOT FOR PUBLICATION. Consult the Rules of the Court before citing this case.

ORDER 1 GRANTING PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AND DISMISSING COUNTERCLAIM

FOGEL, District Judge:

On December 14, 1998, the Court heard argument regarding Plaintiff's motion for summary judgment and Counter-Defendant's motion to dismiss. For the reasons set forth below, Plaintiff's motion for summary judgment will be granted and the counterclaim will be dismissed.

I. BACKGROUND

This action arises out of the refusal of Defendant Bank of the West ("Bank") to honor a tax levy issued by the Internal Revenue Service ("IRS").

The IRS made assessments for unpaid taxes against Stephenson Roofing ("Stephenson") in 1993, 1994 and 1996. The IRS filed notices of liens based upon these assessments in 1996 and subsequently served the Bank with a notice of tax levy for approximately $70,700 held in a checking account which Stephenson maintained at the Bank. Rather than honoring the levy and delivering the $70,700 to the IRS, the Bank foreclosed upon the account pursuant to a security interest which the Bank held against the account. The Bank's actions apparently were motivated by a belief that it had lien priority over the IRS. The Bank also claims that it had arranged to have the levy satisfied by payment of escrow funds belonging to Stephenson and held by Commonwealth Land Title Company ("Commonwealth"). The Bank claims that Commonwealth promised to deliver the escrow funds to the IRS but failed to do so.

The IRS filed this lawsuit on January 29, 1998, contending that under the provisions of the Internal Revenue Code, the Bank was obligated to honor the tax levy and was not permitted to engage in "self help" by foreclosing on the account rather than honoring the levy and then pursuing its claim of lien priority in an appropriate administrative or judicial proceeding. The IRS seeks a statutory award in the amount of the funds levied plus a statutory penalty in an amount of one half the amount of the funds levied.

The Bank filed a counterclaim against Commonwealth, Stephenson, and Stephenson's principals, Michael and Kathy Stephenson. The counterclaim alleges claims for negligence and breach of fiduciary duty against Commonwealth and claims for equitable indemnity against all counterdefendants.

Currently before the Court are the IRS's motion for summary judgment and Commonwealth's motion to dismiss the counterclaim.

II. MOTION FOR SUMMARY JUDGMENT

The IRS's motion for summary judgment should be granted if it demonstrates that there is no genuine issue of material fact and that it is entitled to judgment as a matter of law. See Fed.R.Civ.P. 56(c); Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-48, 106 S.Ct. 2505, 2509-10 (1986). The motion should not be granted, however, if a reasonable jury, viewing the evidence in the light most favorable to the Bank, could resolve a material issue in the Bank's favor. See Anderson, 477 U.S. 242, 248-49, 106 S.Ct. 2505, 2510-11 (1986); Barlow v. Ground, 943 F.2d 1132, 1134-36 (9th Cir. 1991).

The Court concludes that no triable issue of material fact exists and that the IRS is entitled to judgment as a matter of law. Pursuant to 26 U.S.C. 6332(d), a person who refuses to surrender property which is subject to a tax levy is personally liable for a sum equal to the value of the levied property. 26 U.S.C. 6332(d)(1). Additionally, such person is liable for a penalty equal to fifty percent of the value of the levied property if the refusal to honor the levy was "without reasonable cause." 26 U.S.C. 6332(d)(2).

It is undisputed that a bank account is a type of property subject to a tax levy within the meaning of 6332. Moreover, the United States Supreme Court has held that a bank served with a notice of levy has only two defenses for failure to comply with the levy: (1) the bank is not "in possession of" or "obligated with respect to" property or property rights belonging to the delinquent taxpayer; and (2) the taxpayer's property is subject to a prior judicial attachment or execution. United States v. National Bank of Commerce [85-2 USTC 9482], 472 U.S. 713, 721-22, 105 S.Ct. 2919, 2925 (1985). It is undisputed that the bank was in possession of the funds in question at the time it was served with the notice of levy. Further, it is undisputed that the funds in question were not the subject of a prior judicial attachment or execution. Thus it is clear that the Bank is personally liable to the IRS for the amount of funds in the account at the time of the levy. That amount was $70,736.41. 2 Moreover, it cannot be said that the Bank's refusal to honor the levy was reasonable in light of the clear legal authority to the contrary. Accordingly, the Bank is liable for a penalty in the amount of $35,368.21.

The Bank argues that it should be allowed to raise the issue of lien priority as a defense to the lawsuit, citing to a Tenth Circuit decision in which the court held that a bank properly could raise lien priority as a defense to an action pursuant to 6332. United States v. Central Bank of Denver [88-1 USTC 9256], 843 F.2d 1300, 1305-06 (10th Cir. 1988). This Court declines to adopt the Tenth Circuit's approach in light of the Supreme Court's express holding that only two defenses are available to actions pursuant to 6332, neither of which encompasses a defense based upon lien priority. National Bank of Commerce [85-2 USTC 9482], 472 U.S. at 721-22, 105 S.Ct. at 2925. As the Court stated, "[t]hat another party or parties may have competing claims to the accounts is not a legitimate statutory defense." Id. [85-2 USTC 9482], 472 U.S. at 727, 105 S.Ct. at 2928. The Court explained that the restriction of the defenses available to 6332 actions was necessary to effectuate the balance which Congress had struck between the interest in the speedy collection of taxes and the interests of other claimants to the property. Id. [85-2 USTC 9482], 472 U.S. at 729, 105 S.Ct. at 2929.

Moreover, the Court pointed out that the issuance of a tax levy is a provisional remedy, which does not determine the rights of third parties to the levied property. Id., 472 U.S. at 731, 105 S.Ct. at 2930. Such rights to the levied property may be asserted in postseizure administrative or judicial proceedings; the purpose of the levy is merely to protect the government's interest in the property until competing claims to the property may be determined in a postseizure proceeding. 3 Id., 472 U.S. at 731 n.15, 105 S.Ct. at 2930 n.15. Clearly, the Bank should have complied with the levy and litigated its claim of lien priority in an appropriate postseizure proceeding rather than pursuing the "self help" remedy of foreclosing on the account.

The Bank argues that even if it is held liable for the amount of the funds in the account pursuant to 6332(d)(1), it should not be found liable for the fifty percent penalty pursuant to 6332(d)(2). The Bank claims that its refusal to honor the levy was reasonable in light of its belief that its lien on the account was senior to the tax lien and in light of its efforts to ensure that the tax levy was satisfied by Commonwealth. The Court cannot agree. For the reasons discussed above, it was unreasonable as a matter of law for the Bank to believe that lien priority gave it the right to foreclose on the account rather than honoring the levy and pursuing its lien priority claim in the appropriate forum. Moreover, it was unreasonable as a matter of law for the Bank to decide unilaterally that the tax levy which was directed at Stephenson's bank account should be satisfied not from the funds in that account but from funds held by a third party in an escrow account. The IRS could have levied the escrow funds had it wished to do so. The IRS instead chose to levy the bank account funds, and in light of the strong public policies underlying the statute authorizing tax levies its choice must be respected. Adoption of the Bank's legal argument in this case would render the administrative process created by Congress essentially meaningless. This Court is unwilling to be a party to such a result. Accordingly, the motion for summary judgment is granted.

III. MOTION TO DISMISS

Commonwealth moves to dismiss the Bank's counterclaim on the basis that the facts upon which the counterclaim is based do not have a sufficient nexus with the main action by the IRS. The Court need not reach this issue, because the Court declines to exercise supplemental jurisdiction over the counterclaim in light of its ruling with respect to the main action.

A district court has supplemental jurisdiction over a state law claim if that claim is "so related" to claims over which the district court has original jurisdiction that it forms "part of the same case or controversy." 28 U.S.C. 1367(a). If a district court has supplemental jurisdiction over a state law claim, it may decline to exercise such jurisdiction if: (1) the claim raises a novel or complex issue of state law; (2) the claim substantially predominates the claims over which the court has original jurisdiction; (3) the court has dismissed all claims over which it has original jurisdiction; or (4) in exceptional circumstances, other compelling reasons exist for declining jurisdiction. See 28 U.S.C. 1367(c). A decision to decline jurisdiction pursuant to one of these factors should take into consideration judicial efficiency, convenience of the parties, fairness, and comity. See ACRI v. Varian Associates, Inc., 114 F.3d 999, 1001 (9th Cir. 1997).

The counterclaim in this case asserts common law claims of negligence, breach of fiduciary duty and indemnity and also seeks declaratory relief. In light of the Court's decision disposing of the action by the IRS, the Court declines to exercise supplemental jurisdiction over these common law claims. Such state law claims more appropriately may be adjudicated in the superior court. Accordingly, the counterclaim is dismissed without prejudice.

IV. ORDER

IT IS HEREBY ORDERED that:

(1) The United States' motion for summary judgment is GRANTED;

(2) The Bank of the West SHALL pay to the United States statutory damages in the amount of $70,736.41 plus costs and interest on this sum as provided by statute and additionally SHALL pay to the United States a statutory penalty in the amount of $35,368.21; and

(3) The Bank of the West's counterclaim is DISMISSED WITHOUT PREJUDICE on the ground that the Court declines to exercise supplemental jurisdiction over such counterclaim.

1 This disposition is not designated for publication and may not be cited.

2 The Court takes this figure from the Memorandum In Support Of Motion filed by the IRS. The Court presumes that the Bank does not dispute the figure, because its Memorandum Of Points And Authorities in opposition to the motion does not offer a different figure.

3 The necessity of such protection is evident from the facts of this case: although the Bank attempted to replace the Stephenson bank account with proceeds from escrow, the attempt failed, and the IRS has never been paid.

 

[99-2 USTC 50,814] United States of America, Plaintiff-Appellee v. Billie Tarnove, Defendant-Appellant

(CA-11), U.S. Court of Appeals, 11th Circuit, 97-07444-CV-WJZ, 8/20/99, Affirming an unreported District Court decision

[Code Secs. 6332 and 6334 ]

Penalties, civil: Failure to surrender property: Levy, failure to honor: Attorney: Reasonable cause.--An attorney who was in possession of a monetary award from a client's personal injury lawsuit was liable for the 50% penalty for failing to honor a tax levy. The funds were not exempt from levy as subsequently received wages since they had been deposited in the attorney's trust account prior to her receipt of the levy. Therefore, the attorney had an obligation to release the funds to the IRS and she did not show reasonable cause for withholding the funds. Furthermore, the numerous lawsuits filed by the attorney to determine whether the funds were subject to levy did not establish reasonable cause for refusing to release the funds because all of the suits were dismissed after she failed to respond to the government's motions to dismiss.

 

Before: ANDERSON, Chief Judge, and BIRCH and DUBINA, Circuit Judges.

Caution: This court has designated this opinion as NOT FOR PUBLICATION. Consult the Rules of the Court before citing this case.

Per Curiam"

EC: Billie Tarnove ("Tarnove"), an attorney proceeding pro se, appeals the district court's grant of summary judgment holding her personally liable for the tax levy imposed on her client and imposing a 50 percent penalty against her for failing to honor the levy pursuant to 26 U.S.C. 6332(a) and (b). Because Tarnove has not shown reasonable cause to withhold the funds from the Internal Revenue Service ("IRS"), we AFFIRM the district court's ruling.

I. BACKGROUND

Alfred Palladino ("Palladino") was awarded about $377,000.00 in a personal-injury matter. Before final judgment in the personal-injury matter, however, Palladino's attorney was served with a notice of levy by the IRS relating to Palladino's tax deficiencies. Because disagreement existed as to the amount Palladino owed the IRS, the attorneys' in the personal injury matter, Palladino's accountant, and Tarnove, agreed, via letter, that the levied funds should be placed in Tarnove's trust account until the exact amount Palladino owed in back taxes was determined. Once the funds were placed in her trust account, Tarnove instituted a bankruptcy action on behalf of Palladino to determine whether the funds should be released to the IRS. The bankruptcy court held that the levy was not dischargeable in bankruptcy. After the ruling, the IRS served Tarnove with a notice of levy. Tarnove released $68,000.00 of the approximately $102,000.00 she held in her trust account to the IRS contending that the remainder of the levy was exempt as wages.

Tarnove then filed several lawsuits on behalf of Palladino in different courts seeking to dissolve the levy. She filed a petition in tax court which was dismissed. She then filed a petition for declaratory judgment in district court which was dismissed for failure to prosecute after Tarnove did not respond to the government's motion to dismiss for lack of jurisdiction. Tarnove filed another petition for declaratory judgment in district court, including her name on the petition as a plaintiff, and added a count seeking to interplead the funds. The district court dismissed this petition for lack of jurisdiction.

The government moved for summary judgment or alternatively, for entry of a default judgment against Tarnove. The government argued that a third party has only two defenses at its disposal for failing to honor a tax levy. One, that the party possesses neither the property nor rights to the property belonging to the delinquent taxpayer at the time the notice of levy was served. Two, that the property in question was subject to judicial attachment or process. Because Tarnove could not successfully avail herself of either defense, the government argued that she was obligated to honor the entire tax levy. Additionally, the government argued that because Tarnove could not successfully assert the above defenses, she did not have reasonable cause to withhold the funds. Accordingly, the government argued that the district court should impose a penalty of 50 percent of the value of the lien on Tarnove.

Tarnove argued that she honored the tax levy by paying the government $68,000.00 of Palladino's funds. She argued that the remaining $35,559.54 were exempt from levy as wages. Additionally, Tarnove argued that the district court should not impose a 50 percent penalty because she had reasonable cause for withholding the remaining funds and cites in support the numerous lawsuits she filed on behalf of Palladino and herself to determine whether the $35,559.54 was exempt from levy.

II. DISCUSSION

On appeal, Tarnove argues that the district court erred when it imposed a 50 percent penalty against her because she had reasonable cause to withhold the levied funds. Tarnove argues that the table attached to the notice of levy, directing the recipient to calculate exempt funds, and the various legal actions she instituted to determine the validity of the levy demonstrated a genuine concern as to whether the $35,559.54 was subject to levy and thus, she had reasonable cause to withhold the funds.

To permit the government to secure its revenues promptly while competing claims are resolved, Congress granted the IRS the power to levy on the property or the rights to the property of a delinquent taxpayer even when the property is possessed by a third party. See 26 U.S.C. 6332(a). "[A]ny 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, surrender such property or rights to" the property to the Secretary. See id. A person who possesses such property and does not deliver it to the IRS can be held personally liable for the value of the property not surrendered. See 26 U.S.C. 6332(d)(1). A third party honoring a levy imposed against a delinquent taxpayer, however, is immune from suit by said taxpayer or any other person "with respect to such property or rights to property arising from such surrender or payment." 26 U.S.C. 6332(e).

Third parties have only two defenses at their disposal for failing to honor a tax levy. First, they can show that they were not in possession of a delinquent taxpayer's property when they received the notice of levy. See United States v. National Bank of Commerce [85-2 USTC 9482], 472 U.S. 713, 722, 105 S.Ct. 2919, 2925, 86 L.Ed.2d 565 (1985). Second, they can show that the property was subject to judicial attachment or execution at the time the notice of levy was received. See id. If a third party cannot meet these defenses and it does not have reasonable cause for refusing to honor the levy, a court may impose a penalty of 50 percent of the value of the levied property. See 26 U.S.C. 6332(c)(2); see also United States v. Metropolitan Life Insurance [89-1 USTC 9362], 874 F.2d 1497, 1498 (11th Cir. 1989) (upholding the penalty for failure to surrender the funds to the IRS). Because Tarnove was in possession of the property when she received the notice of levy and this property was not subject to judicial attachment or execution, the above defenses are not available to her. The only other viable argument left is whether Tarnove had reasonable cause for refusing to honor the levy.

The treasury regulations state that the penalty provision does not apply in situations where a "bona fide dispute exists concerning the amount of the property to be surrendered pursuant to a levy or concerning the legal effectiveness of the levy." 26 C.F.R. 301.6332-1(b)(2). The regulations explain that "if a court in a later enforcement suit sustains the levy, then reasonable cause would usually not exist to refuse to honor a later levy made under similar circumstances." Id.

The IRS may not, in certain circumstances, levy against a delinquent taxpayer's entire property. See 26 U.S.C. 6334(a) (listing property exempt from levy). Wages, salary and other income are amongst the property exempt from levy. See 26 U.S.C. 6334(a)(9). The subsection states that "[a]ny amount payable to or received by an individual as wages or salary for personal services, or as income derived from other sources . . ." are exempt from levy. Id. The above provision applies only to wages, salary, or other income payable to the taxpayer after the levy is served. See 26 C.F.R. 301.6334-2(a). "No amount of wages, salary, or other income that is paid to the taxpayer before levy is made on the payor will be so exempt from levy under section 6334(a)(9)." Id. (emphasis added). Accordingly, even if we considered the personal-injury proceeds to be wages, Palladino received the personal-injury judgment prior to Tarnove's receipt of the notice of levy and these proceeds were deposited in Tarnove's trust account prior to her receipt of the levy. See R1-1. Contrary to Tarnove's contention that these proceeds were exempt as wages, she had an obligation to release the funds.

Tarnove also argues that the numerous law suits she filed to determine whether the $35,559.54 was subject to levy, and her fear of exposure to liability from Palladino constitutes reasonable cause to withhold the funds. This argument, however, is without merit because these lawsuits were repeatedly dismissed for either lack of jurisdiction or failure to prosecute, R1-14 at unnumbered page 4, and, as previously illustrated, fear of exposure to liability is not one of the two defense available to Tarnove.

Also in support of her reasonable-cause argument, Tarnove alleges that the interpleader action she attempted to file should exempt her from liability under 26 U.S.C. 6332(d). Tarnove also contends that the table attached to the notice of levy, explaining how to calculate which funds are exempt from levy, should prohibit the imposition of the 50 percent penalty because the table served as notice that certain funds were in fact exempt.

Tarnove relies on nonbinding authority in support of her argument that an interpleader action grants a third party immunity from the 50 percent penalty. See Kurland v. United States [96-1 USTC 50,242], 919 F.Supp. 419, 422 (M.D. Fla. 1996) (holding attorney exempt from 50 percent penalty because he filed an interpleader action); see also Hoye v. United States [60-1 USTC 9365], 277 F.2d 116, 120 (9th Cir. 1960) (holding that third party seeking a judicial determination regarding his obligation to honor a tax levy is not personally liable for a penalty). Kurland is, however, distinguishable because the attorney's interpleader action, unlike Tarnove's, was not dismissed for lack of subject-matter jurisdiction. R1-14 at unnumbered page 4. Additionally, the attorney in Kurland actively participated in the interpleader action. Tarnove, on the other hand, filed numerous lawsuits in different courts, all of which were dismissed after she failed to respond to the government's motions to dismiss. See R1-9, Exh. 1, 2, 3; R1-14 at 2-5.

Tarnove's argument that the table attached to the levy put her on notice that she should not release all of the funds has no merit because, as discussed earlier, these proceeds are not exempt wages. Accordingly, Tarnove did not have reasonable cause to refuse to surrender the funds.

AFFIRMED.

 

[2004-1 USTC 50,276] United States of America , Plaintiff v. Debra Waldvogel, Kenneth J. Waldvogel, and Gary Knudson, Defendants.

U.S. District Court, East. Dist. Wis. ; 02-C-1119, May 6, 2004.

[ Code Secs. 6331 and 6332]

Levy: Escrow agent. --

The government was entitled to summary judgment against an escrow agent who failed to turn over proceeds held for taxpayers after receiving a notice of levy. The fact that another party had a competing claim that may have had priority was not a legitimate defense against honoring the notice. The agent's contention that he was not in possession of property belonging to the taxpayer named in the notice was not credible and contradicted by court filings.





DECISION AND ORDER



GRIESBACH, District Judge: This case arises out of an effort by the United States Internal Revenue Service (IRS) to collect unpaid federal employment and unemployment taxes, along with statutory additions, owed by Debra and Kenneth Waldvogel. The taxes were incurred in connection with the operation of Waldvogel Material and Landscaping, a business jointly owned and operated by Debra and Kenneth Waldvogel. The assessments against the Waldvogels have already been reduced to judgment, and the only issue that remains in the case is the liability of their attorney, Gary Knudson, for his failure to honor an IRS Notice of Levy and turn over the proceeds from an auction of the Waldvogel's business inventory and other property. That issue is presently before me on the Government's Motion for Summary Judgment. For the reasons that follow, the Government's motion will be granted.


UNDISPUTED FACTS



In early 2001, the Waldvogel's decided to sell their home and to auction off their business inventory in Waldvogel Materials and Landscaping. Their home was subject to a mortgage held by Banner Bank of Antigo, Wisconsin . Banner Bank also claimed a security interest in Waldvogel Materials and Landscaping business inventory. Because of their outstanding debt and unpaid taxes, the IRS and Banner Bank requested that the auction proceeds be placed in escrow. The Waldvogels retained Attorney Gary Knudson to serve as escrow agent, and on May 10, 2001, Kenneth Waldvogel and Knudson entered into an excrow [ sic] agreement "for purposes of assuring that the Banner Bank will be protected for allowing Kenneth Waldvogel to hold an auction sale of secured property." (Knudson Dep. Ex. 19.) On May 12, 2001, an auction was held of the business equipment and supplies of Waldvogel Materials and Landscaping, netting $15,122 in auction proceeds. Attorney Knudson received the proceeds and they were deposited in the escrow account. On July 26, 2001, Knudson was served with an IRS Notice of Levy. The notice listed the taxpayer as Debra Waldvogel and directed Knudson to turn over to the IRS any money, property or credit that you have or are already obligated to pay the taxpayer.

By this time, the Waldvogels had also moved out of their home and stopped making mortgage payments to Banner Bank. On August 3, 2001, the bank's attorney wrote Knudson advising him that unless the money held in escrow was turned over within two weeks, the bank would "commence legal proceedings to foreclose and obtain the funds which are presently held by you." (Knudson Dep. Ex. 26.) Shortly thereafter, Kenneth Waldvogel telephoned Knudson and directed him to turn the proceeds over to the bank. On August 9, 2001, Kenneth Waldvogal [ sic] met Knudson at the bank. At Waldvogel's direction, Knudson obtained a money order payable to Banner Bank for the full amount of the proceeds and delivered it to Waldvogel, who immediately turned it over to the bank.

On September 7, 2001, the IRS sent Knudson a Final Demand on the original levy. Knudson responded by letter dated September 11, 2001, noting that the Notice of Levy directed him to turn over property belonging to Debra Waldvogel. At the time he received the notice, Knudson stated, he had no money or property in his possession belonging to Debra Waldvogel. Knudson then stated:

I had in my possession a bank account containing auction proceeds which was deposited by Kenneth Waldvogel from a sale of his landscaping business. The proceeds were deposited so that assurance to the Banner Bank of Antigo could be given that they would receive the proceeds of the sale of property subject to their prior security interest. In due course the money was paid over to them.


(Knudson Dep. Ex. 30.)

On the basis of these facts, the Government contends that it is entitled to judgment against Knudson as a matter of law.


ANALYSIS



Section 6321 of the Internal Revenue Code, 26 U.S.C. 6321, provides: "If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount ... 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." The lien generally arises when an assessment is made and continues until the taxpayer's liability "is satisfied or becomes unenforceable by reason of lapse of time." 26 U.S.C. 6322.

The IRS is empowered to enforce such liens in either of two ways. The first is a lien foreclosure suit. Section 7403(a) authorizes the institution of a civil action in federal district court to enforce a lien "to subject any property, of whatever nature, of the delinquent, or in which he has any right, title, or interest, to the payment of such tax or liability." 26 U.S.C. 7403(a). The second means of enforcement, which the IRS sought to use here, is by administrative levy. The levy is a provisional remedy which typically "does not require any judicial intervention." United States v. Rodgers [ 83-1 USTC 9374], 461 U.S. 677, 682 (1983). As used in the Code, the term "levy" includes "the power of distraint and seizure by any means." 26 U.S.C. 6331(b).

In United States v. National Bank of Commerce [ 85-2 USTC 9482], 472 U.S. 713 (1985), the Court described the operation of an administrative levy where the property of the taxpayer is held by a third person:

a notice of levy upon the custodian is customarily served pursuant to 6332(a). This notice gives the IRS the right to all property levied upon, United States v. Eiland [ 55-1 USTC 9487], 223 F.2d 118, 121 (CA4 1955), and creates a custodial relationship between the person holding the property and the IRS so that the property comes into the constructive possession of the Government. Phelps v. United States [ 75-1 USTC 9467], 421 U.S. 330, 334, (1975). If the custodian honors the levy, he is "discharged from any obligation or liability to the delinquent taxpayer with respect to such property or rights to property arising from such surrender or payment." 6332(d). If, on the other hand, the custodian refuses to honor a levy, he incurs liability to the Government for his refusal. 6332(c)(1).


[ 85-2 USTC 9482], 472 U.S. at 720-21.

In this case, the government notes, it is undisputed that Knudson was served with the Notice of Levy while the proceeds from the auction of the Waldvogel's property were in his possession. Despite this fact, he failed to turn over the proceeds to the IRS, and instead paid them to the bank at Kenneth Waldvogel's request. Under these circumstances, the government argues, Knudson is liable for the full amount of the funds he had in his possession.

In opposing the government's motion, Knudson makes essentially two arguments. He first argues that Banner Bank had a prior interest in all or, at least a substantial portion, of the proceeds of the auction based on its chattel security agreement covering the property sold at the auction and the Waldvogels' assignment of the proceeds of the auction to the bank. Knudson argues that the Bank was entitled to all of the proceeds if the court concludes that there was a "completed assignment of funds" prior to the IRS levy. If, on the other hand, the court concludes that the assignment was not complete, he claims that there would still remain a factual issue with respect to what portion of the proceeds was subject to the levy. Knudson contends that the fact that the Waldvogels claim that a substantial portion of the property sold was acquired prior to the filing of the notice of federal tax liens raises a material issue of fact as to the amount of proceeds the IRS was entitled to receive.

As the government points out, this argument fails for the simple reason that it was not up to Knudson to decide how much, if any, of the proceeds the IRS was entitled to receive. "The courts have uniformly held that a bank served with an IRS notice of levy `has only two defenses for a failure to comply with the demand."' United States v. National Bank of Commerce [ 85-2 USTC 9482], 472 U.S. at 721-22 (quoting United States v. Sterling National Bank & Trust Co. of New York [ 74-1 USTC 9336], 494 F.2d 919, 921 (2nd Cir. 1974.)). The same rule applies to escrow agents. United States v. Cuti [ 75-2 USTC 9555], 395 F.Supp. 1064, 1065 ( E.D. N.Y. 1975). A bank or other entity served with a notice of levy can claim that it is not in possession of the property of the taxpayer, or assert that the property is subject to a prior judicial attachment or execution. [ 85-2 USTC 9482], 472 U.S. at 727. But it cannot, as Knudson did here, take it upon itself to decide who is entitled to the taxpayer's property. "That another party or parties may have competing claims to the accounts is not a legitimate statutory defense." Id. If the bank was entitled to priority, it would have been free to request return of the property under 26 U.S.C. 6343(b), or assert its own interest in the property in an action under 26 U.S.C. 7426(a). But by making himself the arbiter of who was entitled to the proceeds, Knudson violated the clear provisions of the Code.

Knudson's second argument, if supported by the evidence, would constitute a legitimate defense. He claims that at the time he received the notice, he did not possess any property belonging to the Debra Waldvogel, the named taxpayer on the Notice of Levy. The difficulty with this argument, however, is that Knudson's own response to the government's motion belies his claim that he did not know Debra had an interest in the proceeds. He states in his response that "[t]he Waldvogels entered into an assignment of all proceeds of their auction sale, whereby the proceeds were paid to Gary D. Knudson, to hold for Banner Bank and was [sic] therefore funds belonging to the bank and not the Waldvogels." (Response at 1.) Thus, it is clear that Knudson knew that the property sold at the auction belonged to both of the Waldvogels. And as an attorney licensed in the State of Wisconsin , Knudson also knew that the property acquired in their business was marital property and could be used to satisfy any marital debt, including any debt incurred by a spouse during the marriage in the interest of the marriage and family, such as the operation of a family owned business. Wis. Stat. 766.55 (2001-02). The fact that Knudson was the Waldvogel's attorney not only for this transaction, but also for their bankruptcy in 1997 (Pl.'s Statement of Undisputed Material Facts 7.), renders incredible any claim by him that he was unaware of Debra's interest in the proceeds entrusted to him.

I conclude from the undisputed facts of the case that Attorney Knudson's failure to comply with the Notice of Levy served upon him renders him liable for the value of the property wrongfully withheld.

IT IS THEREFORE ORDERED that the government's motion for summary judgment is GRANTED and judgment shall be entered in favor of the United States in that amount of $15,122, together with interest allowed by law and costs.

 

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