Tax Liens

BY EDWARD J. SCHNEE

TAX CASE

One troubling aspect of tax practice that CPAs sometimes have to deal with is what to do when the IRS or some other authority attaches a tax lien to a client’s property. The issue is even more complex when the property is in joint name because it involves both federal and state law. Recently the U.S. Supreme Court considered how “tenancy by the entirety,” a form of joint ownership available only to married couples, affects a tax lien.

Don Craft failed to file tax returns from 1979 to 1986. In 1988 the IRS assessed $482,500 in unpaid income taxes against him. It attached a lien to property located in Grand Rapids, Michigan that Don and his wife Sandra Craft owned as tenants by the entirety. After the IRS attached the lien, Don transferred his ownership interest to Sandra for $1. She sold the property and placed half the net proceeds into an escrow account as the IRS required before it would release the lien and allow the sale. The Sixth Circuit Court of Appeals held that the lien did not attach to the property because Don did not have an interest in it separate from his wife’s. The IRS appealed and the Supreme Court granted certiorari , agreeing to hear the case and determine whether a tax lien could attach to property owned as tenancy by the entirety.

Result. For the IRS. Under IRC section 6321, a tax lien may attach to any “property” or “rights to property” a taxpayer owns. Therefore the question before the Court was whether a tenant by the entirety has property or a right to property to which a lien could attach. Although this is a federal-law question, the answer depends on state law. In answering the question it’s necessary to consider property as a bundle of rights and examine how the various types of ownership affect an individual taxpayer’s rights.

By law, tenancy by the entirety can exist only between married persons. Each tenant has a right of survivorship. Under Michigan law a tenant by the entirety has the right to use the property, to exclude others from using it, to share in any income from the property, to receive half the proceeds on sale and to borrow against the property with the other tenant’s consent.

According to the Supreme Court, the fact the Crafts could use the property, receive income from the property and exclude others from it are important rights. By themselves, these rights may be sufficient to be considered a right to property, enabling the IRS to attach a lien. When the right to alienate (borrow against or sell) the property is added to these rights—even if it cannot be done unilaterally—this is sufficient for the Court to decide that each spouse has a right to property. The Court left for another day the effect of the survivorship right on deciding whether a right to property exists. One reason the Court found the other rights sufficient to make this determination is because both tenants had the same rights. If it had held them to be insufficient, the conclusion would be that nobody had a right to the property. The Court pointed out that its own conclusion was not influenced by the fact the state of Michigan reaches the opposite conclusion for state creditors.

Justices Thomas, Stevens and Scalia dissented. However, since most states have similar rights for tenants by the entirety, tax liens will attach to most property owned in this way. For the Craft case, the final answer must await another court’s decision as to whether Mr. Craft’s transfer of his ownership interest in the property to his wife for $1 was fraudulent.

If clients ask CPAs about the effect of different types of ownership on the ability of creditors to attach liens, they should say it appears ownership as tenants by the entirety is ineffective as a means of preventing a federal tax lien from attaching to a property.

United States v. Sandra Craft, 122 Sup. Ct. 1414 (2002).

Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accountancy and director, MTA program, Culverhouse School of Accountancy, University of Alabama at Tuscaloosa.

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