IRS levy trumps decedent’s children’s claim to money held in usufruct

The Fifth Circuit affirmed a district court decision that an IRS levy against a decedent’s estate for unpaid taxes took precedence over his children’s claims to the money, which the decedent held in usufruct under Louisiana law, since the children were essentially unsecured creditors.

Facts: Henry and Tonia Goodrich, a married couple who lived in Louisiana, owned community property that included shares of stock and stock options in Goodrich Petroleum Co. (the Goodrich securities). When Tonia died in 2006, she left her interest in some of the community property to the couple’s three children, subject to a usufruct in favor of Henry. During his life, Henry sold $857,914 worth of the Goodrich securities. One-half of that amount belonged to Henry outright and the other half to the children but held in usufruct by Henry.

Henry died in 2014, owing over $560,000 in income taxes for 2012, 2013, and 2014. His executor opened a bank account for the estate and placed estate funds in it. The IRS placed a levy on the account, and the bank remitted the remaining funds, almost $240,000, to the Service. After that, with penalties and interest, a combined outstanding tax balance of $472,000 remained.

The children sued, claiming that the IRS had wrongfully levied the funds under Sec. 7426(a)(1) and claiming that they were owners of nearly $500,000 of Goodrich securities that Henry had held subject to their usufruct. A magistrate judge held that the IRS’s claims took priority over the children’s claim because the children were essentially “unsecured creditors” of the disputed funds in Henry’s succession. The children appealed the decision to the Fifth Circuit.

Issues: Because Henry held the securities in usufruct, the issue was whether Louisiana law assigned to the Goodrich children a primary interest in the securities as owners or a secondary interest as creditors. Under Louisiana Civil Code Article 535, a usufruct is “a real right of limited duration on the property of another.” Under Article 538, “If the things subject to the usufruct are consumables [including money], the usufructuary becomes owner of them. … At the termination of the usufruct he is bound either to pay the naked owner the value that the things had at the commencement of the usufruct or to deliver to him things of the same quantity and quality.”

Holding: The Fifth Circuit found that the Goodrich children were the naked owners of consumables held in usufruct. Applying Louisiana case law (Succession of Catching, 35 So. 3d 449 (La. Ct. App. 2010)) the court found that the children had a claim against Henry’s estate in connection with the securities, but they did not immediately become owners of the securities when he died. Therefore, they were unsecured creditors with respect to the claim, and thus they did not legally own the property at the time the IRS seized it. Under Sec. 6323, the IRS has priority over other creditors, and so the Fifth Circuit affirmed the magistrate judge’s grant of summary judgment in favor of the IRS.

• Goodrich, No. 20-30422 (5th Cir. 1/25/22)

— Alistair M. Nevius, J.D., is the JofA‘s editor-in-chief, tax.

To comment on Tax Matters or to suggest an idea for an item, contact Alistair M. Nevius at Alistair.Nevius@aicpa-cima.com.