A part of you couldn’t be happier that Uncle Bill obtained the services of another lawyer for one of his stick-it-to-the-man schemes. In this case, Bill wanted to avoid probate and transfer his home in Dixie County, Florida to his son Jethro. Bill and Ethel, however, still wanted to live in the house and wanted to be able to sell the house if Jethro pissed them off, which, in your experience, was a foregone conclusion.
Bill, who fancied himself somewhat of a Presidential historian, caught wind of a device known as a “Ladybird deed,” apocryphally named after the first lady, Ladybird Johnson. Also known as an enhanced life estate deed, it transferred the property to Jethro while retaining a life estate in the property as well as the right to transfer and alienate the property at Bill and Ethel’s discretion. They recorded the ladybird deed sometime in the early 2000s, and you only learned about it last week when Bill came to you as mad as a three-legged dog trying to bury a bone on an icy pond.
It turns out that when Jethro was released from his five-year stint in Raiford (early, for good behavior), he didn’t necessarily file his tax returns. Though he did not have much income, the IRS determined the deficiency of $6,000 and an accuracy-related penalty of $1,200. What’s more, they filed a Notice of Federal Tax Lien against Jethro’s property, which included Bill and Ethel’s house.
Once Bill is done hooting and hollering, he hands you a copy of the lien notice and the ladybird deed. The lien notice a standard, and you are more interested in the language of the deed, which reads in part that “Bill hereby reserves to himself, without any liability for waste, the exclusive possession, use and enjoyment of the said property for and during his lifetime.” Further, Bill “reserved for himself, for and during his lifetime, the right to sell, convey, lease, mortgage or otherwise dispose of said property, in fee simple, with or without consideration, without joinder by Jethro and with full power to retain any and all proceeds generated thereby.”
From a cursory reading, you surmise that Jethro was entitled to possession of the property only (a) upon Bill’s death and (b) if Bill had not “otherwise disposed” of the Property prior to his death. As such, Jethro’s interest in the Property was fully defeasible during Bill’s lifetime. Because the coffee hasn’t kicked in yet, you question aloud “But can a tax lien attach to a defeasible interest?”
“Sounds like a question for a tax lawyer,” Bill replies without hesitation and with much chortling. Indeed, it does, Bill. Indeed, it does.
Attachment of Federal Liens to Property and State Law Property Rights
A Federal tax lien attaches to “all property and rights to property, whether real or personal,” possessed by a delinquent federal taxpayer.[1] Property rights are determined by state law.[2] The Code “creates no property rights but merely attaches consequences, federally defined, to rights created under state law,”[3] and determines whether those rights are the sort of rights to which a Federal tax lien may attach.[4]
A Federal tax lien is “wholly a creature of federal law,” and it is one of the “formidable arsenal of collection tools” necessary “to ensure the prompt and certain enforcement of the tax laws in a system relying primarily on self-reporting.”[5] Stated another way, the attachment of Federal tax lien depends on whether “property” or “rights to property” exist under state law, but the attachment and priority of a Federal tax lien depends entirely upon federal law.[6] Nevertheless, “the Government’s lien under IRC § 6321 cannot extend beyond the property interests held by the delinquent taxpayer.”[7]
Transfer of Property Generally does not Affect Lien
“The transfer of property subsequent to the attachment of the lien does not affect the lien.”[8] That is to say, “once a lien has attached to an interest in property, the lien cannot be extinguished simply by a transfer or conveyance of the interest.”[9]
Federal Tax Lien may Attach to Defeasible Interests
“Where…on the occurrence of an event…an interest will terminate,” such an interest is referred to in the Internal Revenue Code as a “terminable interest.”[10] Under state law, “where an estate has been devised in fee, subject to be defeated by the happening of some future event,” such conveyance may also be known as a “defeasible fee.”[11] A Federal tax lien may attach to a terminable interest or defeasible fee in real property pursuant to IRC § 6321.[12]
To this end, where a taxpayer’s property rights are terminable, “the Government’s rights, by virtue of its lien upon the taxpayer’s interest, are likewise terminable, being no greater than those of the taxpayer.”[13] Thus, “a Federal tax lien may be extinguished if the property [interest] itself is extinguished.”[14] “[W]hen the taxpayer’s interest subject to the lien is a terminable interest…the government’s lien on that particular property is extinguished at the same time as the taxpayer’s interest,”[15] “since there is no longer any property…to which a lien can attach.”[16]
Nature of Jethro’s Interest in Property
As noted above, Bill conveyed the property by the Enhanced Life Estate Deed to his son Jethro, which not only provided Bill with exclusive possession, use and enjoyment of the Property during Bill’s life, but also the right to dispose of the Property in fee simple without joinder of Jethro. This type of deed, which reserves a present possessory life estate interest in the property as well as the right to convey such property, while providing a defeasible fee to another, is known colloquially in Florida and other jurisdictions as a “Lady Bird” deed. As a consequence of the “Lady Bird” Enhanced Life Estate Deed, Jethro did not have a present possessory right to the Property, but instead, Jethro had only an inchoate, defeasible or terminable interest in the Property.
Legal Theory of Jethro’s Property Interest
Law school professors have long used the metaphor of a “bundle of sticks” to describe property interests, with a full bundle representing complete ownership of a piece of property, or fee simple absolute. A life tenant and a remainderman possess interests in a property that together constitute a whole bundle. In the present matter, Bill’s enhanced life estate that he reserved in the “Lady Bird” Enhanced Life Estate Deed not only vested Bill with present possessory interests in the property (the life estate) but also the unrestricted remainder power to convey or alienate the property without joinder of Jethro. Jethro possessed only a contingent future interest in the property, which interest was contingent on Bill’s non-conveyance of the property.
No Merger
In a number of jurisdictions, the common law doctrine of merger would apply to merge Bill’s life estate with his remainder interest to provide him with a fee simple in the Land.[17] Although Florida courts, like the majority of jurisdictions, recognize the doctrine of merger,[18] whereby a life estate and a remainder held by the same person merge in fee simple, Florida courts are in the minority of jurisdictions to hold that merger cannot “take place by the same instrument at the same time and by the same person.”[19] Because merger cannot take place by the same instrument, in Florida a life estate and a remainder interest may be reserved in the same deed (i.e., a Lady Bird deed).
Termination of Jethro’s Interest
Federal courts have long held that generally the “transfer of property subsequent to the attachment of the lien does not affect the lien, for it is of the very nature and essence of a lien, that no matter into whose hands the property goes, it passes cum onere (with the burden of the lien).”[20] Nevertheless, as explained in greater length above, the attachment of the lien terminates when the underlying interest to which it attaches terminates.[21]
Indeed, Rev. Rul. 54-154 and its progeny specifically state that when a taxpayer’s rights “are terminable, the Government’s rights, by virtue of its lien upon the taxpayer’s interest, are likewise terminable, being no greater than those of the taxpayer.”[22] “Accordingly, when the taxpayer’s [property] rights…terminate after the Federal tax lien has arisen, the rights of the United States in the [property] also terminate, since there is no longer any property [rights] to which a lien can attach.”[23]
As stated above, Bill has the unqualified and absolute right to convey the Property to anyone he chooses. Under the bundle of sticks metaphor, Bill’s conveyance of the Property in fee simple absolute is a conveyance of the whole bundle, including any and all interests in and to the sticks. Stated another way, if Bill conveys the Property, the grantee of the conveyance takes full possessory present and future rights to the Property. By conveying the Property, the condition precedent has occurred to divest Jethro of his future possessory interest in the Property.
Thus, all Bill would need to do to terminate the lien on the property would be to execute and record a deed transferring the property back to himself in fee simple absolute, thereby terminating Jethro’s interest in the property and, consequently, the Federal tax lien.
Footnotes:
[1] IRC § 6321.
[2] Drye v. United States, 528 U.S. 49, 58 (1999); United States v. Bess, 357 U.S. 51, 55 (1958); United States v. Librizzi, 108 F.3d 136, 137 (7th Cir.1997).
[3] United States v. Swan, 467 F.3d 655, 656 (7th Cir. 2006) (citing United States v. National Bank of Commerce, 472 U.S. 713, 722 (1985))
[4] Id.; United States v. Craft, 535 U.S. 274, 278-79 (2002).
[5] Rodriguez v. Escambron Dev. Corp., 740 F.2d 92, 96 (1st Cir. 1984) (citing United States v. Rodgers, 461 U.S. 677, 683 (1983)).
[6] Aquilino v. United States, 363 U.S. 509, 513–515 (1960).
[7] United States v. Rodgers, 461 U.S. 677, 690-91 (1983); United States v. Jepsen, 131 F. Supp. 2d 1076, 1085 (W.D. Ark. 2000); Rodriguez, 740 F.2d at 99 (holding “[t]he government’s rights can rise no higher than those of the taxpayer to whom the property [interest] belongs”); see also Rev. Rul. 54-154, 1954-1 C.B. 277 (1954) (holding Federal tax liens attach to property only to the extent of the delinquent taxpayer’s interest therein).
[8] Bess, 357 U.S. at 57.
[9] Rodriguez, 740 F.2d at 99.
[10] See, e.g., I.R.C. § 2056(b)(1).
[11] Dickson v. Alexandria Hosp., 177 F.2d 876, 880 (4th Cir. 1949); Armenian Assembly of Am., Inc. v. Cafesjian, 811 F. Supp. 2d 120, 127 (D. D.C. 2011), aff’d, 758 F.3d 265 (D.C. Cir. 2014) (holding that a “defeasible fee” is an “estate in fee, subject to be defeated on the happening of some future event”).
[12] United States v. Baran, 996 F.2d 25, 27 (2d Cir. 1993) (tax lien attached to life estate); I.R.M. 5.17.2.5.5 (tax lien attaches to terminable interests); Segal v. Rochelle, 382 U.S. 375, 379 (1966) (an “interest is not outside reach of tax lien because it is novel or contingent or because enjoyment must be postponed”). Such attachment, however, ends when the interest terminates; see also United States v. Swan, 467 F.3d 655 (7th Cir. 2006); Rev. Rul. 54-154.
[13] Rodgers, 461 U.S. at 690-91.
[14] Rodriguez, 740 F.2d at 99.
[15] Id.; see also Jepsen, 131 F. Supp. 2d at 1085.
[16] Id.
[17] See, e.g., In re Steffien, 415 B.R. 824, 830 (Bankr. D. N.M. 2009) (applying Florida law); Commissioner. v. Ellis’ Estate, 252 F.2d 109, 114 (3d Cir. 1958) (applying Pennsylvania law).
[18] Blocker v. Blocker, 137 Fla. 285, 293 (Fla. 1931).
[19] In re Rentz’s Estate, 152 So. 2d 480, 483-84 (Fla. 3d DCA 1963).
[20] Bess, 357 U.S. at 57.
[21] See I.R.M. 5.17.2.5.5 (stating “once the [taxpayer’s] interest terminates, the Federal tax lien on that interest also terminates”).
[22] See also Stuart v. Willis, 244 F.2d 925, 929 (9th Cir. 1957); Lloyd, Kane & Wieder, P.A. v. United States, 757 F. Supp. 683, 684 (D. Md. 1991); Rodgers, 461 U.S. at 696.
[23] Id.; see also I.R.M. 5.17.2.5.5.
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