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IRS Lien Attaches to Income Interest in Spendthrift Trust
Headnote:
For purposes of federal tax lien attachment, individual has
interest in trust that should be collected by suit to foreclose, according to
advise issued by Joseph W. Clark, Sr. technician reviewer, branch 2 (general
litigation).
Reference(s): IRC Sec(s). 6321 ; IRC Sec(s). 7403
FULL TEXT:
UIL: 999.98-00
Release Date: 9/8/2000
Date: May 16, 2000
MEMORANDUM FOR ASSOCIATE DISTRICT COUNSEL, SAN DIEGO
CC:WR:SCA:SD
FROM:
Joseph W. Clark
Senior Technician Reviewer, Branch 2 (General Litigation)
CC:EL:GL:Br2
SUBJECT:
* * *
This memorandum responds to your General Litigation Transmittal Memorandum
dated July 7, 1999 in which you requested that we pre-review your Memorandum to
Revenue Officer Colette Frias, Collection Division -- Large Dollar Group,
Laguna Niguel, California, regarding a trust in which the above referenced
taxpayer is a beneficiary. You conclude that the taxpayer's interest in the
trust is not recoverable through the use of a nominee levy. Because normal lien
and levy procedures are applicable against a taxpayers interest in a valid
trust, and there is no indication that the trust at issue in this case was not
valid, we will discuss the possibility of the use of normal lien and levy
procedures. This document is not to be cited as precedent.
ISSUES
(1) Whether the terms of the trust prevent the attachment of the
federal tax lien.
(2) What collection device, if any, should be used to collect from
the taxpayer's interest in the trust.
CONCLUSIONS
(1) The taxpayer has a property interest in the trust subject to
the federal tax lien, despite the spendthrift, discretionary, and remainder
interest provisions. We believe that this property interest is limited to the
payments to be made as provided for by the trust.
(2) A suit to foreclose the federal tax lien would be the
collection action, if any, that we would recommend.
FACTS
The facts are as follows: The taxpayer's mother and stepfather
established a trust for the benefit of several beneficiaries including the
taxpayer. Under the terms of the trust, the taxpayer's share was put into a
benefit trust. As stated in * * * of the trust, the settlors intended that the
taxpayer have the use of the income and principal of the trust; that the trust
assets not be available to the taxpayer's creditors; and that the trust be a
discretionary trust, not basic support trust. The benefit trust also provides
that the trustee “shall pay to or apply for the benefit of * * *, as much
of the net income as the trustee, in the * * * trustee's discretion, shall deem
necessary for * * * proper health maintenance, support, and education.” *
* * In addition, should the trustee determine that the income payments are
insufficient, he “shall . . . pay to or apply for the benefit of * * * a
sum out of the principal as the trustee, in the trustee's discretion, deems
necessary for proper health, maintenance, support, and education” of the
taxpayer. * * * The trust further provides that the taxpayer has the power to
change the trustee at will. 1 Finally, the trust provides that the taxpayer may
designate the beneficiary of the balance of the trust which is undistributed at
the time of the taxpayer's death. If he fails to do so, the balance is to be
paid the taxpayer's children.
DISCUSSION
The key question presented is whether the taxpayer has an interest
in the trust which is subject to the attachment of the federal tax lien. Your
office, in addressing a nominee issue, states that because the taxpayer's
children have, under California law, a vested remainder interest in the trust
assets (subject to displacement by the taxpayer), the taxpayer does not have
property interest in the trust assets under California law to which the federal
lien could attach. The existence of the remainder interests under California
law may indicate, as your office suggests, that there is no merger under state
law. The existence of the remainder interests do not, however, indicate that
the taxpayer has no property interest subject to the tax lien. 2 Instead, in asserting
that the lien does not attach, beneficiaries and trustees in the past have
typically argued that the spendthrift and discretionary provisions of a trust
prevent lien attachment. However, it is now well settled that spendthrift
provisions, which are state-created exemptions, cannot defeat a federal tax
lien. See, e.g., First Northwestern Trust Company v. Internal Revenue Service,
622 F.2d 387 (8th Cir. 1980); United States v. Rye, 550 F.2d 682 (1st Cir.
1977); United States v. Dallas National Bank, 152 F.2d 582 (5th Cir. 1946) In
Leuschner v. First Western Bank and Trust, 261 F.2d 705 (9th Cir. 1958), the
Ninth Circuit held that the taxpayer's interest in a trust could be reached by
the federal tax lien, observing:
Although a trust is a spendthrift trust or a trust for support,
the interest of the beneficiary can be reached in satisfaction of an
enforceable claim against the beneficiary, . . . (d) by the United States . . .
to satisfy a claim against the beneficiary. Restatement, Trusts, section 157
(1948 Supp.). There is no doubt that the paramount right to collect taxes of
the federal government overrides a state statute providing for exemptions.
261 F.2d at 707 (footnotes omitted).
The issue presented by discretionary provisions is generally more
complicated. Discretionary trusts are trusts which do not provide a standard
for distributions. In such trusts, the trustee has absolute, uncontrolled
discretion to pay (or not to pay) the beneficiary as he sees fit. Restatement
of Trusts, Second, section 155. A support trust, on the other hand, provides
that the trustee shall pay from the income and principal of the trust funds
necessary to support the beneficiary. Restatement of Trusts, Second, section
154.
Where a trust gives the trustee uncontrolled, absolute discretion
with respect to the distributions, if any, made to a beneficiary, the
beneficiary has no basis to compel the trustee to make a distribution.
Therefore, he does not have any interest which is subject to the federal tax
lien. On the other hand, a beneficiary does have a right to property subject to
the federal tax lien where, under state law, he can force the trustee to act,
as is the case with a support trust. 3 See, e.g., Magavern v. United States, 550
F.2d 797, (2d Cir.) cert. denied, 434 U.S. 826 (1977). 4 The trust involved in
United States v. Taylor provided that the trustees “shall pay” to
the beneficiary so much of the income from the trust as the trustees deemed
necessary for the proper care, maintenance, and support of the beneficiary. The
court found:
[T]he taxpayer has a lifetime, enforceable, equitable right to
support from the income of the trust. The discretionary feature is limited to
the trustees' determining the amounts they deem 'necessary' for the taxpayer's
proper care, maintenance, and support. The provision that the 'trustees shall
pay' is mandatory and conveys the intent of the testator that his son is to
receive support payments from the net income of the trust if he needs support.
If the trustees refuse to act or act unreasonably, a court of
competent jurisdiction may be invoked to obtain an order compelling the
trustees to act in the exercise of discretion.
254 F.Supp. 752, 755 (N.D. Cal. 1966). 5 The court
concluded that the provision regarding the distribution of the principal,
phrased as a grant of absolute discretion, empowers the trustees to invade the
principal when the trust income is insufficient. The court concluded that the
taxpayer would have an enforceable right: “in this regard, the courts
will compel an honest exercise of discretion by the trustees.” 254
F.Supp. at 756. 6
We believe that, here, the taxpayer has, at a minimum, the right
to an amount necessary for his health, maintenance, support, and education, as
provided in the trust and that that right is subject to collection. 7 However, one twist in
this case is the fact that the settlors, in the trust, stated the intention
that the trust be a discretionary, rather than support, trust. Generally, the
extent to which a beneficiary has an interest in a trust will depend on
“the manifestation of intention of the settlor.” Restatement of
Trusts, Second, section128. Here, while the settlors state that they intend the
trust to be a discretionary one, the language they used is the typical support
trust language. We cannot accurately predict how a court would read these
apparently conflicting provisions. However, we believe that the trust
provisions, taken as a whole, cut against it being a discretionary trust, given
the support language used and the ability of the taxpayer to reach the entire
trust at will.
However, even though the taxpayer could name himself trustee and
could also designate the beneficiary of the remainder interest as we wishes,
including his own estate, we do not believe that the Service can reach the
entire trust (absent showing that the entire amount held in the trust is
necessary for his health, maintenance, support, and education). We believe that
the right to select himself as trustee does not render the entire trust
available for collection because if he named himself trustee he would, as
trustee, be legally obligated to honor the terms of the trust, even though as a
practical matter he could raid the trust with impunity. 8 in addition, we
believe that the right to designate alternative payees, thereby divesting his
children of their interest also does not render the entire trust subject to collection.
While he can designate the remainder as he chooses, he cannot make the Money
available to himself to enjoy while he is alive. We see an analogy to life
insurance proceeds. In United States v. Bess, 357 U.S. 51 (1958), the Supreme
Court found that:
[The] right to change the beneficiary, even to designate his
estate to receive the proceeds, gives him no right to receive the proceeds
while he lives. Cf. Rowen v. Commissioner, 215 F.2d 641, 644. It would be
anomalous to view as 'property' subject to lien proceeds never within the
insured's reach to enjoy.
357 U.S. at 56. Here, there is no step which * * * could take to
obtain an unrestricted right to use the trust assets.
Thus, we have concluded that the federal tax lien attaches to * *
* right to receive payments necessary his he maintenance, support and
education, as determined by the trustee * * *.
If you have any questions contact the attorney assigned to this
matter at 202-622-3610 or 202-622-3620.
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1 The taxpayer was designated the first trustee under
the terms of the trust, but apparently never served as trustee. The current
trustee is the person designated as the second trustee under the trust.
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2 In your memorandum, you cited Ammco Ornamental Iron,
Inc. v. Wing, 26 Cal.App.4th 409, 31 Cal.Rptr.2d 564 (1994). As you noted, the
facts of Ammco are substantially similar to the facts here, including the fact
that the beneficiary was named, but did not serve as trustee and that he could
designate who would receive the remaining trust property, thereby divesting the
named holders of the remainder interest. However, we note that the theory of
case is different. In Ammco the issue was not whether the lifetime beneficiary
had any property interest in the trust, rather is [sic] was whether he was the
SOLE beneficiary of the trust, such that the court would ignore the legal
fiction of the trust and permit the beneficiary's creditor to reach the trust
assets.
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3 Of course, the beneficiary is still only entitled to
payment which will satisfy the terms of the trust. That is, he could not compel
distribution of the entire amount held in trust, unless the trust so permits
and the entire amount is necessary to meet his support needs.
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4 Like the trust here, the trust in Magavern gave discretion
to the trustee. It provided that the trustee “shall” pay whatever
part of the income or principal that he deems necessary for the comfortable
support, maintenance, and/or education of the beneficiaries. The court held
that the taxpayer-beneficiary had a property right subject to attachment
because, under New York law, a beneficiary could enforce his right to the trust
property against a trustee who declines to use the discretion afforded him
under the trust. Compare Pulizzotto v. United States, 90-2 U.S.T.C. paragraph
50,421 (D.N.J. 1990) (trust merely gives the trustee the power to distribute,
but does not command action.)
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5 Compare First of America Trust Company v. United
States, 93- 2 U.S.T.C. Paragraph 50,507 in which the court held that the trust
was discretionary with respect to the principal, where the trust provides that
the trustee “shall” pay the income and so much of the principal as
the trustee in his sole discretion deems necessary for the support, comfort and
welfare to the beneficiaries.
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6 The opinion does not provide the specific language
used in the provision on distribution from the principal; therefore we are not
certain how in [sic] differs from the language used with respect to income
distribution.
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7 Despite stating that the taxpayer has no interest in
the trust, your office did note that in addition to levying on distributions
which are actually made to the taxpayer, the Service can also levy on sums
which can be reasonably be determined to be necessary for the “proper
health, maintenance, support, and education” of the taxpayer.
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8 If * * * were trustee and violated the terms of the
trust the remaindermen would have a cause of action against him. However, he
could divested [sic] the remaindermen of their interest by naming his estate or
a straw man as the residual beneficiary and then raided the trust. Although
there would still be the legal obligation to abide by the terms of the trust,
there would be no one with standing to challenge him.