June 7, 2016

IRS Tax Lien Did Not Attach to Trust Property

Houston Tax Attorney Blog

Houston Tax Attorney

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In Duckett v. Enomoto, Dkt No. 2:14-cv-01771, the U.S. District Court in Arizona concluded that a Federal tax lien for taxes owed by a trust beneficiary did not attach to the entire trust. This issue often comes up in IRS collection cases where the taxpayer is the beneficiary of a trust.

The facts and procedural history are as follows:

    • Dr. Enomoto was the beneficiary of a trust established by his mother in her will.
    • The trust says that Dr. Enomoto is to be paid as follows:

The Trustee shall pay to [Dr. Enomoto] so much or all of the net income and principal of the trust as in the sole discretion of the Trustee may be required for support in the beneficiary’s accustomed manner of living, for medical, dental, hospital, and nursing expenses, or for reasonable expenses of education, including study at college and graduate levels. . . . In the Trustee’s sole discretion and to the extent the Trustee deems advisable, the Trustee may consider or disregard the funds available to the beneficiary from other sources or the duty of anyone to support the beneficiary.

  • The IRS served a Notice of Levy on the trustee demanding that she turn over any of Dr. Enomoto’s “property and rights to property” in her possession pursuant to a federal tax lien.
  • Litigation ensued.
  • Dr. Enomoto and the government asked the court to decide whether the Federal tax lien attach attaches to his rights to the trust fund.

The court concluded that: (1) Dr. Enomoto has a conditional right in the trust funds. He can compel payment only when the trustee’s withholding of funds would be an abuse of discretion in applying the standard of payment set forth in the trust for Dr. Enomoto’s support. (2) The federal tax lien attaches to this right. (3) The tax lien is not presently enforceable because Dr. Enomoto’s right in the trust funds “has no permanently fixed dollar value” and “is variable according to [his] needs.”

Dr. Enomoto’s rights to the trust fund consisted of variable distributions. These rights are different than the immediate right to all of the trust property. Because the court did not specify what amount of the trust was subject to the Federal tax lien, the government asked the court to order that all of the trust was subject to the tax lien.

The court refused to subject the trust to the Federal tax lien. Instead, given the language in the trust, the court noted that the government could assign “a reasonably accurate dollar value by assessing [his] current needs and living demands.” However, the government did not present any evidence of Dr. Enomoto’s current needs and living demands. Thus, the court had no basis to conclude that all of the trust was subject to the Federal tax lien in this case.

The court’s conclusion may have been different if the government had presented this evidence.

This issue often comes up in IRS collections cases, namely, can the IRS include variable income from a trust or trust assets before they are distributed in determining whether there is “reasonable collection potential.” This can impact whether the IRS will accept an installment agreement or offer-in-compromise for the trust beneficiary.

If the trust is included, does the IRS have to use the more liberal ascertainable standards for trustees and fiduciaries or is the IRS to use the more restrictive bankruptcy and IRS collections standards in determining what amount is necessary under the terms of the trust? If the IRS has to use the more liberal standards, how does it establish the amount?

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