Federal Tax Liens and Tenancy by the Entirety
There are several forms of joint ownership of property, some of which provide that upon the death of one owner, the property automatically passes to the joint owner(s) (i.e., by right of survivorship). These types of joint ownership may thus function as substitute for a will or trust and serve as a method of avoiding probate. One such form, “tenancy by the entirety,” is defined as concurrent ownership of property that can only exist between married couples, and ceases to exist on the death of one spouse or upon divorce. Approximately half of the states recognize this form of ownership.
Legal Effects of Tenancy by the Entirety
The legal effect of holding title to property as tenants by the entirety is similar to joint ownership with right of survivorship, but tenancy by the entirety property cannot be converted to a tenancy in common (where each has an undivided interest in the property) absent a divorce or mutual agreement of the spouses. Neither spouse, acting alone, can sell or transfer an interest in the property, or mortgage or force a sale or partition of the property.
When a husband and wife own property as tenants by the entirety, each has individual rights with respect to the property, e.g., the right to use, exclude others from using, and sell (with consent of the other spouse) such property; sale proceeds must be shared equally. Upon the death of one spouse, the survivor owns the entire property. Historically, the laws of many states, and court decisions, have prohibited a creditor with a claim against only one spouse from creating a lien or foreclosing on property held by the entirety. Even the IRS had acquiesced on this point. This changed in 2002 with the U.S. Supreme Court’s decision in U.S. v. Craft.
The U.S. v. Craft Decision and its Effect on Tenancy by the Entireties
Don and Sandra Craft owned a piece of real property under Michigan law as tenants by the entirety. The IRS assessed close to half a million dollars in unpaid federal income taxes against Don in 1988 and attached a lien to “all rights to property, whether real or personal, belonging to” him. After getting notice of the lien, Don quitclaimed his interest in the property to Sandra, for one dollar. When Sandra tried to sell the property a few years later, the lien was revealed. Sandra and the IRS agreed to let the sale go through, provided the sale proceeds were put into escrow.
Sandra sued to establish her right to the money in escrow. Eventually the matter made its way to the U.S. Supreme Court. In 2002, the Court handed down a landmark decision in which it held, among other things, that the IRS was authorized to impose the lien on Don’s interest in the “entireties property.” The Court declared itself bound by neither the earlier cases, nor Michigan law, which stated that a creditor of one spouse cannot create a lien against property held as tenants by the entirety.
The Court likened property ownership to a bundle of sticks, each stick representing a different right in the property. U.S. tax law authorizes attaching a lien to property in which the debtor has interests that constitute “property” or the “right to property.” The Court held that the rights of each spouse to use, exclude others from, and share in the proceeds from the sale of entireties property constitute sufficient rights to property to allow imposition of a tax lien on the debtor/spouse’s interest in the property.
The Court did not decide whether the IRS could foreclose on such a lien, as Don and Sandra’s property had already been sold. As neither spouse has the right to force a sale of entireties property without the other’s consent, the question remained whether the IRS, stepping into the shoes of Don as a creditor, could force a sale. The Court also did not decide how much Don’s right to the property was worth; whether half the proceeds of sale, or a lesser or greater amount.
IRS Policies in Light of the Craft Decision
The IRS issued a Bulletin in September 2003, setting forth general principles it will rely on in addressing issues raised as a result of the Craft decision:
Federal tax liens have always been applicable to property and rights to property of a taxpayer, including any rights held in property as tenants by the entireties. Craft does not represent new law and will not affect federal liens and tax collection. Craft did not, however, provide authority for the IRS to rescind already accepted offers in compromise or terminate installment agreements under settlements.
As administrative policy, the IRS will, under certain circumstances, agree not to apply Craft with respect to certain interests created before the decision that would be to the detriment of third parties who may have reasonably relied on the belief that state law prevents the attachment of federal liens in cases involving entireties property.
Administrative sale of entireties property has practical problems that limit the usefulness of seizure and sale. Levying on cash and cash equivalents held as entireties property is less “problematic” and will be used in “appropriate cases.”
Because of potential consequences to the non-debtor spouse, lien foreclosure for entireties property subject to tax liens will be determined on a case-by-case basis.
As a general rule the taxpayer’s interest in entireties property will be deemed to be one-half.
Where a sale or other transfer of the entireties property, (whether to the spouse or a third party,) does not provide for payment of the lien, the lien will encumber a one-half interest in the property held by the transferor.
This Bulletin also makes clear that such tax liens on entireties property may also:
- Have priority over later created security interests, and mechanics’ and judgment liens.
- Not be applied to transfers in a divorce prior to the Craft decision, but otherwise a spouse who acquires entireties property in a divorce takes the property subject to the federal tax lien.
- Still apply to donated property, although the IRS may refrain from asserting the lien depending on the equities of the case and the surrounding circumstances.
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