Federal Tax Liens and Entirety Property

The Supreme Court of the United States, in the case of United States v. Kraft, 122 S.Ct. 1414(2002) rejected the “state law fiction that a tenant by the entirety has no separate interest in entireties property,” and held that a federal tax lien against one spouse attaches to that spouse’s interest in the entirety property. In reaching its decision, the court relied on 26 U.S.C., Sec. 6321, which imposes a federal tax lien on “all property and rights to property, whether real or personal, belonging to” the taxpayer. The Supreme Court looked to state law to determine that each tenant of a tenancy by the entirety has certain rights in entirety property and then to federal law to determine that those rights qualified as “property” or “rights to property” to which a federal tax lien would attach.

Case Review

A federal tax lien was recorded against Don Kraft. At the time, he and his wife had owned a piece of real property in Michigan as tenants by the entirety. After the notice of the lien was recorded, they executed a quitclaim deed purporting to transfer the property to the wife for $1.00. When she attempted to sell the property a few years later, a title search revealed the lien. The IRS agreed to release the lien and allow the sale, with the stipulation that one-half of the net proceeds be held in escrow pending determinations of the government’s interest in the property.

The wife brought a quiet title action to the escrowed proceeds. The government claimed that its lien had attached to the husband’s interest in the tenancy by the entirety. It further asserted that the transfer of the property to the wife was invalid as a fraud on creditors. The District Court granted the government’s motion for summary judgment, holding that the federal tax lien attached at the moment of the transfer to the wife, which terminated the tenancy by the entirety and entitled the government to one-half of the value of the property. On appeal, the Sixth Circuit held that the tax lien did not attach to the property because under Michigan law, the husband had no separate interest in the property held as a tenancy by the entirety. They remanded to the District Court to consider the government’s alternative claim that the conveyance should be set aside as fraudulent.

On remand, the District Court concluded that where state law makes property exempt from the claims of creditors, no fraudulent conveyance can occur. It found, however, that the husband’s use of the non-exempt funds to pay the mortgage on the entirety’s property, which placed them beyond the reach of the creditors, constituted a fraudulent act under Michigan law, and the court awarded the IRS a share of the proceeds of the sale of the property equal to that amount. Again on appeal, the Sixth Circuit held that its prior opinion on the issue where the lien attached to the husband’s entirety’s property was the law of the case. It also affirmed the District Court’s determination that the husband’s mortgage payments were fraudulent. On certiorari, the Supreme Court of the United States reversed the opinion of the Sixth Circuit, holding that the broad statutory language authorizing the tax lien reveals that Congress meant to reach every property interest that a taxpayer might have. It held that the husband’s interest in the entirety’s property constituted “property” or “rights to property” to which the federal tax lien attached.

The case does not purport to affect exemptions from state-created liens and judgments rendered in state courts. The case was remanded to the Sixth Circuit Court of Appeals to determine the proper valuation of the taxpayer’s interest in the entirety property that was the subject of the action.

Note that this case will affect any federal tax liens that are enforced in the same manner as federal tax liens. These include federal criminal fines/restitution liens and CERCLA liens among others.

Provided as an educational service by John Raymond Dunham, III, Esq..

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