State Law Gives IRS Priority Over Inheritors' Interest in Wrongful Levy Case

(Parker Tax Publishing February 2022)

The Fifth Circuit held that the nature of a brother and sister's interest in property inherited from their mother, but levied by the IRS for their father's unpaid taxes, was that of unsecured creditors rather than owners under state law. The court therefore concluded that the IRS did not seize funds or property that the brother and sister legally owned at the time, so the levy was not wrongful under Code Sec. 7426(a). Goodrich v. U.S., 2022 PTC 21 (5th Cir. 2022).

Background

Louisiana residents Henry Goodrich, Sr. and his wife, Tonia Goodrich, owned community property during their marriage, including personal property, oil-and-gas rights, and shares of stock and stock options in Goodrich Petroleum Corporation (the "Goodrich securities"). Tonia died in 2006. Her succession, which was completed in 2015, left her interest in some of the community property, including the Goodrich securities, to her children, Walter G. ("Gil") Goodrich and Laura Goodrich Watts, subject to Henry Sr.'s usufruct. Under the Louisiana civil code, a usufruct is similar to a life estate in common law, and naked ownership (the type of interest Gil and Laura held) is analogous to a remainder interest.

During his life, Henry Sr. sold $857,914 worth of the Goodrich securities. One half of that amount - $428,957 - belonged to Henry Sr. given his community interest in the property, while the other half was attributable to the children's naked ownership subject to Henry Sr.'s usufruct. Henry Sr. died in 2014 having failed to pay $38,029 in assessed income tax for that year, in addition to $312,078 of taxes for 2013 and $214,806 of taxes for 2012. A month after Henry Sr. passed away, his executor, Gil, opened a succession checking account which handled all estate funds and expenses.

In April 2017, the IRS placed a levy on the succession checking account in order to collect Henry Sr.'s unpaid taxes. In May 2017, the bank remitted all of the remaining funds in the checking account - $239,927 - to the IRS. The IRS applied that amount to Henry Sr.'s 2012 tax liability which, with penalties and interest, totaled $238,922 as of the date Henry Sr. passed away. There remained a combined outstanding balance of $471,818 on Henry Sr.'s 2013 and 2014 tax liability.

The same month that the bank remitted the $239,927 payment to the IRS, Gil and Laura filed a lawsuit claiming that, under Code Sec. 7426(a)(1), the IRS had wrongfully levied those funds. Under Code Sec. 6321 and Code Sec. 6322, when an individual neglects or refuses to pay his or her taxes, a lien arises on "all property and rights to property" belonging to that person once the IRS assesses the tax liability. The IRS may then collect the unpaid taxes by placing an administrative levy on the property. Code Sec. 7426(a)(1), however, gives third parties (such as Gil and Laura) the right to challenge the IRS's levy when they have an "interest" in the property.

In Oxford Capital Corp. v. U.S., 211 F.3d 280 (5th Cir. 2000), the Fifth Circuit held that, to establish a wrongful levy claim, the third party must show (1) that the IRS filed a levy with respect to a taxpayer's liability against property held by the third party, (2) the third party had an interest in that property superior to that of the IRS, and (3) the levy was wrongful. The last element requires proof of some interest in the property in order to establish standing.

Gil and Laura alleged that the IRS had taken money that in actuality belonged to them as owners of nearly half-a-million dollars' worth of liquidated Goodrich securities. The parties filed cross motions for summary judgment. As part of their motion, Gil and Laura attached a final accounting of Henry Sr.'s succession, which indicated that all of the cash remaining in the succession was needed to satisfy the children's property claims against it. A magistrate judge ordered the IRS to return $86,774, which represented the children's share of proceeds from the sale of personal property and oil-and-gas revenues that had been deposited into the succession checking account. The magistrate judge, however, held that Gil and Laura were not entitled to any funds attributable to their portion of the liquidated Goodrich securities because they were "unsecured creditors" of Henry Sr.'s succession under Louisiana law and the IRS's levy therefore took priority.

The children appealed to the Fifth Circuit. In Goodrich v. U.S., 2021 PTC 208 (5th Cir. 2021), the Fifth Circuit determined that no Louisiana court had decided that precise issue of the nature of Gil's and Laura's interest. The Fifth Circuit therefore certified to the Louisiana Supreme Court the question of whether Gil and Laura were owners or unsecured creditors of the levied funds. The Louisiana Supreme Court denied the Fifth's Circuit request for certification, but referenced in its opinion Article 538 of the Louisiana Civil Code and two Louisiana appellate court decisions, one of which is Succession of Catching, 35 So. 3d 449 (La. App. 2d Cir. 2010).

Article 538 of the Louisiana Civil Code provides that if things subject to a usufruct are "consumables," i.e., things (such as money) that cannot be used without being expended, the usufructuary becomes the owner of them and may consume, alienate, or encumber them as he or she sees fit. At the termination of the usufruct, Article 538 provides that the usufructuary is bound either to pay to the naked owner the value that the things had at commencement of the usufruct or to deliver to the naked owner things of the same quantity and quality. The Succession of Catching case involved an inheritor, Phillip Catching, who became the naked owner of $476,758 worth of consumables when his mother died, subject to his father's usufruct. Before the father died, he made a $100,000 bequest to a church that later sought the legacy gift from his succession. When the father died, however, his total assets were only worth $330,307. A Louisiana court denied the church's claim for the legacy gift because under Article 538, the consumables held by the usufructuary (the father) became a debt owed by the succession to the naked owner (Phillip) at the termination of the usufruct and the succession was worth less than the debt owed.

Analysis

The Fifth Circuit affirmed the magistrate judge's judgment after finding that the IRS's claim took priority over that of Gil and Laura under Article 538 of the Louisiana Civil Code and the ruling in Succession of Catching. The court found that Gil and Laura had a claim against Henry Sr.'s estate in connection with the Goodrich securities, but they did not immediately become owners of the disputed funds at the time of his death. Rather, the court determined that under Louisiana law they became unsecured creditors of the succession with respect to their claim. Consequently, the court held that the IRS did not seize funds or property that the children legally owned at the time, so the levy was not wrongful. The court concluded that, because Gil and Laura were considered creditors rather than owners of the disputed funds, the IRS prevailed because under Code Sec. 6323, the IRS can establish priority of its lien over third parties by filing a notice of federal tax lien.

For a discussion of wrongful levy actions, see Parker Tax ¶260,540.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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