Ninth Circuit: Question Exists on Whether Lien Attached to Property Purchased With Ponzi Scheme Proceeds

(Parker Tax Publishing January 2019)

The Ninth Circuit certified to the Oregon Supreme Court the question of whether federal tax liens could attach to an individual's interest in real property that he purchased using funds he fraudulently obtained in a Ponzi scheme after determining that there was no controlling precedent under Oregon law. The Ninth Circuit found that the issue turned solely on whether, under Oregon law, a constructive trust arises at the moment property is purchased using fraudulently obtained funds or later, when a court imposes a constructive trust as a remedy. Wadsworth v. Talmage, 2018 PTC 451 (9th Cir. 2018).

Background

Ronald Talmage, an investment manager, began fraudulently diverting his clients' funds in the 1990s as part of a Ponzi scheme. John Wadsworth and other members of the RBT Victim Recovery Trust (the Trust) entrusted Talmage with over $55 million between 2002 and 2015.

In 1997, Talmage and his first wife purchased RiverCliff Property in Corbett, Oregon for almost $1 million using proceeds of Talmage's Ponzi scheme. From 1998 to 2008, Talmage spent over $12.5 million of entirely stolen funds to improve the property. After Talmage and his first wife divorced, Talmage paid $1.5 million using stolen money to purchase his ex-wife's half interest in RiverCliff. Talmage resided at RiverCliff throughout this time. Talmage failed to pay federal income taxes from 1998-2005 and in 2007. The IRS filed notices of tax liens in 2008, 2013, and 2014 and then brought an action in a federal district court to foreclose on its liens on RiverCliff. The Trust sought to intervene, but was denied.

The Trust then brought an action to quiet title in a federal district court, arguing that because Talmage used wholly stolen funds to obtain and improve RiverCliff, he did not hold an enforceable or legitimate property interest in the property. As a result, the Trust argued, the government's federal tax liens could not attach to RiverCliff under Code Sec. 6321. Code Sec. 6321 authorizes liens on all property and rights to property belonging to a person who owes back taxes. The Trust contended that it has either an exclusive or superior interest in RiverCliff under Oregon law as a resulting trust, as a constructive trust, or based on other equitable relief.

The government argued that Talmage had the property rights of any deed-holder in RiverCliff and that, even assuming Talmage should be treated as holding voidable title based on the Trust's constructive trust, Talmage had the right to transfer the property to a bona fide purchaser under Oregon law. The government argued that RiverCliff therefore belonged to Talmage within the meaning of Code Sec. 6321, and that a federal tax lien could attach. It argued that the Trust had, at most, a claim that did not become choate until after the federal tax liens had attached; thus, the government said, its tax liens were superior to any claims the Trust might have.

The district court held that the Trust failed to show that its beneficiaries currently owned the RiverCliff property in either constructive or resulting trust under Oregon law. The district court found that Talmage had acquired rights to the property because he acquired title and thereafter resided at RiverCliff, asserting substantial control over the property. The district court also held that even if a constructive trust existed or would exist in the future, the federal tax liens would still take priority because they had already attached to Talmage's interest in RiverCliff, while any claim to a trust had not. The Trust appealed to the Ninth Circuit.

Analysis

Code Sec. 6321 authorizes a lien on all property and rights to property belonging to a person who owes back taxes. Whether property belongs to someone within the meaning of Code Sec. 6321 depends on the individual's rights under state law. In determining an individual's rights under state law, the important consideration is the breadth of control the individual can exercise over the property.

Under Oregon law, a constructive trust arises where (1) an individual's property interest was obtained by someone else under wrongful or inequitable circumstances, (2) the person now in possession of the property is not a bona fide purchaser for value and without notice, and (3) by strong, clear and convincing evidence, the property on which the individual seeks to impose a constructive trust rightfully belongs to that person or is a product of that property.

The Trust argued that because Talmage used wholly stolen funds to obtain and improve RiverCliff, he did not hold an enforceable property interest and the IRS's tax liens therefore could not attach. The Trust contended that it had either an exclusive or superior interest in RiverCliff as a constructive trust because RiverCliff was the product of funds that rightfully belonged to Trust members but were taken by Talmage under wrongful circumstances.

The government moved to dismiss the Trust's quiet title claim for failure to state a claim on which relief could be granted and reiterated the arguments it made before the district court, claiming its liens were superior to any claims the Trust might have.

In the Ninth Circuit's view, the Trust plausibly argued that RiverCliff was the product of funds that rightfully belonged to Trust members and that RiverCliff was subject to a constructive trust under Oregon law, with the Trust members as beneficiaries. Thus, the Ninth Circuit concluded that the issue was what rights Oregon law gives to the beneficiary of a constructive trust in a case where the property is subject to a federal tax lien. The Ninth Circuit determined that the rights of Talmage as legal titleholder and of the government as a lienholder depended on when the constructive trust arose. Such a trust, the court explained, could arise either at the moment a purchase is made with fraudulently obtained funds or when a court imposes the trust as an equitable remedy. Finding no controlling precedent under Oregon law, the Ninth Circuit certified the question to the Oregon Supreme Court for an authoritative decision of the issue.

The Ninth Circuit noted that state law varies on this issue. Under the majority rule, a trust arises automatically at the moment of purchase, and the legal titleholder is a constructive trustee who holds no rights beyond bare legal title. Thus, for purposes of Code Sec. 6321, property held in a constructive trustee's name does not "belong" to the individual and a tax lien cannot attach under the majority rule. Under the minority rule, on the other hand, a constructive trust arises only once it is imposed as a judicial remedy. In that situation, the holder of legal title retains all rights of a property owner until such a remedy is imposed by a court. The Ninth Circuit explained that under the minority rule, the property "belongs" to the title holder for purposes of Code Sec. 6321 and tax liens can attach. If no court has imposed a trust when the tax liens attach, according to the Ninth Circuit, the beneficiaries of a potential constructive trust hold at most an inchoate claim to the property.

The Ninth Circuit therefore found that the Trust could prevail in its quiet title action only if, under Oregon law, a constructive trust arises at the moment of the purchase of a property with ill-gotten gains, such that the purchaser never acquires rights beyond bare legal title. The Ninth Circuit found that no Oregon statute addressed the issue and that decisions of the Oregon Supreme Court and intermediate appellate courts provided support for both the majority and minority rules. The Ninth Circuit found that in one decision, the Oregon Supreme Court wrote that it was "universally recognized" that a constructive trust arose when embezzled funds are used to purchase other property. However, in a later decision, the Court described a constructive trust as an equitable remedy available to divest an individual who has been unjustly enriched. Opinions by the Oregon Court of Appeals similarly lent support to both approaches, the Ninth Circuit found. In one case, the Oregon Court of Appeals described constructive trusts as remedial devices to avoid unjust enrichment but cited an earlier decision holding that a constructive trust may be imposed only when the putative trustee holds property which rightfully belongs to another and is thereby unjustly enriched.

For a discussion of tax liens, see Parker Tax ¶260,530.

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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