Fifth Circuit Asks State Court to Decide Property Interest in Wrongful Levy Case

(Parker Tax Publishing July 2021)

The Fifth Circuit determined that the nature of a brother and sister's interest in property inherited from their mother, but seized by the IRS for their father's unpaid taxes, had to be ascertained under state law in order to establish whether they had standing to bring a wrongful levy claim under Code Sec. 7426. After determining that the Louisiana Supreme Court had not decided the nature of such an interest under Louisiana law, the Fifth Circuit certified to that court the question of whether the children were owners or merely unsecured creditors of the disputed funds. Goodrich v. U.S., 2021 PTC 208 (5th Cir. 2021).

Background

Louisiana residents Henry Goodrich, Sr. and 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 for 2013 and $214,806 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 within the checking account - $239,927 - to the IRS. The IRS applied that amount to Henry Sr.'s 2012 tax liability, which also included penalties and interest and 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. They alleged that the IRS had taken money that in actuality belonged to Gil and Laura 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.

Without considering whether he had subject-matter jurisdiction to entertain the children's claim, 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. Relying on a Louisiana appellate court decision and the Louisiana Civil Law Treatise, the judge reasoned that the IRS's claim to that money took priority over that of the children since they were "unsecured creditors" of Henry Sr.'s succession. The children appealed to the Fifth Circuit, contending that they were owed the remaining amount levied from the succession checking account, i.e., $153,153, since it reflected (at least some of) their share of the liquidated Goodrich securities.

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 through 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.

Analysis

The Fifth Circuit noted that it has yet to clarify whether the standing requirement of Code Sec. 7426(a)(1) is jurisdictional or what satisfies this standard. The court observed that in their appellate brief, Gil and Laura assumed (like the magistrate judge) that the standing requirement is a merits issue. In the court's view, the issue was whether the children had an interest in the levied funds sufficient for a court to conclude that their claim fell within the scope of Code Sec. 7426(a)(1), and since that inquiry required interpretation of a statute, it would seem to go to the merits of the claims. However, the court also noted that Code Sec. 7426(a)(1) operates as a waiver of the government's sovereign immunity, which the Fifth Circuit held in Oxford to be jurisdictional. Thus, if Gil and Laura lacked standing for their wrongful levy claim, then sovereign immunity applied, and the magistrate judge lacked subject matter jurisdiction over their claim.

With respect to what qualifies as an interest in property for the purposes of Code Sec. 7426(a)(1), the Fifth Circuit noted that in Frierdich v. U.S., 985 F.2d 379 (7th Cir. 1993), the Seventh Circuit held that the right of a third party to challenge a wrongful levy is confined to persons who have a fee simple or equivalent interest, a possessory interest, or a security interest in the property. The Seventh Circuit explained that its standard was grounded in a contextual reading of Code Sec. 7426(a)(1) and added that, based on this interpretation, unsecured creditors cannot sue for wrongful levy. The Fifth Circuit adopted the Seventh Circuit's definition of "interest" as used in Code Sec. 7426(a)(1).

In the view of the Fifth Circuit, the dispositive question in this case was whether Gil and Laura had demonstrated the requisite interest in the disputed funds, and state law controlled in determining the nature of their legal interest in the property. However, the court found that no Louisiana court had decided the precise issue of whether the naked owner of money occupies the status of owner or creditor. If Gil and Laura occupy the status of creditors rather than owners, the court observed, then the government would prevail. The court noted that under the rules of the Louisiana Supreme Court, a circuit court may certify questions of state law to that court when there are no clear controlling precedents in its decisions. The Fifth Circuit determined that certification was appropriate in this case and thus certified to the Louisiana Supreme Court the questions of whether: (1) a usufructuary's testamentary usufruct of consumables renders naked owners unsecured creditors of the usufructuary's succession, and (2) if not, what is the naked owner's relationship to those consumables.

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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