Armstrong v. U.S.

• Decision Date: 26 May 1998
• Docket Number: No. Civ.A. 96-00100-H.,Civ.A. 96-00100-H.
• Citation: 7 F.Supp.2d 758
• Parties: Frank ARMSTRONG, III, et al., Plaintiffs, v. UNITED STATES of America, Jefferson National Bank, Defendants. UNITED STATES of America, Defendant and Third-Party Plaintiff, v. Frank ARMSTRONG, Jr. Trust for the Benefit of Frank Armstrong, Jr., et al, Third-Party Defendants.
• Court: U.S. District Court — Western District of Virginia

Page 758

7 F.Supp.2d 758

Frank ARMSTRONG, III, et al., Plaintiffs, v. UNITED STATES of America, Jefferson National Bank, Defendants.

UNITED STATES of America, Defendant and Third-Party Plaintiff, v. Frank ARMSTRONG, Jr. Trust for the Benefit of Frank Armstrong, Jr., et al, Third-Party Defendants.

No. Civ.A. 96-00100-H.

United States District Court, W.D. Virginia, Harrisonburg Division.

May 26, 1998.

Charles S. McCandlish, Harrison & Johnston, Winchester, VA, for Plaintiffs.

Charles S. McCandlish, Harrison & Johnston, Winchester, VA, Aubrey J. Owen, Owen & Truban, Winchester, VA, for Frank Armstrong, III, Trustee of the Frank Armstrong, Jr. Trust for the benefit of Frank Armstrong, Jr., Estate of Frank Armstrong, Jr., Frank Armstrong, III, Executor of Estate of Frank Armstrong, Jr.

Julie C. Dudley, U.S. Atty's Office, Roanoke, VA, Angelo Frattarelli, Washington, DC, U.S. Dept. of Justice, for U.S.

MEMORANDUM OPINION

MICHAEL, Senior District Judge.

I. Background

This case comes before the court following a labyrinthine chain of events. In many ways, the case illuminates the arcane and convoluted nature of the Internal Revenue Code, forcing a recognition of the challenging — and somber — task of integrating and reconciling a multitude of the provisions of that and other statutes. The tortuous activities of the taxpayer groups further confounds analysis. In December 1991 and January 1992, Frank Armstrong, Jr. ("Decedent") made gifts of National Fruit Products, Co., Inc. (NFP) stock to certain family members, others, and various trusts ("Plaintiff Donees"),¹ for which stock he estimated the value as $100 per share on his tax returns. On January 3, 1992, the Plaintiff Donees agreed, in exchange for the gifts, to waive any claim for reimbursement for any gift taxes, penalties, or interest required to be advanced by them. On January 6, 1992, Decedent established The Frank Armstrong, Jr. Trust for the benefit of Frank Armstrong, Jr. ("Trust").

The Trust had the primary purpose of paying federal gift taxes (and professional fees) based on the 1991-92 gifts of stock and the secondary purpose of paying Decedent's federal income tax (and professional fees) arising from the redemption of NFP stock. The Trust was funded, for the most part, with a non-negotiable promissory note ("Contract"²) from NFP in favor of decedent for approximately six million dollars. Decedent transferred his interest in the Contract to the Trust on January 6, 1992. The Contract provided that NFP would pay certain tax liabilities for 1991 and 1992 gifts and stock redemptions before certain dates or events and on demand of the holder, in an amount determined by a certified public account. The Contract further provided that once such payments were made, "any remaining principal balance of this note shall be paid to the noteholder on demand." The Trust instrument directed that the Trustee "shall demand and receive" the amounts necessary for the 1991 and 1992 redemptions and gifts. Moreover, the Trust directed the Trustee to demand and receive from NFP on the Contract, and pay to the Internal Revenue Service, amounts reasonably approximated as necessary for tax liability arising from the 1991 and 1992 stock gifts and redemptions The interplay of the Contract and the Trust instrument, as it is affected by the tax assessments and payments made between 1992 and 1995, is central to the dispute before the court.

Prior to his death, Decedent faithfully calculated and paid his gift and income tax liabilities. On April 15, 1992, Decedent determined his federal income tax for the preceding year, which tax liability he paid in part and the Trust paid in part, according to the Trust instrument.³ Also on April 15, 1992, Decedent filed his 1991 gift tax return and remitted payment with that return. On January 8, 1993, Decedent filed a 1992 federal gift tax return and remitted full payment. On November 17, 1995, additional federal gift tax liabilities were assessed for tax years 1991 and 1992, which liability was paid on that same date.⁴

Decedent passed away on July 29, 1993 and the IRS has since experienced greater difficulty in collecting for the tax liability of the Trust. On October 14, 1994, the Trustee filed a fiduciary income tax return for the Trust for 1993. The Trustee did not remit payment with the form. On April 15, 1995, the Trustee filed a fiduciary income tax return for the Trust for 1994. Again, the Trustee did not remit payment with the form. In response to the non-payment of the tax liability, the IRS issued, on June 12, 1995, a Notice of Intent to Levy to recover for the fiduciary income tax liability for the Trust for 1993.

At approximately the same time, the parties were engaged in ongoing negotiations regarding a reassessment of gift taxes for 1991 and 1992. Despite the negotiations and the Notice of Intent to Levy, Plaintiff Donees and the taxpayer (the Trust) entered, on June 14, 1995, into a Security Agreement and Pledge Agreement ("Security Arrangement") with Jefferson National Bank as escrow agent. On November 13 and 14, 1995, Plaintiff Donees recorded financial statements related to the Security Arrangement with the appropriate clerk of court and with the Virginia State Corporation Commission. The Security Agreement purports to secure payment of all sums required to be paid by the Trust (1991 and 1992 gift taxes and related costs for interest, penalties, carrying charges, professional fees, and escrow fees) with the assets of the Trust, including the Contract as the collateral. In consideration for the commitment of the Trust, the Plaintiff Donees gave the Trustee one dollar and a promise to forbear from bringing an action for declaratory judgment to determine the parties' rights under the trust and/or an action for specific performance of the Trust's commitment to pay the 1991 and 1992 gift taxes.⁵

The IRS followed the Contract to the escrow agent in an attempt to satisfy the tax liability of the Trust. After issuing the May 31, 1996 Notice of Intent to Levy for the 1993 and 1994 fiduciary taxes due, the IRS filed in state court, on June 6, 1996, a Notice of Federal Tax Lien. On July 8, 1996, the United States delivered a Final Demand to the escrow agent who then delivered the Contract and the Document of Transfer and Assignment to the IRS on July 12, 1996. On July 17, 1996, the IRS demanded payment from NFP on the Contract of either the unpaid balance of the Contract or the amount of taxes due. NFP refused to pay on the Contract.

On July 23, 1996, in response to the IRS's demand for payment, the plaintiffs⁶ filed suit under 26 U.S.C. § 7426, claiming wrongful levy. On October 4, 1996, the United States filed a Third-Party Complaint against Frank Armstrong, Jr. Trust for the Benefit of Frank Armstrong, Jr. and NFP, seeking a right, as a third-party beneficiary of the Contract, to foreclose on the Contract as payment of Frank Armstrong, Jr.'s remaining unpaid 1991 federal income tax liability. On August 15, 1997, plaintiffs and third-party defendants moved for summary judgment, as did the United States. Plaintiffs and third-party defendants claim that, as a matter of law, either the Plaintiff Donees, the Estate, or the Trust have a lien on the Contract superior to that of the IRS. Alternately, they claim that certain of these parties actually have ownership of the Contract which prevents the imposition of a levy by the United States. The United States seeks summary judgment in its favor as to its right to foreclose on the Contract to recover payment for the 1993 and 1994 fiduciary income tax liability and as to its right to demand payment on the Contract, as the third-party beneficiary, for unpaid portion of Frank Armstrong, Jr.'s federal income tax liability for 1991. The United States asserts that either the lien of the United States is superior to that of the plaintiffs as a matter of law or that plaintiffs lack standing to bring a wrongful levy suit at all. The United States further asserts that it is a third-party beneficiary to the Contract, who may enforce the Trustee's obligation to demand payment from NFP and to pay Frank Armstrong, Jr.'s additional federal income tax liability for 1991, as subsequently assessed by the I.R.S.⁷

On September 8, 1997, United States Magistrate Judge B. Waugh Crigler heard oral arguments in support of the parties' cross motions for summary judgment. The magistrate judge issued, on March 16, 1998, a report and recommendation for this court's consideration. In the report and recommendation, Magistrate Judge Crigler recommends that this court find that the government could not levy on the Contract because conditions precedent to a demand on the remainder of the Contract had not been met. Thus, the magistrate recommended that this court find that the Contract was not property upon which a lien would be created under 26 U.S.C. § 6321 because the property interest was too inchoate. Because the Magistrate Judge recommended the court find that the Contract was not property under section 6321, he further recommended that the court not reach the other issues raised by the parties, but rather simply quash the levy of the United States upon the Contract.

All parties have objected to the report and recommendation. The plaintiffs and third-party defendants argue that the magistrate judge erred in not determining that either the plaintiff Donees, the Trust, or the Estate had a superior lien on the Contract. The United States objects that the magistrate judge's finding that the conditions precedent to a demand on the Contract had not been met was an erroneous finding. Rather, the United States asserts, all (or most) of the tax liabilities provided for in the Contract have been paid. Therefore, the United States argues, the current holder (the United States) may demand payment of the remaining principal. The United States further objects that the one liability not satisfied but provided for in the...