In re Krause

• Decision Date: 01 April 2011
• Docket Number: No. 10–3012.,10–3012.
• Citation: 637 F.3d 1160
• Parties: In re Gary E. KRAUSE, Debtor.United States of America, Plaintiff–Appellee,v.Gary E. Krause; Richard L. Krause, Defendants,andLinda S. Parks, Intervenor–Appellee,v.Drake Krause; Rick Krause, Intervenors–Appellants.
• Court: U.S. Court of Appeals — Tenth Circuit

637 F.3d 1160

107 A.F.T.R.2d 2011-1606

2011-1 USTC P 50,314

In re Gary E. KRAUSE, Debtor.United States of America, Plaintiff–Appellee,

v.Gary E. Krause; Richard L. Krause, Defendants,andLinda S. Parks, Intervenor–Appellee,

v.Drake Krause; Rick Krause, Intervenors–Appellants.

No. 10–3012.

United States Court of Appeals, Tenth Circuit.

April 1, 2011.

John Val Wachtel, Klenda, Mitchell, Austerman & Zuercher, L.L.C., Wichita, KS, for Intervenors–Appellants.Melissa Briggs, Attorney, Tax Division, Department of Justice, Washington, D.C. (John A. DiCicco, Acting Assistant Attorney General, and Bruce R. Ellisen, Attorney, Tax Division, Department of Justice, Washington, D.C., and Lanny D. Welch, United States Attorney, with her on the brief), for Plaintiff–Appellee United States of America.F. James Robinson, Jr. and Gaye B. Tibbets, Hite, Fanning & Honeyman, LLP, Wichita, KS, on the brief for Intervenor–Appellee Linda S. Parks.Before KELLY, Circuit Judge, BRORBY, Senior Circuit Judge, and GORSUCH, Circuit Judge.GORSUCH, Circuit Judge.

Can a taxpayer avoid the IRS by moving money to a “diet cookie” company and then destroying records that might show the company to be a sham? Or by transferring assets to his “children's trusts” only to use the trusts to pay for his country club membership, buy cars, and fund his lifestyle? The answer, of course, is no. Why this is so takes a bit more explanation.

I

Gary Krause's feud with the IRS traces back decades. Beginning in the 1970s, Mr. Krause developed public housing projects and promoted tax-shelter partnerships. It didn't take long, however, before the IRS challenged his attempts to deduct a variety of claimed losses. As happens in these things, litigation soon broke out and proceeded to consume the better part of a decade. At the end of it all, the two sides reached a settlement in which Mr. Krause agreed that he owed taxes for 1975, 1978, 1979, 1980, 1981, 1982, 1983, and 1986, and the IRS calculated his liability at $3.5 million.

But as it turned out the settlement settled nothing. In 2005, Mr. Krause declared bankruptcy under Chapter 7, claiming that he had no meaningful assets and seeking a discharge of his federal tax liabilities. The IRS responded by initiating an adversarial proceeding in bankruptcy court. The agency sought a declaration that Mr. Krause's tax debts were not dischargeable in bankruptcy, that Mr. Krause had fraudulently conveyed various of his assets to other entities, and that the IRS's pre-existing tax lien should attach to the assets held by those entities. Yet more litigation over these questions followed, but when the dust finally settled the bankruptcy court had decided two things.

First, the bankruptcy court held that two companies—Drake Enterprises and PHR, LLC—were the nominees or alter egos of Mr. Krause and that the IRS's tax lien attached to their assets. What these companies actually did and whether they enjoyed any existence independent of Mr. Krause was never quite clear. Drake Enterprises claimed to market a so-called “diet cookie.” PHR appeared to do no more than hold title to the family residence. What was clear, however, was this. During discovery Mr. Krause intentionally erased computer hard drives containing the records of both companies. And in the process he violated court orders compelling production of the materials. For this misconduct and after an exhaustive three-day evidentiary hearing, the court entered a sanctions order declaring that it would treat PHR and Drake Enterprises as the “nominees or the alter ego[s] of Krause and ... thus [the] property of [Mr. Krause's bankruptcy] estate and subject to turnover” to the IRS. Aplt's App. vol. 1, at 176.

Second, the bankruptcy court held that Mr. Krause had fraudulently conveyed certain assets to trusts nominally created for the benefit of his now-adult children, Drake and Rick Krause. Given this, the bankruptcy court held, the IRS tax lien attached to those assets as well. Unlike its holding with respect to Drake Enterprises and PHR, however, the bankruptcy court reached its conclusions about the trust assets on the merits and after a nine-day trial at which the court allowed Drake and Rick to intervene and participate along with their father.

After the bankruptcy court issued its final judgment, Drake and Rick, along with their father, appealed to the district court. The district court, however, affirmed the bankruptcy court's judgment, and it is this decision that Drake and Rick, now proceeding without their father, ask us to reconsider and reverse.

II

Turning to second things first, we begin with the bankruptcy court's judgment that assets Mr. Krause transferred to the children's trusts are subject to the IRS's lien under 26 U.S.C. § 6321. The scope of our review here is governed by that familiar formulation: we assess legal questions de novo but will reverse the bankruptcy court's factual findings only if they are proven to be clearly erroneous. See In re Paul, 534 F.3d 1303, 1310 (10th Cir.2008) (noting that although matters like this one reach us only “after an affirmance by the district court, we directly review the bankruptcy court's” decision). Because the facts found by the bankruptcy court in this case aren't meaningfully disputed, we proceed directly to our own analysis of the law's application to those facts.

On that score, § 6321 allows the IRS to satisfy a tax deficiency by attaching a lien on any “property” or “rights to property” belonging to the taxpayer.¹ To determine whether a particular asset falls within the reach of a § 6321 lien, we and any court must engage in a two-part inquiry. First, we must ask what rights under state law, if any, the taxpayer has in the asset the IRS seeks to attach. This step is necessary at the outset because it is, after all, “state law [that] creates legal interests and rights” in things. Drye v. United States, 528 U.S. 49, 58, 120 S.Ct. 474, 145 L.Ed.2d 466 (1999) (internal quotation omitted). Second, now with a sense of what state legal entitlement the taxpayer enjoys in the asset at issue—with a sense of the bundle of rights state law gives him to the thing or res at issue—we must ask, under federal law, whether those “state-delineated rights qualify as ‘property’ or ‘rights to property’ within the compass of the federal tax lien legislation.” Id. As the Supreme Court has explained the relationship between these two steps, it is “[s]tate law [that] creates legal interests and rights [and it is] [t]he federal revenue acts [that] designate what interests or rights, so created, shall be taxed.” Id. (quoting Morgan v. Commissioner, 309 U.S. 78, 80, 60 S.Ct. 424, 84 L.Ed. 585 (1940)).²

A

In Kansas, as in most states, a debtor cannot evade his creditors by fraudulently conveying his property to someone else. Such conveyances are, as a matter of state law, “deemed utterly void and of no effect.” See K.S.A. § 33–102.³ Put differently, the transferor retains equitable ownership of the assets and those assets remain subject to attachment by his creditors. See Gorham State Bank v. Sellens, 244 Kan. 688, 772 P.2d 793, 796 (1989) (“[A] debtor's property shall be liable for his debts, and he cannot avoid liability by a fraudulent transfer.”) (internal quotation omitted). To determine whether a conveyance is fraudulent and so void as a matter of state law, Kansas law directs us to look for “six badges or indicia of fraud”: “(1) a relationship between the grantor and grantee; (2) the grantee's knowledge of litigation against the grantor; (3) insolvency of the grantor; (4) a belief on the grantee's part that the contract was the grantor's last asset subject to a Kansas execution; (5) inadequacy of consideration; and (6) consummation of the transaction contrary to normal business procedures.” Koch Eng'g Co. v. Faulconer, 239 Kan. 101, 716 P.2d 180, 184 (1986) (internal quotation omitted).

Mr. Krause wears these badges boldly. In setting up the “children's trusts,” he transferred money first to his wife who, in turn, transferred them to the trusts, all for no consideration. Mr. Krause also transferred various insurance policies to the trusts, again for no consideration. Each of these transfers took place after Mr. Krause knew the IRS was conducting an audit of his taxes and after the IRS issued a notice disallowing certain of his claimed losses. And while Mr. Krause's brother, Richard, served as trustee for the children's trusts, both he and Mrs. Krause have admitted that Mr. Krause controlled the assets in question at all times. Indeed, Mr. Krause maintained no personal bank account after 2000 but instead used the children's trusts to pay for his country-club memberships, car loans, and other personal expenses. And Mr. Krause did all this without objection from Richard, who candidly described his philosophy toward the trusts as “stick your head in the sand and then you don't know what is going on.” Aplt's App. vol. 1, at 300. In light of these remarkable and undisputed facts, badges of fraud all, it is plain that Mr. Krause remained the owner of the transferred assets; that the children's trusts held those assets simply as his nominees; and that those assets are subject to attachment by Mr. Krause's creditors under Kansas law. See also William D. Elliott, Federal Tax Collections, Liens and Levies ¶ 9.10[1] (2d ed. 2000) (“The subject of nominee liens refers to situations when taxpayer's property or rights to property is held in the name of another or transferred to another party.”).

When the facts are bad, they say, argue the law. And with the facts so badly against them, that's exactly what Rick and Drake do here. According to the brothers, our analysis and the bankruptcy court's necessarily rest on “reverse veil piercing.” And this is legally problematic, they say, because Kansas courts haven't yet adopted that doctrine. Neither, the brothers predict, are Kansas courts likely to do so if and when confronted with the...