IRS v. Orr

• Decision Date: 14 January 1998
• Docket Number: C.A. No. C-97-357.
• Citation: 239 BR 130
• Parties: INTERNAL REVENUE SERVICE, Appellant, v. John Davis ORR, Appellee.
• Court: U.S. District Court — Southern District of Texas

239 B.R. 130 (1998)

INTERNAL REVENUE SERVICE, Appellant, v. John Davis ORR, Appellee.

C.A. No. C-97-357.

United States District Court, S.D. Texas, Corpus Christi Division.

January 14, 1998.

COPYRIGHT MATERIAL OMITTED

Joseph A. Pitzinger, III, Dept. of Justice Tax Division, Dallas, TX, for Appellant.

Ronald A. Simank, Schauer, Simank and Ledbetter, Corpus Christi, TX, for Appellee.

ORDER ON APPEAL FROM ORDER GRANTING SUMMARY JUDGMENT AND DELIMITING THE ATTACHMENT OF APPELLANT'S LIEN TO APPELLEE'S SPENDTHRIFT TRUST

JACK, District Judge.

On this date came on to be considered Appellant Internal Revenue Service's ("IRS") Appeal from the Order Granting Summary Judgment issued by the United States Bankruptcy Court for the Southern District of Texas, Corpus Christi Division. That Order granted Appellee John Davis Orr's ("Orr") motion for summary judgment, finding that the IRS's federal income tax liens attach only to the distributions which Orr received from his spendthrift trust prior to April 30, 1996. In effect, the Bankruptcy Court found that Orr's prepetition equitable interest in his future spendthrift trust income did not constitute "property" within the meaning of 26 U.S.C. § 6321. This Court reverses.

I. JURISDICTION

The Court has jurisdiction pursuant to 28 U.S.C. § 158(a).

II. PROCEDURAL & FACTUAL HISTORY

In 1965, Orr's grandmother created a spendthrift trust which yields the income that is at issue in the present dispute. This trust provides that "all net income of the trust shall be distributed" to Orr, provided only that Orr is competent and over the age of thirty. (Trust para. 5.) In accordance with the trust, Orr has regularly received payments of the annual income and has also been made a co-trustee. The trust income is granted to Orr unconditionally and permanently, and the trust requires the trustee to disburse all of the income to Orr at least annually.¹

Between 1984 and 1991, Orr failed to file his federal income tax returns, incurring over $630,000 in tax liabilities. Consequently, in 1993, the IRS properly filed Notices of Federal Tax Liens pursuant to 26 U.S.C. § 6671, thereby securing payment of these tax liabilities. On November 1, 1995, Orr petitioned for bankruptcy relief under Chapter 7, and he received a discharge of personal liability on May 21, 1996. Of course, in accordance with 11 U.S.C. § 524(a)(1), this discharge did not remove the federal tax liens from Orr's prepetition property.

Months prior to receiving his discharge, in February 1996, Orr filed an adversary requesting the Bankruptcy Court to determine precisely to what property interests the federal tax liens had attached. In particular, with respect to the spendthrift trust, Orr wanted to know whether the liens attached only to prepetition income payments, or if the liens attached to his interest in the trust income such that the IRS could also collect its debt from the post-petition disbursements. That is, Orr asked the court to choose between two plausible construals of what constituted Orr's property upon filing for relief: (1) Orr owned only the income already disbursed to him from the spendthrift trust, or (2) Orr owned an interest in the spendthrift trust which was in itself an attachable property interest. Orr preferred the former construal since it would mean that the IRS' liens are dischargeable as to his trust income which is disbursed post-petition. In contrast, the IRS maintained that the federal tax liens had attached to Orr's prepetition interest in the spendthrift trust itself, and therefore the IRS could collect its debts from all of Orr's trust income— whether disbursed prepetition or post-petition.

On April 7, 1997, the Bankruptcy Court ruled in favor of Orr—i.e., that the IRS could satisfy its tax liability only out of trust income distributions made prior to Orr's petition (i.e., through April 30, 1996).² In effect, the Bankruptcy Court held that, in these circumstances, Orr's interest in his spendthrift trust income was not attachable property until Orr had the right to alienate the disbursed income, even if he did have exclusive rights to all future income accrued during his life. In making this decision, that court relied on a case from 1945, United States v. Dallas Nat'l Bank, 152 F.2d 582 (5th Cir.1945), modified, 164 F.2d 489 (5th Cir.1947), modified, 167 F.2d 468 (5th Cir.1948), which was subsequently modified twice by the Fifth Circuit and, regardless, does not address the issue before this Court.

III. STANDARD OF REVIEW

This Court has capacity to hear appeals from decisions of a bankruptcy court, See 28 U.S.C. § 158, and it reviews findings of fact by the bankruptcy court under the clearly erroneously standard and decides issues of law de novo. Matter of Haber Oil Co., Inc., 12 F.3d 426, 434 (5th Cir.1994); Matter of Killebrew, 888 F.2d 1516, 1519 (5th Cir.1989).

IV. DISCUSSION

a. The Nature of Federal Tax Liens Issued Pursuant to 26 U.S.C. § 6321

When a person fails to pay federal taxes, all property rights that the person has or acquires thereafter are subject to a federal tax lien immediately and automatically. See 26 U.S.C. § 6321. Such a lien will attach to all property acquired during the life of the lien, including property acquired after its assessment. Glass City Bank of Jeanette, Pa. v. United States, 326 U.S. 265, 66 S.Ct. 108, 90 L.Ed. 56 (1945). While the reach of a § 6321 lien is very broad, it does not apply to property acquired after bankruptcy. In re Connor, 27 F.3d 365, 366 (9th Cir.1994); see e.g., In re Braund, 289 F.Supp. 604 (C.D.Cal.1968), aff'd sub nom, United States v. McGugin, 423 F.2d 718 (9th Cir.), cert. denied, 400 U.S. 823, 91 S.Ct. 44, 27 L.Ed.2d 51 (1970).

A § 6321 lien is not easily limited. First, such federal tax liens are not subject to any state laws that govern ordinary liens or to any state perfection requirements. See United States v. Security Trust & Sav. Bank, 340 U.S. 47, 51, 71 S.Ct. 111, 113-14, 95 L.Ed. 53 (1950); Leggett v. United States, 120 F.3d 592, 594 (5th Cir.1997). With respect to the operation of such liens, "there is no doubt that the paramount right to collect taxes of the federal government overrides a state statute providing for exemptions." Leuschner v. First Western Bank and Trust Company, 261 F.2d 705, 708 (9th Cir.1958). This means, for example, that barriers against creditors—which are the hallmark of a spendthrift trusts created under state law—cannot prevent a federal tax lien from attaching to the beneficiary's interests in that trust. United States v. Rodgers, 461 U.S. 677, 683, 103 S.Ct. 2132, 2137, 76 L.Ed.2d 236 (1983); United States v. Bess, 357 U.S. 51, 56-57, 78 S.Ct. 1054, 1057-58, 2 L.Ed.2d 1135 (1958) (once it has been determined that state law has created property interests sufficient for federal tax lien to attach, state law "is inoperative to prevent the attachment" of such liens); see also, Dallas 1, 152 F.2d at 585 ("If IRS statutes are in conflict with State law, constitutional or statutory, the latter must yield"). Second, a § 6321 lien is not limited by a discharge in bankruptcy: such a discharge only extinguishes the debtor's personal liability, 11 U.S.C. § 524(a)(1), and does not prevent the enforcement of valid tax liens against the debtor's bankruptcy estate. 11 U.S.C. § 522(c)(2)(B).

Further, § 6321 is intended to be broad in scope and to apply to every interest the taxpayer has in property. See United States v. National Bank of Commerce, 472 U.S. 713, 719-20, 105 S.Ct. 2919, 2923-24, 86 L.Ed.2d 565 (1985); Leggett, 120 F.3d at 594. The statutory language used in § 6321 "reveals on its face that Congress meant to reach every interest in property that a taxpayer might have. . . . `Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes'" National Bank of Commerce, 105 S.Ct. at 2924, citing, Glass City Bank, 326 U.S. at 267, 66 S.Ct. at 110.

In sum, when a federal tax lien is created pursuant to § 6321, it attaches (and remains attached) to all of the debtor's prepetition property interests, notwithstanding state law spendthrift trust restrictions on alienation. Three questions remain for this Court. First, what kind of prepetition property interest did Orr have? Second, does a § 6321 lien attach to such property interests? And, third, what effect, if any, did Orr's filing for bankruptcy have on the lien's prepetition attachment?

b. The Nature of Orr's Property Interest

Property is generally characterized as an aggregate of rights; "the right to dispose of a thing in every legal way, to possesses it, to use it, and to exclude everyone else from interfering with it." Black's Law Dictionary 1095 (5th ed.1979). This so-called "bundle of rights and powers" can be divided among a number of persons, each of whom then possesses an interest that is less than absolute ownership. In re Terwilliger's Catering Plus, Inc., 911 F.2d 1168, 1178 (6th Cir.1990), cert denied, 501 U.S. 1212, 111 S.Ct. 2815, 115 L.Ed.2d 987 (1991); In re Kimura, 969 F.2d 806, 810 (9th Cir.1992). Thus, there are various types of property interests.

While the Supreme Court mandates a broad scope of attachment to property under § 6321, the section does not define what kind of property interests constitutes an attachable property interest for § 6321 purposes. Instead, in this context, it is left to state law to determine whether a taxpayer has a property interest to which a federal lien may attach. See National Bank of Commerce, 105 S.Ct. at 2925-26; Bess, 357 U.S. at 55, 78 S.Ct. at 1057; Leggett, 120 F.3d at 594. Therefore, the Court must look to Texas law for a characterization of Orr's property interest in the spendthrift trust.

Texas courts have long upheld and enforced spendthrift trust provisions. Burns v. Miller, Hiersche, Martens, 948 S.W.2d 317, 320 (Tex.App.—Dallas 1997 writ denied); Dierschke v. Central Nat'l Branch of First Nat'l Bank at Lubbock, 876 S.W.2d...