Kane v. Capital Guardian Trust Co.

• Decision Date: 15 June 1998
• Docket Number: No. 97-3030,97-3030
• Citation: 145 F.3d 1218
• Parties: -2323, 98-2 USTC P 50,491, 22 Employee Benefits Cas. 1395, Pens. Plan Guide (CCH) P 23943P, 98 CJ C.A.R. 3150 Gerald E. KANE, Plaintiff-Appellant, v. CAPITAL GUARDIAN TRUST COMPANY, Defendant-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1218

145 F.3d 1218

81 A.F.T.R.2d 98-2323, 98-2 USTC P 50,491,

22 Employee Benefits Cas. 1395,

Pens. Plan Guide (CCH) P 23943P, 98 CJ C.A.R. 3150

Gerald E. KANE, Plaintiff-Appellant, v. CAPITAL GUARDIAN TRUST COMPANY, Defendant-Appellee.

No. 97-3030.

United States Court of Appeals Tenth Circuit.

June 15, 1998.

John C. King, King Law Offices (John L. Brennan with him on the brief), Wichita, KS, for Plaintiff-Appellant.

Eric B. Metz, Triplett, Woolf & Garretson, LLC (Jeffrey C. Dahlgren with him on the brief), Wichita, KS, for Defendant-Appellee.

Before ANDERSON, BALDOCK, and MURPHY, Circuit Judges.

BALDOCK, Circuit Judge.

The issue in this case is whether a trust company becomes liable to the holder of an individual retirement account when the company responds to a federal tax levy against the account by liquidating the mutual fund shares in the account and remitting the cash proceeds to the Government. On the facts of this case, we hold that the trust company is not liable to the account holder.

I.

At the end of 1975, Plaintiff Gerald E. Kane (hereinafter "Kane"), then 51 years old, established an individual retirement account (hereinafter "IRA") under a trust agreement with Defendant Capital Guardian Trust Company (hereinafter "Capital Guardian"). Under the terms of the trust agreement, Kane had the right to withdraw funds from his IRA, but had no right to demand the issuance of share certificates representing his IRA's underlying investments. Rather, Capital Guardian retained sole discretion whether to issue share certificates for such investments.

In September 1993, Kane's IRA consisted of unissued shares in two open-end mutual funds--5,290.870 shares of the Investment Company of America and 286.202 shares of the Growth Fund of America--valued at more than $107,000. Shares in an open-end mutual fund are "redeemable securities" which means that the account holder upon presentation to the issuer "is entitled ... to receive approximately his proportionate share of the issuer's current net assets, or the cash equivalent thereof." 15 U.S.C. § 80a-2(a)(32). Therefore, while Kane's interest in the mutual funds represented a proportionate share of the two companies' current assets, he had no right to any actual share certificates.

Kane admits that due to financial difficulties, he failed to pay his 1989 federal income tax liability of more than $100,000. On August 5, 1993, the Internal Revenue Service (hereinafter "IRS") issued a Notice of Levy to Capital Guardian under 26 U.S.C. § 6331, specifically attaching the funds in Kane's IRA. Consistent with the IRS' instructions "to turn over to us this person's [Kane's] property and rights to property (such as money, credits and bank deposits) ... which you are already obligated to pay this person," Capital Guardian responded to the levy by liquidating Kane's IRA, and remitting the cash proceeds of $107,706.25 to the IRS. Capital Guardian then submitted the appropriate 1993 IRS Form 1099-R, reporting a gross distribution from Kane's IRA in the same amount. Capital Guardian's cash distribution from Kane's IRA resulted in an additional tax liability to Kane in 1993 of $41,418.

Eleven months after Capital Guardian liquidated his IRA, Kane responded by filing suit in Kansas state court against Capital Guardian for conversion and breach of fiduciary duty. Kane alleged that Capital Guardian had no authority to liquidate the mutual fund shares in his IRA and remit the cash proceeds to the IRS. Kane did not dispute the validity of the levy. He acknowledged that his interest in the IRA was a property interest to which a federal tax lien could attach and upon which the Government could levy. Instead, Kane claimed that Capital Guardian should have responded to the levy by issuing share certificates in the mutual funds to the IRS, and its failure to do so deprived him of his right to redeem the shares prior to a tax sale. See 26 U.S.C. § 6337. Consequently, Kane demanded that Capital Guardian (1) restore his IRA to its pre-levy status, and (2) pay both his 1989 and 1993 federal tax liabilities.

Capital Guardian removed the suit to federal district court on the bases of federal question and diversity jurisdiction. ¹ On cross motions for summary judgment, see Fed. R Civ. P. 56, pursuant to stipulated facts, the district court ruled that Capital Guardian could not "be held liable for complying with the IRS' lawful demand to which it had no valid defense." Kane v. Capital Guardian Trust Co., 953 F.Supp. 1200, 1208 (D.Kan.1997). Accordingly, the district court entered judgment for Capital Guardian, and Kane appealed. Our jurisdiction arises under 28 U.S.C. § 1291. We review a grant of summary judgment de novo employing the same legal principles as the district court. See Lytle v. City of Haysville, 138 F.3d 857, 862 (10th Cir.1998). Applying this standard, we affirm.

II.

Federal law places a tax lien in favor of the Government upon "all property and rights to property, whether real or personal, tangible or intangible" of a taxpayer who fails to pay taxes due and owing after assessment and demand. 26 C.F.R. § 301.6321-1; accord 26 U.S.C. §§ 6321-22. The reach of a federal tax lien is broad. Congress intended the lien "to reach every interest in property that a taxpayer may have." United States v. National Bank of Commerce, 472 U.S. 713, 719-20, 105 S.Ct. 2919, 86 L.Ed.2d 565 (1985). A federal tax lien may reach a taxpayer's interest in "property or rights to property" to the extent that applicable state law recognizes the subject interest as property. Id. at 722, 105 S.Ct. 2919. Federal law, however, defines the tax consequences which attach to a state-created property interest. Id.

Because a federal tax lien is not self-executing, the IRS must take affirmative measures to collect the delinquent taxes. Id. at 20, 105 S.Ct. 2919. Federal law provides a provisional remedy to the IRS for the collection of delinquent taxes which requires no judicial intervention. See 26 U.S.C. §§ 6331-43. This remedy is known as an administrative levy, and is justified by "the need of the government promptly to secure its revenues." Nat'l Bank of Commerce, 472 U.S. at 720-21, 105 S.Ct. 2919. Unlike the lien-foreclosure suit authorized by 26 U.S.C. § 7403, an administrative levy does not determine priority disputes between the Government and other claimants, but instead protects the Government against diversion or loss while such disputes, if any, are resolved. See Nat'l Bank of Commerce, 472 U.S. at 721, 105 S.Ct. 2919.

Ten days after notice and demand to the taxpayer, the IRS may levy "upon all property and rights to property (except such property as is exempt under section 6334) belonging to such person or on which there is a lien ... for the payment of such tax." 26 U.S.C. § 6331(a). The IRS begins the levy process "by serving a notice of levy on any person in possession of, or obligated with respect to, property or rights to property subject to levy." 26 C.F.R. § 301.6331-1(a)(1). The IRS effectuates a levy upon tangible property through (1) notice of levy, and (2) seizing, posting, or tagging the property. See G.M. Leasing Corp. v. United States, 429 U.S. 338, 350, 97 S.Ct. 619, 50 L.Ed.2d 530 (1977). The IRS effectuates a levy upon intangible property, that is to say property which is not subject to physical seizure, posting, or tagging, such as mutual fund shares, see Baum v. Investors Diversified Serv., Inc., 409 F.2d 872, 875 (7th Cir.1969) (redemption right in mutual fund shares constitutes intangible property interest), by the sole act of serving notice of levy upon the third party holding the property. See G.M. Leasing Corp., 429 U.S. at 350, 97 S.Ct. 619. Upon service of the notice of levy, the IRS "steps into the shoes of the taxpayer and acquires 'whatever' rights to the property the taxpayer possessed." United States v. Bell Credit Union, 860 F.2d 365, 369 (10th Cir.1988).

Under 26 U.S.C. § 6332(a), only two defenses to a levy will excuse a third party's noncompliance. That section provides:

[A]ny person in possession of (or obligated with respect to) property or rights to property subject to levy upon which levy has been made shall, upon demand ... surrender such property or rights (or discharge such obligation) ... except such part of the property or rights, as is, at the time of such demand, subject to attachment or execution under any judicial process.

Id. Thus, to avoid liability to the Government for failure to comply with a notice of levy, a third party must establish that (1) it is not in possession of the taxpayer's "property or rights to property," or (2) the taxpayer's "property or rights to property" was subject to prior judicial attachment or execution. Id.; accord Nat'l Bank of Commerce, 472 U.S. at 721-22, 105 S.Ct. 2919. In the absence of either defense, a party failing to honor a federal tax levy is liable for a sum equal to the value of the property plus interest and costs. 26 U.S.C. § 6332(c)(1). If the failure to surrender the property is without reasonable cause, the third party may incur a 50% penalty as well. Id. § 6332(c)(2).

III.

The district court concluded that because neither of the foregoing defenses were available to Capital Guardian, it had no choice but to honor the levy against Kane's IRA. To support its judgment in favor of Capital Guardian, the district court relied principally upon 26 U.S.C. § 6332(e), concerning the effect of honoring a federal tax levy. Kane, 953 F.Supp. at 1206-08. That section provides:

Any person in possession of (or obligated with respect to) property or rights to property subject to levy upon which levy has been made who, upon demand by the Secretary, surrenders such property or rights to property (or discharges such obligation) to the Secretary ... shall be discharged from any obligation or liability to the delinquent taxpayer and any other person with respect to such property or rights to property...