In a recent case,[1] the Federal District Court for the District of Maryland held that the U.S.’s federal IRS tax lien did not attach to a piece real property after the transfer to the taxpayer was voided under the Maryland Uniform Fraudulent Conveyance Act (“MUFCA”).[2]

Facts

Transfer from Insolvent Estate

Plaintiff, BG, is a nursing home that provided care for the Defendant’s Mother, for a short period of time prior to her death in the fall of 2014. Shortly thereafter, the Defendant (Son), was appointed personal representative for the estate and a will was admitted for probate. The only significant asset in the Mother’s estate was her home.

BG filed a claim against Mother’s estate, and, on June 19, 2017, the Orphan’s Court entered a judgment approving BG’s claim for approximately $85 thousand. However, a few days before the Orphan’s Court judgement was entered, the Son transferred the real property to himself for no consideration.

At the time of the transfer, Son was indebted to the IRS and the State of Maryland for unpaid taxes. Both the IRS and the State of Maryland had filed tax liens in the Son’s home county (Montgomery County, Maryland).

After learning of the transfer, BG moved to enforce the court’s order and remove Son as personal representative, which the court granted in September 2017. The Orphans’ Court granted the motion and appointed a new personal representative.

BG Brings Suit to Set Aside Transfer and Quiet Title

In October 2017, the new personal representative and BG filed suit in Maryland District Court seeking to invalidate the transfer of the real property to Son. In addition, BG also sought a judgment declaring that the federal and Maryland tax liens did not encumber the property.

The State of Maryland asked the District Court to grant BG’s request. However, the U.S. continued to assert that their preexisting federal tax liens against the Son continued to enjoy priority over BG’s claim against Mother’s estate.

BG argued that the federal tax liens never attached to the property.

Opinion

Court’s Analysis of BG’s Request to Set Aside the Transfer under MUFCA

The court did not have to break a sweat on this part of the opinion. Section 15-204 provides:

“ Every conveyance made … by a person who is or will be rendered insolvent by it is fraudulent as to creditors without regard to his actual intent, if the conveyance is made … without a fair consideration.” Md. Code Ann., Com. Law S 15-204. Maryland courts have carved this provision into its constituent elements, holding that a fraudulent conveyance under S 15-204 requires: “(1) a conveyance, (2) the debtor either already is insolvent, or will be made insolvent by this conveyance; (3) the existence of a debtor-creditor relationship; and (4) lack of fair consideration.’ Greystone Operations, LLC v. Steinberg, No. 454,2017 WL 1365365, at *3 (Md. Ct. Spec. App. Apr. 12,2017).”^[3]

Here, the transfer of the title to Son was a conveyance, Mother’s estate only held about $6,000 of additional funds and property after the transfer of the real property, BG was a valid creditor of the estate, and Son did not provide any consideration for the transfer of the real property. After the transfer of the real property, the estate was insolvent because “the present fair market value of [the estate’s] assets is less than the amount required to pay [the estate’s] probable liability on [the estate’s] existing debts as they become absolute and matured.” See Maryland Code Ann. 15-202(a). Therefore, the court found that the conveyance was clearly unlawful under MUFCA.

The court did point out that Son alleged that BG did not properly care for his mother while she resided at BG’s facility. The court indicated that Son is free to pursue this allegation in a separate lawsuit, but the claim is not relevant to the analysis of the conveyance of Mother’s real estate under MUFCA.

Scope of IRS Tax Lien

It was undisputed that Son owed the IRS around $125,000 of tax, penalties, and interest. It was also undisputed that the IRS had properly filed tax liens in Montgomery County, Maryland. The issue presented to the court was whether or not the tax liens continued to attach to the real property after the court voided the transfer to Son.

The court pointed out that, under IRC 6321, there was a lien in favor of the U.S. on all property and rights to property belonging to Son.

Under § 6321:

“If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.”

“There is no question that such liens apply to property a delinquent taxpayer acquires after the government files notice of the lien, so long as the lien remains enforceable.”[4]

In support of its position that the federal tax lien should enjoy priority over BGs’ claims, the IRS advanced two legal arguments: (i) the federal tax liens against Son attached to the real estate prior to BG’s judgment because the federal tax lien attached to the Son’s beneficial interest in Mother’s estate upon her death; and (ii) the federal tax liens against Son attached to the real estate when Son transferred the real estate to himself from Mother’s estate (again prior to BG’s judgment).

No Unqualified Right to Property, Therefore Federal Tax Lien Did Not Attach Upon Death

The IRS argued that the lien attached to the Son’s right to inherit from his Mother upon her death. The court noted that, while the US tax lien has a very broad reach, federal tax law does not create property rights but merely attaches to rights created under state law.[5] The court agreed that the federal tax lien attached to the Son’s beneficial interest in his mother’s estate. However, that does not necessarily mean that the federal tax liens attached to the real estate while the property is legally held by Mother’s estate.

The court indicated that the critical question is the extent to which the Son (i.e., the interest holder) could exercise control over the real estate (i.e., property in question) as a beneficiary.[6] To make that determination, the court looked to Maryland law.

Under Maryland law, it is the personal representative – not the intended beneficiary under the decedent’s will – who holds the power to sell, mortgage, or lease the property.[7] But, Maryland law also obligated the personal representative (i.e., Son) to “fairly consider [], the interests of all creditors.”[8] As a result, the court held that the Son did not have an unqualified right to receive the entire value of the property because Maryland law required the Son to satisfy the estate’s debts, including BG’s claim, before distributing the property to himself. As a result, the court concluded that the federal tax lien did not attach to the real estate at the time of Mother’s death.

Parties Are Restored to Pre-Conveyance Position after Voiding Transaction under MUFCA

The IRS also argued that despite the fact that the transfer from an insolvent estate to the taxpayer was voidable under MUFCA, the IRS’s tax lien under IRC § 6321 still attached because the taxpayer still held some rights in the title for a period of time (i.e., between transfer to Son and before the court set aside the transfer). During this period in time he could convey title to the real estate to innocent purchasers. The IRS argued that, during that period, the IRS’s valid federal tax lien against the taxpayer attached to the real estate.

The court noted that if the conveyance was valid, it is clear that the IRS tax lien would have attached to the real estate. However, the transfer to the Son was not legal under MUFCA.

In fact, the IRS did not argue that the transfer was not voidable under MUFCA. The IRS argued that the lien still attached because the conveyance was not void ab initio (i.e., had no legal effect). Rather, it was voidable upon a court action to set aside the transfer. The IRS reasoned that transactions that are void ab initio are completely ineffective, but transactions that are merely voidable has some legal effect and the holder may be able to convey an interest in the asset.[9] Therefore, in the voidable transaction, there is some property right upon which the federal tax lien can attach.

The court determined that it did not matter whether the transaction was void ab initio or merely voidable. The court held that the transfer was fraudulent under § 6321, so the transaction was voidable under MUFCA. And, under MUFCA, once the creditor moved to have the transfer voided, the Court had the authority under the remedy provisions of MUFCA to void the transfer and restore the parties to their positions prior to the unlawful activity. The court reasoned that since the IRS’s tax lien did not attach to the real estate prior to the transfer of the real estate to Son, the IRS lien should not attach to the real estate after the transfer was voided and it was back in possession of the estate. As a result, the IRS held in favor of BG that the estate held title to the real property free of any IRS tax liens filed against Son.

Conclusion

The judgment will place the asset back in the estate free and clear of the tax liens. The estate will be able to sell the property to pay the judgment in favor of BG. Nevertheless, once the estate’s liabilities are paid off, there will be remaining funds available for distribution to the Son as beneficiary. The court noted that the IRS’s lien attaches to Son’s beneficial interest. Therefore, the IRS will likely receive payment from the estate, but the remaining funds after paying BG may not be sufficient to full pay the IRS liens.

As the court noted, the facts of the case were unusual. Nevertheless, it is unlikely to be the last time that a personal representative transfers property from an insolvent Maryland estate to a beneficiary that is indebted to taxing authorities. And, the court’s analysis may prove instructive in future cases in which there is a different type of fraudulent conveyance under MUFCA to a transferee that is indebted to the IRS.

Notes

[1] Brooke Grove Foundation, Inc. et al. v. Edgar C. Bradford et al., 8:17-cv-03364-PWG (D.MD)(December 4, 2018).

[2] 2016 Maryland Code – Commercial Law – Title 15 – Debt Collection — Special Provisions, Subtitle 2 – Fraudulent Conveyances – Link

[3] Opinion at 5.

[4] Opinion at 10 citing Glass City Bank v. United States, 326 U.S. 265, 268 (1945)(link); In re Avis, 178 F.3d 718, 721 (4th Cir. 1999)(link).

[5] Opinion at 11 citing Drye v. United States, 528 U.S. 49,56 (1999)(link) and United States v. Craft, 535 U.S. 274, 278 (2002) (link).

[6] Citing Drye.

[7] Md. Code Ann., Est. & Trusts – 7-401 (n). Link

[8] Opinion at 13 citing Md. Code Ann., Est. & Trusts § 7-101(a). Link

[9] The court seemed to be persuaded that the transaction was voidable, rather than void ab initio, under MUFCA. The court pointed out that someone that holds a voidable deed may be able to transfer title to an innocent buyer for value under MUFCA. Thus, MUFCA provided some protections to innocent purchasers. Nevertheless, the court determined that it had the authority under remedy provisions of MUFCA to restore the parties to the positions they held before the unlawful activity.