In 2002, the Supreme Court, in United States v. Craft, held that a federal tax lien could attach to one spouse’s interest in property held by the entireties even though the co-owning spouse was not liable for the unpaid taxes. Following the Craft decision, the Internal Revenue Service issued guidance as to how it intended to enforce a tax lien against entireties property in situations where only one spouse is liable for the underlying tax. The guidance (Notice 2003-60) stated that although administrative sale of only the delinquent taxpayer’s interest in entireties property would generally be impractical, the Service can and, “in appropriate cases” will foreclose and force a sale of the property. The guidance recognizes that the non-liable spouse “must be compensated for his or her interest.” The guidance goes on to state that “the Service generally will determine the value of the Government’s interest to be one-half the value of the property, which is determined for this purpose by first taking into account the amount of senior liens.”
An “appropriate case” was recently decided in the Sixth Circuit (United States v. Davis). Ronald, the sole owner of a business, failed to pay federal employment taxes over a four year period and, by 2013, the Service had assessed over $1 million in unpaid taxes, interest and penalties. The Service sent multiple demands for payment and, when these demands went unanswered, a lien against all of Ronald’s property – including entireties interests with his wife, Diane (who was not liable for the unpaid taxes), in their primary residence and a vacation home. The government brought suit against both Ronald and Diane to foreclose its lien against both properties and sell them at auction.
Ronald and Diane stipulated to the sale of the vacation home (the decision does not discuss the split of the proceeds from that sale) however Diane contested the forced sale of the residence, claiming that sale of the property would leave her undercompensated. Diane objected to the auction, arguing that such sales typically yield only 80% of fair market value, which would deprive her of just compensation required by the Fifth Amendment. Diane also objected to a 50:50 split of the net proceeds, arguing that she had a greater life expectancy than Ronald (based on both women’s longer life expectancy in general and her and Ronald’s relative states of health), and, therefore, a greater than 50% interest in the residence.
The trial court rejected Diane’s claim, holding that, under Supreme Court precedent it had only limited discretion not to order a forced sale. Although the sale of Diane’s interest could be considered a taking the precedent “requires only that courts distribute the proceeds of the sale according to the respective interests of the parties, and says nothing about which foreclosure sales methods are proper.” However, with the Service’s agreement, the trial court gave Ronald and Diane four months to sell the residence through a realtor, after which the Service would be authorized to sell it by auction.
The Sixth Circuit viewed Diane’s appeal as a question whether the trial court abused its discretion in ordering the sale of the residence and the 50:50 split of the net proceeds. The Sixth Circuit noted that the Supreme Court has articulated four factors to guide a trial court in the exercise of its limited discretion not to authorize the forced sale of an entire property: i) the extent to which the government’s financial interests would be prejudiced if it were relegated to a forced sale of the partial interest actually liable for the delinquent taxes; ii) whether the third party with a nonliable separate interest in the property would, in the normal course of events have a legally recognized expectation that that separate property would not be subject to forced sale by the delinquent taxpayer or his or her creditors; iii) the likely prejudice to the third party, both in personal dislocation costs and in practical undercompensation; and iv) the relative character and value of the nonliable and liable interests held in the property. Although these factors are not exhaustive, the Supreme Court has indicated that they will almost always be “paramount” in the trial court’s decision whether to exercise its limited discretion.
The Sixth Circuit rejected Diane’s argument that limiting her interest in the property to 50% would undercompensate her, referring to the law of Michigan, where the property was located. The court noted that Michigan law “dictates that spouses are entitled to equal interests in entireties property in every situation [it] contemplate[s].” Faced with a similar argument in the past, the court had concluded that under Michigan law “differences in life expectancy do not result in different survivorship interests.” Although the court acknowledged that there may be circumstances where actuarial valuation of survivorship interests is warranted, tenancy by the entireties is not such a case. Accordingly, the trial court did not abuse its discretion in ordering sale of the property.
The Sixth Circuit also observed that even if Diane had shown that the 50:50 split undercompensated her, undercompensation was only one of the four principal factors articulated by the Supreme Court; and the other factors would have to be considered in determining whether the trial court had abused its discretion.
As to Diane’s claim that a sale at auction, presumably for less than the property’s fair market value, would constitute a taking in violation of the Fifth Amendment’s due process clause, the Sixth Circuit cited Supreme Court precedent stating that §7403 of the Internal Revenue Code (which authorizes an action in federal district court to enforce a tax lien) “provides compensation for that “taking” by requiring that the court distribute the proceeds of the sale according to the findings of the court in respect to the interests of the parties and of the United States.” (The trial court’s order allowing Ronald and Diane four months to sell the residence through a realtor was not disturbed.)
Somewhat alarming is the lack of any discussion in either the trial court or Sixth Circuit opinion of the “personal dislocation costs” imposed on the nonliable spouse when her home is sold out from under her. At first glance, the government appears to be overreaching in putting the nonliable spouse on the street, with proceeds from the forced sale which, almost certainly, would not be sufficient to enable her to secure an equivalent residence. Undoubtedly, there are facts in this case that were not before the court but that may have influenced the Internal Revenue Service’s initial decision that his was an “appropriate case” for foreclosure.