Monday, April 10, 2006

What Did the Trustee Know and When Did He Know It?

A memorandum recently issued by IRS Area Counsel, PLR 200614006, promises to be a major headache for trustees of various types of trusts. Specifically, the memorandum asserts the following:
  1. The IRS can levy upon payments from any trust to a beneficiary in order to enforce its rights under a tax lien even if the trust contains spendthrift provisions.

  2. Perhaps more significantly, in the event that the delinquent taxpayer/beneficiary has a fixed right to trust income, the levy attaches not only to each payment, but also to the taxpayer/beneficiary's "fixed right to obtain a future distribution from the trust." This means that the Service can seize and sell the actuarial right to the payment stream. It does not mean that it can demand immediate payment from the trustee. However, this is potentially devastating to the taxpayer/beneficiary since the payment stream, sold at auction, is likely to be sold at a deep discount. Thus, the seizure and sale will likely make only a small dent in the taxpayer's liability to the IRS, while possibly stripping the taxpayer of his or her patrimony.

  3. Most troubling from the standpoint of a trustee, the memorandum concludes that when a trustee distributes funds that he knows are encumbered by a federal tax lien and the funds "enter the stream of commerce and cannot be traced" (which presumably occurs virtually any time cash is paid to the beneficiary and it can't be recovered), the trustee is liable for tortious conversion for intentionally impairing the lienor's security. This would seem to pose significant problems for institutional trustees such as banks. In many cases, one department of a bank (e.g., the mortgage service department) may have knowledge of a tax lien against a beneficiary. That knowledge is likely not regularly transmitted to the trust department and, in many cases, the mortgage service department may not even be aware that its customer is a beneficiary of a trust with respect to which the bank is the trustee.
PLR 200614006 is part of an emerging trend where the Service aggressively pursues various sorts of rights to satisfy tax liens, even in cases where the rights had traditionally been considered protected from creditor attack. These methods of asset protection, most of which are effective against non-governmental creditors, such as disclaimers, tenancies by the entireties, and spendthrift provisions in trusts, simply will no longer ward off attacks from the Service.


Davis Nelson said...

Great summary! I just referenced it on my blog in a post that highlights the use of this information for business development purposes.


Anonymous said...

The memo wasn't released BY the Area Counsel, but by the National Office TO the Area Counsel.

These memos aren't even intended for the public to see, but the IRS is required to release them due to Tax Analysts' FOIA lawsuit.