In U.S. v. Craft, 122 S.Ct. 1414, 2002-1 USTC ¶50,361, 2002 WL 561332 (U.S. April 17, 2002) the United States Supreme Court reversed prior law and held that the federal tax lien for taxes owed by only one spouse could attach to their partial interest in tenancy by the entirety property.
Taxpayer-husband failed to pay federal income tax and a federal tax lien attached to “all [of his] property and rights to property.” Wife was not liable for these taxes. After the notice of the lien was filed, the couple jointly executed a quitclaim deed purporting to transfer husband’s interest in Michigan tenancy by the entirety property to wife for one dollar (that conveyance terminated the entirety estate, and the rulings of both the District Court and Court of Appeals that the transfer did not constitute a fraudulent conveyance were not appealed by the IRS). Subsequently, after taxpayer-husband’s death, the IRS released the lien and allowed respondent to sell the property with half the net proceeds to be held in escrow pending determination of the IRS’ interest, and wife brought suit to quiet title to the escrowed proceeds. The U.S. District Court awarded the IRS a share of the proceeds and the IRS and taxpayer-wife appealed. The 6th Circuit Court of Appeals held husband had no separate interest in the entireties property under Michigan law so no lien attached. The U.S. Supreme Court majority held that husband, as tenant by the entirety under Michigan law, possessed “property” or “rights to property” to which federal tax lien could attach.
While State law determines which sticks are in a person’s bundle, federal law determines whether those sticks constitute property for federal tax lien purposes. The Supreme Court referred to a common idiom describing property as a “bundle of sticks” — a collection of individual rights which, in certain combinations, constitute property. Michigan law gave respondent’s husband, among other rights, the right to use the entireties property, the right to exclude others from it, of survivorship, to become a tenant in common with equal shares upon divorce, to sell the property with spouse’s consent and to receive half the proceeds, to encumber the property with spouse’s consent, and to block spouse from selling or encumbering the property unilaterally. The Court looked to husband’s rights of use, exclusion, and income as giving him a substantial degree of control over the property and perhaps sufficient to subject his entireties interest to the lien, and found that the unilateral alienation stick is not essential to “property.”
Justice Scalia’s dissent
Justice Scalia dissented, joined by Justice Thomas, stating “a State’s decision to treat the marital partnership as a separate legal entity, whose property cannot be encumbered by the debts of its individual members, is no more novel and no more “artificial” than a State’s decision to treat the commercial partnership as a separate legal entity, whose property cannot be encumbered by the debts of its individual members. … the Court nullifies (insofar as federal taxes are concerned, at least) a form of property ownership that was of particular benefit to the stay-at-home spouse or mother. She is overwhelmingly likely to be the survivor that obtains title to the unencumbered property; and she (as opposed to her business-world husband) is overwhelmingly unlikely to be the source of the individual indebtedness against which a tenancy by the entirety protects.”
Justice Thomas’, joined by Justices Stevens and Scalia, dissent
Justice Thomas, joined by Justices Stevens and Scalia, dissented, stating “[i]t is uncontested that a federal tax lien itself ‘creates no property rights but merely attaches consequences, federally defined, to rights created under state law.’ … . Consequently, the Government’s lien under § 6321 ‘cannot extend beyond the property interests held by the delinquent taxpayer,’ under state law. Before today, no one disputed that the IRS, by operation of § 6321, ‘steps into the taxpayer’s shoes,’ and has the same rights as the taxpayer in property or rights to property subject to the lien.” [citations omitted].
This case may also have consequences regarding priority of and the protection afforded by tenancy by the entirety property from state judgments creditors.
- Hatchett v. U.S., 2003-1 USTC ¶50,504, rev’g 2000-1 USTC ¶50,455 (DC Mich., June 4, 2003)
- In re Jerry Gallivan and Jeannette Gallivan, Debtors, 2004-2 USTC ¶50,386, U.S. Bankruptcy Court, West. Dist. Mo.; 03-60525, July 23, 2004