Federal tax liens – failure to pay the estate taxes

Homes sold by estate beneficiary remained subject to federal estate tax liens

First American Title Insurance Co., et al. v. U.S. (CA9 3/27/2008) 101 AFTR 2d ¶ 2008-622

Mike Habib, EA


The Court of Appeals for the Ninth Circuit, affirming a district court, has held that title companies couldn’t recover estate taxes that they paid after distressed homeowners informed them of IRS’s threats to seize their homes based on an increased tax assessment on the estate from which they’d acquired their properties.

Facts. Roberta C. Smith died in ’91 leaving an estate primarily consisting of three houses and stock in Frisko Freeze, a drive-in restaurant in Tacoma, Washington. A court admitted her will to probate, named her daughter, Penny Jensen, as the estate’s personal representative, and gave Ms. Jensen the power to transfer the estate’s real and personal property without further court order (a so-called non-intervention probate order).

Ms. Jensen deeded the three houses in the estate to herself and her husband. She filed a federal estate tax return and paid the estate tax. The Jensens later sold the houses to purchasers who obtained title insurance policies issued by the taxpayers in this case: First American Title Insurance Company, Commonwealth Land Title Insurance Company, and Chicago Title Insurance Company (“the Title Companies”).

IRS audited the estate and increased the value of the Frisko Freeze stock by almost $150,000 more than was reported. After the estate failed to make installment payments on the estate taxes owed, IRS sent letters to the purchasers of the three houses threatening to seize and sell the houses unless they paid the remaining estate tax owed.

The homeowners gave the IRS letters to the Title Companies who paid about $189,372 in estate taxes under protest. They then filed refund claims. After IRS denied the claims, they brought their case to a district court. Specifically, they sued under 28 USCS 1346 to recover federal estate tax erroneously or illegally assessed and collected. The district court held in favor of IRS.

Background. Code Sec. 6324(a)(1) creates a special estate tax lien that attaches to the gross estate of a decedent for ten years from the date of death. Under the holding of U.S. v. Vohland, Lewis, (1982, CA9) 50 AFTR 2d 82-6112, probate property (which the three homes in the current case were) retains the special estate tax lien upon transfer to a purchaser unless IRS discharges the personal representative of the lien under Code Sec. 2204 . The gross estate is divested of the special estate tax lien to the extent that the gross estate is “used for the payment of charges against the estate and expenses of its administration, allowed by any court having jurisdiction thereof.” (Code Sec. 6324(a)(1))

Failed arguments in district court. Before the district court, the Title Companies agreed that a special estate tax lien attached to the gross estate of Roberta Smith at her death in ’91. They also acknowledged that Ms. Jensen, the estate’s personal representative, didn’t obtain a discharge of liability under Code Sec. 2204 before selling the properties in question. Rather, the Title Companies contended that the proceeds from the sale of the three homes were used to pay charges against the estate and expenses of its administration, thereby divesting the lien under Code Sec. 6324(a)(1). The court said that to prove that divestment occurred under Code Sec. 6324(a)(1), the Title Companies had to show that: (1) the sale proceeds satisfied charges against the estate or expenses of its administration; and (2) a court with proper jurisdiction allowed the satisfaction.

The Title Companies contended that they used the proceeds from the house sales to pay encumbrances, taxes, title insurance premiums, and real estate commissions and that these payments qualify as “charges against the estate or expenses of its administration.” For example, the Title Companies said that one of the three houses was encumbered by a $124,000 deed of trust in the name of Roberta Smith. After the sale, First American Title paid $122,829.98 from the sale proceeds to the company owning the deed of trust. The Title Companies argued that if the deed of trust “was paid out of the proceeds of the sale of the property, the special lien was automatically divested.” The Title Companies also claimed that a portion of the sale proceeds from the homes was used to satisfy loans Ms. Jensen may have incurred in “expenses of the estate” after her mother’s death.

The court said that the arguments were too hypothetical to show that a material issue of fact was in dispute that would warrant denying summary judgment. However, the court said, even if it is assumed that the Title Companies used the sale proceeds from the three homes to satisfy the charges or expenses of the estate, the Title Companies still could not prevail because they did not establish that a court with proper jurisdiction allowed the payments.

The Title Companies contended that the state court non-intervention probate order met this second prong of the test. However the district court disagreed.

Ninth Circuit. The Ninth Circuit noted that 28 USCS 1346 is the general statute providing jurisdiction in the district courts for taxpayer suits against IRS. It said, however, that Code Sec. 7426 is the statute providing jurisdiction for suits by persons other than taxpayers. According to the Appeals Court, the problem for the Title Companies is that Code Sec. 7426(c) does not let them challenge the assessment of how much Frisko Freeze was worth, and the assessment is what they claim makes the taxes they paid too high.

The Ninth Circuit stressed that justice does not require that 28 USCS 1346 be embraced to avoid the Code Sec. 7426 limitation on challenges to assessments. Had Jensen paid the estate taxes when due, or paid the installments and not gone bankrupt, she could not have challenged the assessment, because she had agreed to it. There is no good reason why her failure to pay the estate’s taxes should reopen the valuation of Frisko Freeze, Inc. True, the homeowners and the title insurers that stepped into their shoes did not have a chance to challenge the assessment. But the assessment was not really their problem. Their problem was that the real estate chain of title included an estate that had not paid its taxes. A third party that pays a tax to eliminate a tax lien on the third party’s property is, under Code Sec. 7426(c), bound by the assessment on the property.

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