WHAT IS THE VALUE OF AN INTEREST HELD AS TENANTS BY THE ENTIRETIES AFTER UNITED STATES V. CRAFT?

By Frances D. Sheehy, Esq.

   On April 17, 2002, the Supreme Court of the United States ruled that a federal tax lien for the separate income tax liability of the husband attaches to all of his “property and rights to property”, including his interests in entireties property.  The case has been remanded to the 6^th  Circuit to determine the property valuation of the husband’s interest in the entireties property.  United States v. Craft, 535 U.S. _____ (2002); 2002 U.S. LEXIS 2790.                                                        The facts in the Craft case are exactly what the IRS has been looking for to pierce entireties since at least 1987, and they found the perfect case.  1988, the IRS assessed  $482,446 in unpaid income tax liabilities against Don Craft, the husband of respondent Sandra Craft for unfiled federal income tax returns for the years 1979 through 1986. Craft failed to pay the tax, and the IRS  filed a federal tax lien, which attaches to all “property and rights to property” of Craft. I.R.C. Section 6321. After the notice of lien was filed, the Crafts jointly executed a quitclaim deed  transferring to Sandra, ownership in a piece of real property in Michigan, owned as tenants by the entirety. The IRS agreed to release the lien and allow Sandra to sell the property as long as half the net proceeds were held in escrow pending determination of the government’s interest in the property.

Sandra then brought a quiet title action to determine ownership of the escrowed proceeds. The government claimed among other things, that its lien had attached to the husband’s interest in the tenancy by the entireties property. The District Court granted the summary judgement for   the government,  holding that the federal tax lien attached at the moment of transfer to Sandra which terminated the tenancy by the entirety and entitled the government to one half of the value of the property. Both parties appealed. The Sixth Circuit held that the tax lien did not attach to the property because under Michigan State law, the husband had no separate interest in the entireties property. On remand,  the District Court found that no fraudulent  conveyance can occur with respect to exempt property, but awarded the IRS a share of the proceeds of the sale of the property based on  fraudulent  conveyance, equal to the amount of non-exempt funds used to pay mortgage payments. Both parties appealed, the government again claiming that the lien attached to the entireties property. The 6^th Circuit held that the entireties issue had already been determined and affirmed the fraudulent conveyance with respect to the mortgage payments.                  On  appeal, the Supreme Court looked at the “bundle of sticks” held by the  husband, and considered whether the the husband had a separate interest in the entirety property to which the federal tax lien attached. The court purported to look to state law to determine what rights, if any, the taxpayer has in property, and agreed that the federal tax lien statute creates no property rights but merely attaches consequences, yet described the state law entireties ownership  and protection from creditors as a “fiction”.  The Court found that under Michigan tenants by the  entireties,  each spouse has the right of use,  possession, survivorship, to alienate with consent of the spouse, and income of property owned as tenants by the entireties.  The Court concluded that these rights  to property  are sufficient individual rights that they can be reached by a federal tax lien under U.S.C. Section 6321.  The Court declined to determine whether the right of survivorship alone would qualify as    property, or rights to property under 6321.

Although the Court recognized that Michigan law protects entireties property from individual creditors of either the husband or the wife, the Court determined that the Supremacy Clause allowed the federal government to erase the state-created protection of entireties just as it does with respect to homestead and other exemptions under state law.  The Court then goes on to  warn that future determinations with respect to the fraudulent conveyance question will probably be   answered in favor of the government since the “fiction” of entireties as exempt has been  determined in favor of the government.                                                                                                           Does this mean that title companies who have issued clear title in situations that involved entireties and federal tax liens for one of the spouses are potentially liable?  The insurance companies have already issued a bulletin advising that a recorded federal tax lien against one or both spouses will require a release or satisfaction in the case of a sale of property and in a  refinance situation, will require a release, satisfaction or subordination.    Will the IRS foreclose its federal tax liens on the property of the new owners for transactions pre-Craft, that have occurred based on the understanding of entireties prior to the Craft decision?   Will it matter if the IRS sanctioned the  transfer and acknowledged that it had no interest in the entireties prior to the closing?  These   questions remain to be answered.  The Sixth Circuit now must decide what the value of Mr.  Craft’s “bundle of sticks” is.  If the IRS position is consistent with the position they have taken in offer in compromise situations, they will argue that they are entitled to half of the entireties  property (just as they did prior to the sale in this case.).   Such a value would be totally contrary to all of the valuation cases recently decided with respect to family partnerships and other entities that involve limitations with respect to sale, minority interest, and lack of marketability.                                                                                                                                     What  is clear is that there is no entireties asset protection for separate tax liability among spouses, and  we may have now entered a new valuation morass which might require tracing  sources for payments and acquisition of entireties assets.   Another area for consideration is  whether amended joint returns should be filed to reduce the total tax liability in cases where entireties protection required separate returns.   Such a decision must also include consideration  of innocent spouse and potential divorce consequences of joint returns.