Why Craft isn't scary

Johnson, Steve R

Editors' Synopsis: The Supreme Court recently decided Craft, in which it held that the federal tax lien attaches to a tax-debtor spouse's interest in property held in tenancy by the entirety. Responding to concerns that were voiced most frequently about Craft, this Article argues that Craft does not impermissibly impinge on the traditional state role in establishing property and debtor-creditor rules. The Article concludes by describing how rights and legitimate interests of nontax-debtor spouses can be safeguarded in light of Craft.

I. INTRODUCTION

In April 2002, the Supreme Court of the United States decided United States v. Craft.1 The Court held that the federal tax lien attaches to a tax-- debtor spouse's interest in property held in tenancy by the entirety even when the other spouse does not owe tax and state law provides that entireties property and interests cannot be reached by separate creditors of only one spouse.

Craft was correctly decided. The older, contrary view that Craft displaced was fundamentally at odds with federal tax collection analysis as laid out by the Court. In addition, the old view invited tax abuse and created unfairness.2

Despite the wisdom of Craft, the decision has troubled some commentators. This is not surprising. As those involved in law reform efforts will readily attest, human beings, especially legal professionals, tend to eye change with suspicion. Though unsurprising, the concern about Craft is unnecessary. The message of this Article is that Craft is neither radical nor dangerous. Some of the concerns are misplaced. Other, more legitimate concerns can be assuaged by sensible answers to the implementation issues that arise as a result of Craft.

Part II of this Article describes the issue addressed in Craft and the Court's resolution of that issue. Parts III and IV address the two concerns most frequently voiced about Craft. Part III maintains that Craft does not impermissibly impinge on the traditional role of the states in establishing property and debtor-creditor rules. Part IV describes how the rights and legitimate interests of the spouses not owing tax can be safeguarded in light of Craft.

II. FOUNDATIONS

Understanding Craft requires an appreciation of the Court's decision in December 1999 in Drye v. United States.3 Thus, this part of the Article begins with Drye and then advances to Craft.

A. Drye

Drye is a landmark case delineating the respective roles of federal and state law in federal tax lien analysis. Although a number of special liens also exist,4 the general federal tax lien is by far the most important. The general lien comes into existence when the Internal Revenue Service ("Service") has assessed the tax and the taxpayer has failed to pay it after the Service has made notice and demand for payment.5 Once it arises, the lien relates back to the date on which the assessment was made and continues until the liability has been paid or "becomes unenforceable by reason of lapse of time."6 The statute of limitations on collection typically expires ten years after the assessment was made,7 although many circumstances suspend the running of this limitations period.8

The scope of the general tax lien matters most for present purposes. The general tax lien is governed by Internal Revenue Code ("Code") section 6321, which provides that the lien attaches to "all property and rights to property, whether real or personal" of the tax delinquent.9 The word "all" makes the statutory language sound sweeping, and that is how the Court consistently has read it. For example, in 1945, the Court remarked: "Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes."10 In 1985, the Court reemphasized that the language of section 6321 "is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have."11

fundamental importance. Long ago, the Court noted that "taxes are the life-blood of government, and their prompt and certain availability an imperious need."12 The Court has repeated this recognition several times since,13 and contemporary national and international events surely reinforce it.

But precisely what are "property and rights to property"? The Code does not define the terms, and nor do the Treasury Regulations promulgated thereunder. That being so, one naturally thinks of the rich body of state property law and wonders what role it may play in the enterprise. State law does at least the following three things: (1) it creates estates, interests, and rights in property; (2) less frequently, it categorizes the powers created-that is, it labels them as property or nonproperty; and (3) it establishes debtor-creditor rules, that is, it declares how and when creditors may proceed against property to satisfy unpaid debts and identifies property that is immune or exempt from creditors.14 Which, if any, of such rules apply to or are incorporated into federal tax collection analysis?

taxes from disability payments18 and retirement benefits19 even though state law expressly places them beyond the reach of the creditors of recipients.

Considerable confusion, however, surrounds the second element. The better view always has been that state labels and categorizations are not controlling, or even relevant20 to whether a particular item rises to the level of being property or a property right for section 6321 purposes.21 Many holdings support this view.22 Many Court utterances also give effect to this. But other opinions contain loose language that could be interpreted--and sometimes has been interpreted-to mean that state law could control the definitional question.23

Thus the matter stood when the Court took up Drye. Narrowly put, the issue in Drye was whether the general tax lien attaches to disclaimed interests. Rohn F. Drye, Jr. had unpaid tax assessments of nearly a third of a million dollars. He was the sole heir of his mother's estate of $230,000. However, he disclaimed his interest in the estate, causing it to pass to his daughter. She used the proceeds to establish a spendthrift trust. She and her parents were the beneficiaries; their attorney was the trustee. The Service asserted that its liens against Mr. Drye attached to the disclaimed interest.24

ceased the decedent. Accordingly, Mr. Drye maintained that, by virtue of the relating-back disclaimer, he never had a property interest in his mother's estate. Thus, there was nothing to which the tax liens against him could attach.

The Court held unanimously for the Service. For present purposes, the key part of the Court's opinion was its clarification of the role of state law in federal tax lien analysis. The Court held: "The Internal Revenue Code's prescriptions are most sensibly read to look to state law for delineation of the taxpayer's rights or interests, but to leave to federal law the determination whether those rights or interests constitute 'property' or `rights to property' within the meaning of sec 6321.27

Accordingly, Drye makes clear that recourse to state law is appropriate for only one purpose, to identify which strings, powers, or controls the tax delinquent has as to the assets out of which the Service seeks to effect collection. Once that has been done, recourse to state law ends and all further matters are governed exclusively by federal law. Thus, whether the identified strings, powers, or controls rise to the level of being property or rights to property under section 6321 is purely a question of federal law.28 Similarly, what steps the Service can take against the property after attachment of the tax lien and what defenses or protections the taxpayer or third parties may have against those steps are purely questions of federal law.

disclaim, he would get the property; if he did disclaim, his act would channel the property to his daughter. He had the power to direct where the property would go. That was enough to give him a property right for section 6321 purposes.32

B. Craft

Craft is the first case after Drye in which the Court tested the role of state law in federal tax lien analysis. In fact, much of the drama in Craft involved whether the Court would adhere to its salutary clarification in Drye or would undercut it, returning us to the pre-Drye muddle. Fortunately, the Court took the first course.

Despite the expansive reading generally given to section 6321, for a long time an anomaly existed with respect to a tax delinquent's interests in tenancy-by-the-entirety property. In its original conception, this tenancy was based on a fiction: the notion that, by virtue of marriage, the husband and especially, the wife had lost their separate identities and became one person in law.33 The fiction reflected "a particularly difficult form of doublethink,"34 and many states abolished tenancy by the entirety as a form of ownership.35

proceed against entireties property to collect separate debts of one of the spouses. The following discussion focuses on two patterns of state law, which I call, respectively, the "partial bar" and the "full bar" jurisdictions.36

There are approximately ten partial bar jurisdictions. In these jurisdictions, the liens of separate creditors can attach, but are subject to the rights of the other spouse.37 This means that the underlying property cannot be levied on until the entireties estate ends. For example, divorce converts an entireties estate into a tenancy in common,38 which would allow the separate creditor to proceed against the debtor's now separate interest. Or, death of one spouse leaves the survivor as the sole, fee simple owner of the property.39 Therefore, if the debtor spouse is the survivor, the creditor may act against the whole property; however, if the nondebtor spouse is the survivor, the creditor is left without recourse.

There are approximately sixteen full bar jurisdictions. In these jurisdictions, separate creditors have even less recourse. Their liens do not attach at all to, and they may not levy on, entireties property or interests.40

The extent to which the federal tax lien attaches to entireties property or interests first was litigated generations ago,41 before Drye's clarification of the limited role of state law in federal tax lien analysis. The early cases followed the state rules, importing them into the tax lien area. Subsequent cases typically followed suit. There were numerous such decisions,42 and only a few discordant notes.43

ment of the federal tax lien to entireties interests and property depended on the content of state law. Under the pre-Craft view: (1) if the spouses were jointly liable for the unpaid tax,44 the tax lien attached because under state law, entireties property is answerable for joint debts;45 (2) if only one spouse was liable in a partial bar state, the tax lien attached to that spouse's interest subject to the other spouse's interest;46 (3) if only one spouse was liable in a full bar state, the tax lien attached to nothing.47

However, the Court never embraced the pre-Craft view. Although the Court did not directly address the issue of the attachment of the federal tax lien to entireties property until Craft, dicta in a 1983 decision cast doubt on the pre-Craft view,48 and the pre-Craft view seemed hard to reconcile with several decisions of the Court.49

nearly a half million dollars against him, but not Sandra, for those years. When the Service filed notices of tax lien against Don, the Crafts quitclaimed the parcel into Sandra's sole ownership. The Service asserted that the conveyance was fraudulent.

Later, Sandra wished to sell the parcel. The Service agreed to discharge the parcel from the liens against Don,51 subject to the sale proceeds being held in escrow pending determination of whether the tax lien attached to part of the proceeds.

Several rounds of litigation ensued. Despite some support for the Service's position,52 the Sixth Circuit ultimately followed the pre-Craft view, holding that the tax lien did not attach to any part of the sale proceeds.53 By a six-to-three vote, the Court reversed, overthrowing the pre-Craft view.54

The main thrust of the Court's decision is the inconsistency of the pre-- Craft view with Drye. The Court followed its holding in Drye that state law is consulted only to identify which powers, strings, or controls the tax delinquent has as to the asset in question and thereafter, state law is irrelevant.55

tion.

(1) Identification: The Court looked to Michigan law to ascertain what powers Don had as to the parcel.

According to Michigan law, [Don] had, among other rights, the following rights with respect to the entireties property: the right to use the property, the right to exclude third parties from it, the right to a share of income produced from it, the right of survivorship, the right to become a tenant in common with equal shares upon divorce, the right to sell the property with [Sandra's] consent and to receive half the proceeds from such a sale, the right to place an encumbrance on the property with [Sandra's] consent, and the right to block [Sandra] from selling or encumbering the property unilaterally.56

(2) Characterization: Under the characterization made by state law, Don had no interest in the parcel. "Following Blackstone, Michigan characterizes its tenancy by the entirety as creating no individual rights whatsoever."57 But that characterization under state law clearly is a fiction, as the above enumeration of Don's powers reveals. Following Drye, Craft rejected the relevance of state law fictions.58

Indeed, the fiction under state law is hard to swallow. As the Court noted, Sandra "had no more interest in the property than [Don]; if neither of them had a property interest in the entireties property, who did?"59 The Court properly labeled this result absurd and noted its potential to facilitate abuse of the tax system.60

Fortunately, we are not compelled to endure either logical contortion or tax abuse. Whatever their nature, state law characterizations are not germane to the section 6321 characterization. As the Court observed, following Drye:

State gives these rights or the conclusions it draws from them. Such state law labels are irrelevant to the federal question of which bundles of rights constitute property that may be attached by a federal tax lien.61

So, irrespective of Michigan's characterization, did the bundle of powers Don had as a tenant by the entireties constitute property or property rights for section 6321 purposes? The Court said "yes." Its reasoning proceeded as follows:

First, the Court noted approvingly the previous case law62 reading the language of section 6321 as sweeping.63

Second, the Court focused on Don's present powers regarding the parcel. The Court noted his right to use the parcel, to receive income produced by it, and to exclude third parties from it, calling these rights "some of the most essential property rights,"64 a conclusion amply supported by the Court's previous decisions.65 The Court stated: "These rights alone may be sufficient to subject [Don's] interest in the entireties property to the federal tax lien. They gave him a substantial degree of control over the entireties property."66 That is significant because "as [the Court] noted in Drye, in determining whether a federal taxpayer's state-law rights constitute property or rights to property, the important consideration is the breadth of the control the taxpayer could exercise over the property."67

unilaterally alienate the property was relevant to the characterization, but not sufficient to remove Don's bundle of powers from the category of property rights described in section 6321.68 That conclusion69 was supported by the fact that cases already had established that the tax lien attaches to other types of interests that are not unilaterally alienable, such as interests in homesteads,70 community property,71 and spendthrift trusts.72 Drye had been to the same effect,73 and other bodies of law could be enlisted in support of the same conclusion.74

The Court seems to have found the characterization question an easy call. Once characterization is understood as a federal question, as Drye teaches it must be, the powers, strings, and controls that each entireties tenant possesses, when taken in the aggregate, easily rise to the level of property or property rights for section 6321 purposes.75

Fourth, the Court rejected the relevance of state law restrictions on creditors of entireties spouses. The Court noted that the fact that Michigan law does not permit separate creditors to proceed against entireties property or interests

exempt status under state law does not bind the federal collector.76

Doctrinally, the Court's decision in Craft clearly is correct. A contrary holding could not have been squared with Drye; indeed, it would have remuddied the waters Drye clarified. When disquiet is expressed about Craft, it usually is not on doctrinal grounds. Rather, the concerns relate more to policy, principally the effect of the decision on federalism and on nondebtor spouses. As described in Parts III and IV respectively, these concerns can be answered.

III. CRAFT AND FEDERALISM

As Drye was foundational in Part II, another Court precedent is foundational in Part III: the 1983 decision in United States v. Rodgers.77 Below, we consider Rodgers first, then explore the federalism implications, if any, of Craft.

A. Rodgers

Rodgers involved two consolidated cases presenting the same legal issue.78 For simplicity, we will note the facts of only one of the cases.79 Lucille Mitzi Bosco Rodgers and her then-husband acquired a residence in Texas, which they occupied as a homestead. In 1971 and 1972, the Service assessed nearly a million dollars of wagering taxes, interest, and penalties against the husband. The husband's debts remained unpaid as of his death in 1974. Lucille owed no tax.

The Court held that the property could be sold under section 7403.81 Because section 7403 operates only when the tax lien is in place, this holding means that the federal tax lien attached to Lucille's deceased husband's interest in the homestead property.82

For our purposes, it is particularly striking that Texas law-indeed the state constitution-established a formidable set of protections for homestead property. Specifically:

(1) With exceptions not here relevant, Texas homesteads were "protected from forced sale, for the payment of all debts . . . . No mortgage, trust deed, or other lien on the homestead shall ever be valid."83

(2) "[T]he owner or claimant of the property ... [may not], if married, sell or abandon the homestead without the consent of the other spouse . ."84

(3) Upon the death of the first spouse, the homestead property "shall not be partitioned among the heirs of the deceased during the lifetime of the surviving husband or wife, or so long as the survivor may elect to use or occupy the same as a homestead."85

For state law purposes, these provisions operated in two directions.

One is that these laws confer a mere privilege of exemption, which operates to prevent the use of the process of the court to sell certain property for the payment of debts. The other is that the homestead right is considered an estate in land vested in the person designated by law.86

The Court summarized it as follows:

spouse or by his or her heirs.87

Although there are differences in detail,88 Texas homestead interests at issue in Rodgers are, for our purpose, comparable in essential nature to the full-bar entireties interests at issue in Craft. As the full bar states did, the state of Texas created a type of interest in property and imbued it with certain characteristics, including strong protections against creditors' claims or the actions of the other spouse. We shall return to this similarity in evaluating the federalism implications of Craft.

B. Craft

A principal complaint of the dissenters in Craft was that the decision "ignores the primacy of state law in defining property interests"89 and "works a sea change in the role States have traditionally played in `creating and defining' property interests."90 The dissenters also warned that Craft "creates a new federal common law of property."91

I believe that concern is misplaced. First, Craft does not break new ground in terms of federal/state relations. The case travels paths well-- trodden by prior decisions. Second, Craft merely involves a federal definition of terms in a federal statute for federal purposes. Defining terms in a federal statute for federal purposes is legitimately within the realm of the federal government's powers. Craft does not displace the ability of the states to define the same terms however they wish for their own nonfederal purposes.

1. Not Groundbreaking

discussed below.

Mitchell v. United States93 was a consolidated case involving two sets of Louisiana taxpayers, the Mitchells and the Sparacios. In the first case,94 Mr. Mitchell earned a salary, half of which was his and half was his wife's under Louisiana community property law. Neither spouse filed federal income tax returns, and tax was not paid on the earnings. In 1961, some years after the income was earned, Mrs. Mitchell formally renounced the community property as part of the Mitchells' divorce. As a result, Mrs. Mitchell received neither a distribution of community property nor a property settlement on dissolution of the marriage, and instead, she was exonerated of "debts contracted during marriage."95

The Service determined deficiencies against Mrs. Mitchell based on her half of the community income, and it sought to collect the deficiencies out of property she had owned and gratuitously transferred. The Fifth Circuit held that, by virtue of her state law renunciation, Mrs. Mitchell avoided tax liability on the community income.96 The Court unanimously reversed, noting that "with respect to community income, as with respect to other income, federal income tax liability follows ownership."97 The Court noted that, in determining ownership, "state law creates legal interests but the federal statute determines when and how they shall be taxed."98

The results urged by the [taxpayers] might follow, of course, in connection with a tax or other obligation the collection of which is controlled by state law. But an exempt status under state law does not bind the federal collector. Federal law governs what is exempt from federal levy.

... [S]tate law which exempts a husband's interest in community property from his premarital debts does not defeat collection of his federal income tax liability for premarital tax years from his interest in the community. The result as to [the taxpayers in the instant case] is no different.101

United States v. Irvine102 considered whether a transfer subject to the federal gift tax resulted from disclaimer of a remainder interest in a trust. The taxpayer argued that a Treasury Regulation governing disclaimers was inapplicable and, thus, that state law applied. "Under state property rules, an effective disclaimer of a testamentary gift is generally treated as relating back to the moment of the original transfer of the interest being disclaimed. . . ."103

The Court, in a unanimous decision, rejected that argument. It referred, as had the Mitchell court, to "the general and longstanding rule in federal tax cases that although state law creates legal interests and rights in property, federal law determines whether and to what extent those interests will be taxed."104 The Court concluded that "Congress had not meant to incorporate state-law fictions as touchstones of taxability when it enacted the [statute]. Absent such a legal fiction, the federal gift tax is not struck blind by a disclaimer."105

While Irvine involved fictions arising under state disclaimer rules in the tax liability context, Drye involved fictions in the tax collection context. The result, though, was the same: a clear and unanimous holding that state law rules do not control federal taxation.106

property or debtor-creditor rules. As a result, federalism complaints about Craft are reminiscent of similar complaints about the prior decisions. For instance, just as the dissenters in Craft said that Craft "ignores the primacy of state law in defining property interests,107 a commentator said that Drye "reversed the long held belief that state law defines property."108

The dissenters in Craft, though, found Craft unique and, with respect to the history discussed above, noted that: "Drye, like Irvine and Mitchell before it, was concerned not with whether state law recognized 'property' as belonging to the taxpayer in the first place, but rather with whether state laws could disclaim or exempt such property from federal tax liability after the property interest was created."109 They read the prior cases as establishing a "careful line between state laws that purport to disclaim or exempt property interests after the fact, which the federal tax lien does not respect, and state laws' definition of property and property rights, which the federal tax lien does respect."110

This distinction is not viable, however. The dissenters read the prior cases selectively and invented the distinction, rather than finding it in the precedents. The "careful line" of distinction to which the dissenters refer is drawn infrequently or not at all in the prior cases. The only cases that possibly support the dissenters' position are the 1940 Morgan v. Commissioner111 and the 1960 Aquilino v. United States112 decisions. But Morgan is internally inconsistent, and the language in both cases is best regarded as an imprecise statement of a view compatible with Drye and Craft rather than as the statement of a different view.113

end" limitations and fictions.

Finally, the proffered distinction wholly omits Rodgers. The dissenters infer the careful line of distinction only from the above cases and do not attempt to fit Rodgers into the distinction.114 Nor could they. The distinction the dissenters offer explains neither the language nor the facts of Rodgers. In Rodgers, there was no back-end exemption. The exemption of homestead interests from creditors' claims was part and parcel of those interests from the outset; indeed, the exemption was central to the state's creation of such interests. Similarly, in Rodgers there was no renunciation or disclaimer.

Thus, the dissenters failed to show that Craft was unique in that it created federalism concerns not present in prior cases. One can say, of course, that multiple wrongs do not make a right. Nonetheless, it is hard to think that Craft "works a sea change"115 when it merely navigates waves and billows that have felt the same prow before.

2. Federal Definition for Federal Purposes

The dissenters in Craft objected that the decision "creates a new federal common law of property."116 One answer to that objection is that any such creation was the work of Drye, not of Craft. Indeed, considering prior cases on the subject, Drye is best understood as a clarification, not a change of law.117 Drye held that whether the bundle of state-created rights constitutes section 6321 property or property rights is a matter of federal law.118 Inevitably, that calls into being a federal common law of property, for this limited purpose. The Court recognized that when it decided Drye because a substantial portion of the Drye opinion consists of the distillation of criteria from prior federal cases that bear on the resolution of this federal question, i.e., criteria indicative of section 6321 property status.

to a federal enterprise of fundamental federal interest. This act does not offend federalism; it respects it.

In this regard it is significant that: (1) a Court known for its solicitude toward the principle of federalism decided Drye unanimously;119 (2) Justice O'Connor wrote the Craft majority opinion; and (3) she along with Chief Justice Rehnquist and Justice Kennedy-all numbered among federalism's strong advocates on the current Court-constituted half of the six-person Craft majority.

The majority's understanding-that federalism is not traduced by federal definitions for purposes of federal revenue laws-has considerable support in Court precedents. For example, in an early depreciation case, the Court stated: "It does not matter that in Ohio, where the properties lie, [a different characterization exists.] The Act of Congress has its own criteria, irrespective of local law." 120 Similarly, the Court instructed in an early capital gains case:

Here we are concerned only with the meaning and application of a statute enacted by Congress, in the exercise of its plenary power under the Constitution, to tax income. The exertion of that power is not subject to state control. It is the will of Congress which controls, and the expression of its will in legislation, in the absence of language evidencing a different purpose, is to be interpreted so as to give a uniform application to a nation-wide scheme of taxation. State law may control only when the federal taxing act, by express language or necessary implication, makes its own operation dependent upon state law. 121

Many other cases could be cited to the same effect.122

not undercut when one sovereign defines a word in a particular fashion entirely for its own purposes. Nor is federalism undercut when one sovereign defines the word differently from how other sovereigns define the word for their own, separate purposes.

IV. CRAFT AND PROTECTION OF NONDEBTOR SPOUSES

Cases previously discussed are relevant to the issue of the protection of the nondebtor spouse as is a case not yet emphasized: United States v. National Bank of Commerce,123 ("NBC'). This part of the Article first discusses NBC, then considers whether, in light of NBC and other cases, Craft excessively compromises the legitimate interests of entireties spouses who do not owe tax.

A. NBC

In NBC, the Service had assessed income taxes, interest, and penalties against Roy Reeves, but part of the assessments remained unpaid.124 Roy, his wife Neva, and his mother Ruby were the joint holders of two bank accounts. The record did not disclose, indeed the parties stipulated that they would submit no evidence as to, which of the coholders owned the monies in the accounts. Under applicable state (Arkansas) law, each of the three coholders had the right to withdraw the full amounts in the accounts without notice to or consent by the other coholders.125

The Government brought suit against the bank for failure to honor the levy. The district court held for the bank on the constitutional ground that due process requires "something more than" the post-levy remedies available under the Code.128 Specifically, it concluded, due process requires at least that the Service identify the other account holders, notify them of the intended levy, and give the account holders a pre-levy opportunity to be heard.129 The Eighth Circuit affirmed, although on different grounds.130 It expressed no opinion on the district court's constitutional analysis, but reached the same result as a matter of statutory construction.131 Specifically, the court held that the levy statute, section 6331, imposes on the Service the burden of proving "the actual value of the delinquent taxpayer's interest in jointly owned property,"132 which the Service had not done as to the two accounts. Although refusing to allow levy on the accounts, both the district court and the circuit court suggested that the Government would have been permitted to bring suit133 to foreclose the tax lien against the accounts. 134

affording them the opportunity to show the extent of their respective interests in the account.138

By a vote of five to four, the Court reversed the Eighth Circuit, upholding the levy. Many aspects of the Court's opinion in NBC undergird positions advanced earlier in this Article. These are noted briefly below.

1. Reinforcement of Prior Positions

In NBC the Court reemphasized that the language of section 6321 is broad and should be applied that way.139 It also noted "the need of the government promptly to secure its revenues,"140 which explains Congress's choice to write the tax collection statutes broadly.

The Court held that Roy's right to withdraw the funds, even if he did not own them, was a property right for section 6331 purposes.141 Necessarily, this holding means that it was a section 6321 property right too. The Service cannot levy under section 6331 on items to which its section 6321 lien does not attach; indeed, the operative language of the two sections is identical.142

Because the right to withdraw in NBC was property or a right to property for federal tax collection purposes, it follows that, as held in Craft, entireties interests are as well. Plainly, the right to withdraw money that must be returned upon demand by the owner is not a thicker bundle of sticks than the powers of an entireties spouse, which include an absolute right to occupy or use the property, an absolute right to share in income from it, an absolute right to exclude third parties from it, among others.143 That being so, NBC foreshadowed, indeed compelled the Craft result.

federal law," not state law.145 In addition, the Court decisively rejected the "erroneous assumption that state law dictates the extent of the Government's power to levy. It does not...."146 The Eighth Circuit had held that because state law provided that an account holder's creditors are not subrogated to his right to withdraw, the Service was similarly limited. But the Court noted that such an approach "would remit the [Service] to the rights only an ordinary creditor would have under state law. That result `compare[s] the government to a class of creditors to which it is superior'."147 State law is used only to identify the powers possessed by the tax debtor as to the property. Beyond that, state law is irrelevant.148

2. Protection of Other Owners or Interest-Holders

For purposes of part IV, the greater significance of NBC lies in its instruction as to the rights of, and protections for, those persons who hold interests in property along with a tax delinquent, but do not owe tax. In NBC, Ruby and Neva were such persons; in entireties cases, the nondebtor spouses are such persons.

NBC teaches the following: (1) the remedies available to the nondebtor co-owner are important and must be examined; (2) such remedies may be seen as adequate even if they entail some inconvenience, burden, or risk to the co-owner; and (3) a balancing of the respective interests of the Government and the co-owner is required. These aspects are discussed below.

First, central to the Court's decision in NBC was the fact that administrative levy under section 6331 is only a provisional measure. It "settles no rights in the property subject to seizure."149 Unlike a lien foreclosure suit under section 7403, "levy does not determine whether the Government's rights to the seized property are superior to those of other claimants."150

have the opportunity to establish their ownership and thus, to secure return of the funds from the Service. If the Service "determines that property has been wrongfully levied upon," it has authority to return to the owner, in the case of cash, "an amount of money equal to the amount of money levied upon" or, in the case of noncash property, the specific property itself or an amount equal to what the Service got by selling it.151 The Court viewed this as "an effective and inexpensive administrative remedy" for the true owner. 152

In addition, should the administrative remedy prove unavailing, a judicial remedy exists. "If a levy has been made on property or property has been sold pursuant to a levy, any person [other than the tax delinquent] who claims an interest in or lien on such property and that such property was wrongfully levied upon" may sue the Government in federal district court.153 The prevailing plaintiff would receive, as appropriate, an injunction prohibiting enforcement of the levy or sale of the property,154 return of the specific property, judgment for the amount of money levied on, or judgment for the greater of what the Service got from the sale or the fair market value of the property immediately before levy.155 The prevailing plaintiff also may recover interest.156

Thus, a section 6331 levy is only provisional and does not finally determine rights to the property. In upholding such levy, the Court examined the subsequent remedies available to interest-holders other than the tax delinquent.

[O]ne would hardly characterize as "provisional" the Government's taking of an innocent party's property without notice, especially when, even if the taking is discovered, the burden is then on the innocent party to institute recovery proceedings. Furthermore, absent notice of any kind, the nine months that the . . remedies ordinarily give third parties to contest a levy is a short time indeed. There is no certainty that within this time they will discover that their property has been used to pay someone else's taxes. 159

Thus, what matters is that the nondebtor co-owners have recourse to vindicate their interest. That they bear some cost or burden of vigilance is not controlling-those are normal incidents of our legal system.

Third, the implication of the foregoing is that the adequacy of the system is determined by a balancing of interests. Moreover, when Congress has effected a balance through its statutory arrangements, that balance is entitled to considerable deference. The NBC Court taught:

Congress thus balanced the interest of the Government in the speedy collection of taxes against the interests of any claimants to the property, and reconciled those interests by permitting the IRS to levy on the assets at once, leaving ownership disputes to be resolved in a postseizure administrative or judicial proceeding. Its decision that certain property rights must yield provisionally to governmental need should not have been disregarded by the Court of Appeals.160

B. Craft

Craft raises the question as to whether permitting the tax lien to attach to the debtor spouse's interest will unduly compromise the rights and legitimate interests of the nondebtor spouse in the entireties property. Fear of such a result was one of the reasons early courts barred the liens.161 In fact, this fear-with a gender spin-prompted Justice Scalia's separate dissent in Craft. He said:

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. It is regrettable that the Court has eliminated a large part of this traditional protection retained by many States.162

Some will think the model of social roles and relations Justice Scalia wants to protect to be of diminishing relevance in contemporary society. In my view, the injection of gender effects is unnecessary. If Craft truly did compromise legitimate interests of nondebtor spouses, that would be a grave deficiency, regardless of whether those spouses were mostly husbands or mostly wives.

Reasonable protection of nondebtor spouses should be a principal objective as Craft is implemented administratively and judicially. Collecting one person's tax liabilities out of another person's assets would be fundamentally unfair even if those persons are married to each other. Indeed, doing so would raise substantial questions of due process.163

However, Craft poses little danger of oppressing nondebtor spouses. I say this for the following three reasons: (1) Craft poses no risks beyond those already found acceptable in other contexts; (2) the mere attachment of the lien does not harm nondebtor spouses; and (3) realistic post-lien-- attachment options contain ample protections for nondebtor spouses.

1. Uniqueness

The same fact noted as to the federalism concern operates here as well. Craft entails no danger to non-liable co-owners that is unique in either kind or degree. While the same concerns exist in other contexts, they have been deemed acceptable or shown to be exaggerated.

that risk in NBC because the system provides substantial protections and remedies for aggrieved co-owners. As indicated below, that same situation pertains as to nondebtor spouses in entireties estates.167

In Rodgers, the Court permitted the Service to seek judicial sale of homestead property under section 7403.168 As with NBC, Rodgers arguably poses a greater risk to third parties than Craft.169 The Court concluded that the concerns were alleviated by the formidable safeguards section 7403 contains to protect nondebtor co-owners of property.170 We will see that section 7403 will be the mechanism that the Service uses in entireties cases too, if it seeks to go beyond mere attachment of the lien. Thus, these same formidable safeguards will protect entireties spouses.171

some states, community property interests are not. 178

Accordingly, Craft has not cast us into uncharted seas. Most of the property owned by spouses in this country is and has been held in forms permitting attachment of the tax lien to the interest of one spouse when only that spouse owes tax. Craft simply ends an anomaly. Nondebtor spouses have been adequately protected in those contexts. They can be here as well.

2. Mere Lien Attachment Not Threatening

Craft by itself is not threatening. Craft held only that the tax lien attaches to entireties property. Mere attachment of the lien does not imperil substantial interests of the nondebtor spouse. Nondebtor spouses can continue to occupy or use the property, receive their shares of income produced by it, exclude third parties from it, and the like. Moreover, the nondebtor spouse's contingent rights would be preserved. In the event of divorce, the nondebtor spouse would receive a tenancy-in-common interest just as before the lien attached. If the debtor spouse died first with the marriage intact, the nondebtor's survivorship interests would ripen into fee simple ownership of the whole property, just as before the lien attached.179

As a practical matter, the couple could not sell the property once the lien attached. After the Service files notice of the tax lien, a purchaser or grantee takes the property subject to that lien.180 As a result, the property would be effectively unsaleable. But that is no substantial circumscription of rights. The nondebtor spouse could not unilaterally alienate the property or her interests in it even before the lien attached. She needed the consent of the other spouse. After lien attachment, she would, in effect, need the consent of the Service, which would stand in the shoes of the debtor spouse.181

How likely would it be that the Service would so forebear? Quite likely in many, though not all, cases. 182

The Service makes levies, seizures, and sales in the distinct minority of unpaid assessment cases,183 for a variety of reasons, which are set forth below. In some cases, the liability may be too small, or the taxpayer's interest worth too little to warrant the effort and expense of levy or sale.184 In other cases, the Service may determine that the hardship to the taxpayer outweighs the benefit to the Government.185 And in others, the revenue officer may feel that, on the particular facts of the case, there would be an excessive public relations risk to the Service186 or personal career risk to the officer from aggressive collection.187 Finally, in an increasing number of cases, there simply are not enough revenue officers to handle all, or even most, of the collection cases in the queue.188

the oral argument of Craft.189 That remark does not bind the Service, of course. Still, at least three reasons explain why this prediction is likely to be correct.

First, enforced collection in entireties cases will be expensive for the Service. Revenue officers usually prefer to proceed via levy or seizure followed, in the case of noncash property, by administrative sale. This process is comparatively simple and inexpensive for the Service because it usually can be effected by collection personnel only. In entireties cases, though, that preferred route typically will be infeasible, and the Service will be required to act through judicial sale under section 7403.190

The section 7403 avenue requires the revenue officer to send the case to Service counsel, which, if it concurs, then must send the case to the Department of Justice Tax Section for commencement of the proceeding.191 The proceeding can be protracted and costly because "[a]11 persons having liens upon or claiming any interest in the property" must be joined in the action.192 Moreover, the net proceeds of any ensuing sale are divided among the parties in proportion to their respective interests in the property.193 Dividing the proceeds requires valuation, likely through expert testimony, thus adding to the expense. 194 Thus, the costs in time and dollars will incline the Service to go beyond lien attachment only as a last resort.

Accordingly, in this era of the "ten deadly sins,"198 this potential is unlikely to escape notice by revenue officers. The Service likely will rest at mere attachment of the lien unless some factor in the case shifts the equities in favor of more aggressive collection. The following are factors the Service will consider in judging the benefits of more aggressive collection:

(1) Whether the property is cash or noncash. The fact that the real property in Craft had been sold and the case was about dividing a pot of cash, was helpful to the Government.199

(2) Whether the property is central to the marital union or the welfare of the couple. The marital residence usually will be the most sensitive type of property200 and probably will be actively pursued by the Government only rarely. Depending on the circumstances, certain other kinds of property also may be sensitive, an awareness reflected in various current statutes and in administrative practice.201

(3) Whether the nondebtor spouse colluded with the debtor spouse. One of the problems with the pre-Craft rule was that it created a ready pathway for abuse. By filing separate returns and holding their properties by the entireties, spouses effectively could underpay their taxes with impunity from collection, especially in the full bar jurisdictions.202 That is not to say that all entireties estates were vehicles for such abuse. Some were, but many were not. How the equities of the particular enforcement case are perceived will depend in part on whether the facts show that the nondebtor spouse colluded with the other spouse or participated in a scheme to defeat tax collection.203

action. This could happen in any of several ways:

(1) Sometimes, the spouses voluntarily will pay an amount corresponding to the value of the debtor spouse's interest in the property. They will do this to put the matter behind them or, more frequently, to remove the cloud on title and make the property saleable.204 This happened occasionally before Craft; it will happen much more frequently now.

(2) Sometimes the Service will be able to "piggy back" onto a collection proceeding brought by another creditor. Lenders in entireties states, aware of the problems faced by separate creditors, typically require both of the spouses to be obligors. If the loan is not repaid, the lender (a joint creditor and, thus, eligible to proceed) may seek payment out of the entireties property. The Service will be joined in such a case, or will intervene, on account of the tax lien. Depending on the values and the priorities of the various claims,205 the Service may receive some payment without being required to initiate action against the property.

(3) Divorce is common. If there is some prospect of divorce in a particular case, the Service could simply wait. When, on account of dissolution of the marriage, the entireties estate is converted into a tenancy in common,206 the Service then could proceed against the now-severable property interest of the debtor spouse.

(4) Should the ages or health of the spouses suggest that the nondebtor spouse is likely to die first, the Service may wait until, by virtue of survivorship, the debtor spouse becomes the sole owner of the whole property.207

3. Enforced Collection Not Threatening

Although the Service often will rest at mere attachment of its lien, in many entireties cases it inevitably will proceed to enforced collection in some cases. Will such cases pose unacceptable risks to nondebtor spouses?209 I think not. My conclusion rests on two pillars: (1) the only practicable enforced collection option for entireties cases is judicial sale and division of proceeds under section 7403, and (2) section 7403 sale-and-- division entails substantial safeguards that will adequately protect nondebtor spouses.

The Court noted in Rodgers that the Service normally has three main tools of enforced collection.210 First, the Government may "sue for the unpaid amount, and, on getting a judgment, exercise the usual rights of a judgment creditor."211 Second, the Service may levy under section 6331 followed, in the case of noncash property, by administrative sale under section 6335. Third, the Government may request that a federal district court authorize a sale of the property and a division of the proceeds among the Service and the other claimants who are interest-holders under section 7403.

The first of these options will be unavailing in entireties situations except in the easiest cases. Having obtained a judgment, the Government still would need to collect on it. If the delinquent had enough nonentireties assets to satisfy the judgment, the Government could have levied on those assets without bothering to obtain a judgment. If the delinquent's nonentireties assets are not enough, the Government will be back in the original position. Obtaining a judgment is unnecessary in easy cases and not helpful in hard ones.

purchaser of the debtor's interest from the Service would be unable to eject the nondebtor from occupation and use of the property, would be unable to transfer or encumber the property without the nondebtor's consent, and would lose his interest entirely if he predeceased the nondebtor.213 No one would buy the debtor's interest from the Service under such circumstances, at least not at a price making the effort worthwhile for the Service.214

Thus, neither of the principal alternatives is likely to be helpful to the Service in entireties situations. When the Service feels compelled to move beyond mere attachment of its lien, it typically will do so through the third alternative: section 7403 sale and division of proceeds.215

In upholding the section 7403 sale of homestead property in Rodgers, the Court noted that "sec 7403 is punctilious in protecting the vested rights of third parties caught in the Government's collection effort, and in ensuring that the Government not receive out of the proceeds of the sale any more than that to which it is properly entitled."216 There are four reasons why this is so.

First, the Service alone conducts administrative levy and sale. In contrast, although the Government initiates a section 7403 proceeding by petition, a court controls the procedure and makes the decisions.

Second, "ja]ll persons having liens upon or claiming any interest in the property . . . shall be made parties" to the section 7403 proceeding.217 Thus, the court will have the advantage of hearing all viewpoints and considering all interests.

sale,219 although such discretion is limited, not open-ended.220 In fact, district courts often exercise such discretion.221 In all likelihood, there would be considerable sympathy for nondebtor entireties spouses in district courts, especially when sensitive property is involved or substantial hardship is threatened.222

Fourth and finally, when the district court does authorize sale of the property, the nondebtor spouse will receive a share of the proceeds corresponding to such spouse's proportionate interest in the property.223 The Court has held that this compensation arrangement obviates possible due process objections to the sale.224

I have argued that the legitimate interests of nondebtor spouses will not be unduly compromised as a result of Craft. That is not to say that life will be precisely the same for nondebtor spouses after Craft as before it. For example, before Craft, nondebtor spouses could, by their unilateral decision, prevent entireties property from being converted into cash via sale. Were a section 7403 sale to occur after Craft, that power would no longer be absolute. Does that significantly disadvantage the nondebtor spouses? No. Three reasons explain such an answer.

the couple could preserve cherished entireties property by paying off the tax liability with their other assets, and, in extreme cases, the district courts may exercise their discretion not to sell.226

Second, the gate swings both ways. Both spouses-the debtor spouse as well as the nondebtor spouse-can block the other's desire to dispose of property. Presumably, cases now exist in which the debtor spouse is preventing sale of property the nondebtor spouse wants to sell. In such cases, a section 7403 sale would provide relief to the nondebtor spouse because of the adequate compensation requirement of section 7403. Thus, cases in which dispositions undesired by the nondebtor spouse occur will be partly or fully offset by cases in which dispositions desired by the nondebtor spouse now can occur. Because of Craft and section 7403, cases of enhanced freedom will counter cases of lessened freedom.

Third, some loss of flexibility for some nondebtor spouses should not be viewed as decisive. We have never viewed an owner's right to hold onto property as absolute when a strong public interest is involved and the owner will be adequately compensated. One example is the power of eminent domain pursuant to which a unit of government may force citizens to sell their property, whether entireties or not, to the unit.

Another example is the treatment of entireties interests in the bankruptcy process. Assume only one spouse files a bankruptcy petition. The resultant bankruptcy estate consists of "all legal or equitable interests of the debtor in property,"227 including that spouse's interest in entireties property.228 The bankruptcy trustee typically is empowered to sell the whole of the property, notwithstanding objection by the nondebtor spouse, and then to pay the nondebtor the value of his or her interest in the property, retaining the remainder of the sale proceeds to pay creditors.229 This approach reminds one of section 7403, and the courts have viewed it as adequately protecting the debtor spouse.230

bankruptcy. Surely, the loss of prerogative should yield to the Government's strong interest in collecting taxes that are owed.232 Lien attachment, even if followed by section 7403 sale, merely would bring to the entireties area a balancing well known and accepted as reasonable in other areas.

V. CONCLUSION

Steve R. Johnson*

* E.L. Wiegand Professor of Law, William S. Boyd School of Law, University of Nevada, Las Vegas. I invite questions or comments. My email address is [email protected]. I thank my friend and former colleague, Professor Jeffrey Stake, whose sometimes different views of the issues discussed herein sharpened my own thoughts. I also thank the audience and participants at the May 2002 session of the American Bar Association Section of Taxation, Individual Income Tax Committee, where I spoke on these issues and received many useful questions.

Copyright American Bar Association, Real Property, Probate and Trust Law Section Fall 2002
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