Those who perform shell games often view them as games of skill. Those who lose money view them as blue collar swindles. I personally lost money at one on the streets of New York in the early 1980’s, a tuition payment to the School of Hard Knocks.
Sophisticated taxpayers use shells—layers of entities—to protect assets in a white collar version of the shell game. In last week’s Campbell v. Commissioner, T.C. Memo. 2019-4 (Feb. 4, 2019) (Judge Kerrigan), it looks like the IRS lost money to one. There, in a CDP proceeding, the Court found that the IRS abused its discretion in refusing an OIC of $12,600 to satisfy a $1.1 million tax liability. The interesting part of the decision for me was trying to figure out how the taxpayer’s various shells affected the ability of the federal tax lien to attach to property or rights to property of the taxpayer. Just based on what the Court wrote in its opinion, I think it possible that the IRS Chief Counsel attorney did not do enough to educate the Court on how to properly analyze the extent of IRS collection powers.
Of course, I am always trepidatious when critiquing an opinion, especially when the opinion is missing information that might well fix some of the problems I see. Here, in particular, it may be me who is confused by the taxpayer’s shell game. As usual, I welcome anyone who spots holes in my thinking to comment.
Of Liens and Levies
To understand my thoughts about this case, one really must understand the difference between a tax lien and a tax levy. Don’t be ashamed if you don’t know the difference. It took me two years in Chief Counsel before I even knew there was a difference! It will take you, however, only the time to read the next few paragraphs. You can find the kitchen sink treatment in Bill Elliot’s very thorough treatise Federal Tax Collections, Liens, and Levies.
Liens. A lien is just a formalized claim. It arises as a matter of law once the IRS assesses, sends the taxpayer a notice and demand and the taxpayer fails to pay. §6321, 6322. I like to think of federal tax liens as virtual sticky notes wafting in the atmosphere seeking to latch onto “all property and rights to property” belonging to the taxpayer. §6321. If there are other claim on the property, federal law uses a “first in time, first in right” rule to determine the order of payoff. United States v. City of New Britain, 347 U.S. 81 (1953).
Once it arises, the federal tax lien relates back to the assessment date, §6322, and so the assessment date becomes the relevant date for determining priority. However, at this point the tax lien is secret. Congress did not think it fair for the secret tax lien to take priority against four types of competing creditors (the “four horsemen”): a purchaser, a holder of a perfected judgment lien, a holder of a perfected security interest, or a holder of a perfected mechanic’s lien. To defeat the four horsemen, the IRS must make the federal tax lien public. The IRS does that by filing a Notice of Federal Tax Lien (NFTL) in the place designated by each state. §6323. Once the NFTL is filed, the tax lien is darned near invincible, even as to any property the taxpayer later acquires. United States v. McDermott, 507 U.S. 447 (1993).
Courts use a two-step process to resolve lien attachment questions because federal law only “attaches consequences, federally defined, to rights created under state law.” United States v. Bess, 357 U.S. 51, 55 (1958). That means courts must first look to see what legal interests state law creates for the taxpayer. The second step is to see whether federal law classifies those interests are “property or rights to property,” within the meaning of §6321. If so, the federal tax lien attaches.
Property is often viewed as a bundle of rights. Importantly for today’s case, the Supreme Court has repeatedly said that the lien attaches to even individual state-created sticks in the bundle---that’s the “rights to property” language in the statute. See, e.g., United States v. Craft, 535 U.S. 274 (2002)(right to occupy and right to prevent unilateral sale of property by others); Drye v. United States, 528 U.S. 49 (1999)(power to disclaim); United States v. Rodgers, 461 U.S. 677 (1983)(right of possession); United States v. National Bank of Commerce, 472 U.S. 713 (1985)(power of withdrawal). Even contingent future interests are subject to the tax lien. Bigheart Pipeline Corp. v. United States, 600 F. Supp. 50, 53 (N.D. Okla. 1984), aff’d, 835 F.2d 766 (10th Cir. 1987).
Levies. A levy is an action, a taking, a seizure. Section 6331 permits the IRS to summarily seize all “property or rights to property” belonging to the taxpayer once the IRS properly assessed and given proper notices to the taxpayer. One of those notices triggers the right to a CDP hearing and Tax Court review. Once that opportunity goes by, however, the IRS can levy with no further pre-levy judicial oversight.
A levy differs from a lien in its scope. While both operate on any “property or rights to property” of the taxpayer, the levy statute also gives the IRS the power to levy any property to which the federal lien is still attached, even after the taxpayer ditches the property to a third party. Treas. Reg. § 301.6331-1(a)(1). See, e.g., U.S. v. Pflum (C.D.Ca. 2017), 120 AFTR 2d 2017-5778 (only on Westlaw or LEXIS).
Importantly, even when a taxpayer does not own property outright, but instead owns a company that owns the property, a levy can still seize the taxpayer’s ownership interest in the company that owns the actual property and the IRS can then use that power to sell the assets owned by the shell. PM Group Inv. Corp. v. PYK Enterprises, Inc., 145 F.3 1332 (6th Cir. 1998). In effect, the levy power permits the IRS to step into the shoes of the taxpayer and exercise any power or rights the taxpayer can take with respect to the property.
In sum, tax liens are passive but pervasive. They attach to property and force payment to the IRS when the taxpayer sells the property and someone has to pay the IRS to clear the lien. The IRS uses its levy powers to seize property, or to vindicate a lien. The IRS can also vindicate a lien by asking the DOJ to file a §7403 lien foreclosure suit.
Today’s case involves both tax liens and levies. Let’s look at the sequence of events.
We start in 2001, when Mr. Campbell was rich. How rich? Rich enough to buy into the CARDS tax shelter to shelter some $14 million of income. The IRS identified CARDS transactions as a listed tax shelter in Notice 2002-21 (Mar. 18, 2002). The Notice told taxpayers how to correctly report the transaction and urged taxpayers who had already filed to amend their returns. Mr. Campbell paid no nevermind to Notice 2002-21. He went ahead and reported only about $200,000 of taxable income instead of the almost $14 million he should have.
In 2004, Mr. Campbell was still rich. How rich? $25 million net worth rich, according to Judge Kerrigan’s opinion. In April he created what Judge Kerrigan calls “an irrevocable grantor trust” (the Trust) in Nevis, West Indies. He funded it with $5 million. One month after creating the Trust, the IRS notified Mr. Campbell that it was opening an examination on his 2001 return. We’ll get back to the trust in more detail below.
In 2006, Mr. Campbell was not quite as rich. His $25 million net worth had shrunk to $19 million. He still raised $27 million to invest in “real estate opportunities in the gulf Coast region” according to the Court, all through shells. In particular he invested in properties in Slidell, Louisiana, through a shell company called, Slidell Property management, LLC (Slidell). Slidell’s sole member was Mr. Campbell. After making these various investments, Mr. Campbell “had approximately $6.5 million remaining in liquid assets.”
In 2007, the IRS issued an NOD proposing to assess a tax deficiency north of $1 million. Mr. Campbell petitioned Tax Court. We don’t know how rich he was then.
In 2010, the Tax Court issued a judgment permitting the IRS to assess about $1.4 million in taxes and penalties against Mr. Campbell. After assessing in April 2010, the IRS filed NFTLs in September and notified Mr. Campbell of the NFTLs and of its intent to start levies. Both actions triggered CDP rights. Mr. Campbell timely invoked his CDP rights as to both the NFTL and the proposed levies. Negotiations and delays ensued, all of which tolled the §6502 statute of limitations on collections.
In 2011, Mr. Campbell became poorer when the lender on the Slidell development foreclosed, selling the properties for $1.35 million to recoup a $4.5 million loan. Over the next five years, Mr. Campbell used a series of shells to repurchase the Slidell properties and develop them. One of the shells he used was the Trust. Again, I am saving the gritty details for the Lesson.
In 2012 the IRS Office of Appeals issued a Notice of Determination to proceed with levies and Mr. Campbell contested it in Tax Court. The case bounced back and forth between the Tax Court and the Office of Appeals for six years between 2012 and 2018, with Mr. Campbell consistently offering his paltry OIC and the IRS consistently rejecting it, each time giving different reasons for why. Generally, the IRS did not think Mr. Campbell’s shell companies were legit. The Office of Appeals kept green-lighting the Service’s levy powers. The Tax Court kept remanding.
The opinion last week is Judge Kerrigan’s judgment about the Office of Appeals “second supplemental Notice of Determination.” The mandate from Judge Kerrigan is simply “the supplemental notice of determination will not be sustained.” Judge Kerrigan appears to think the shells are legit. Nothing in the opinion says whether Appeals also issued a Notice of Determination to keep the NFTLs filed or, if they did, whether Mr. Campbell also petitioned the Tax Court for review of that decision.
The lesson lies in the nature of the shells. We need a closer look at them.
My read of the case is that both parties got the Court off track here by centering their dispute over whether the taxpayer was trying to avoid collection. Key for the Court was the finding that the TP “did not waste his wealth in an effort to deprive the Government or to shirk his financial obligation to the public fisc.” Maybe that is true. Properly framed, however, the question is not whether Mr. Campbell is pure as snow or dirty as Beijing air. The question is whether the government is entitled to rely on its liens to evaluate its collection potential and to start looking for property to seize. The answer to that question does not necessarily turn on whether the shells Mr. Campbell used are legit or whether they are shams. Even if they are legit, I think the IRS has two potentially fruitful sources of collection that make it quite reasonable to proceed with collection action against Mr. Campbell: the Slidell properties and the Trust.
1. Slidell properties.
Remember that the IRS assessed taxes on April 11, 2010. That is the magic date on which the federal tax lien arose and flew about. The IRS filed three NFTLs in September 2010, thus establishing the government’s priority over all later creditors of Mr. Campbell, even as to later acquired property. United States v. McDermott, 507 U.S. 447 (1993).
Thwack! The tax lien attached to Mr. Campbell’s interest in the Trust as of April 11, 2010.
Thwack! The tax lien attached to Mr. Campbell’s interest in Slidell as of April 11, 2010.
Remember Slidell is the wholly owned LLC that owned real estate in Louisiana until losing it to a lender’s foreclosure action in 2011. So the tax lien did not attach directly onto the properties but instead onto Mr. Campbell’s interest in the shell. That’s how legit shells work to protect assets.
It is on the Slidell properties where I found Judge Kerrigan’s opinion confusing. According to Judge Kerrigan, Louisiana law “provided borrowers litigious rights to repurchase properties that had been sold by a lender...” Apparently, either Mr. Campbell or Slidell exercised these rights and repurchased the properties. But I cannot tell from the opinion just who did this: Mr. Campbell or Slidell.
On the one hand, Judge Kerrigan writes that Mr. Campbell brought the suit permitted by Louisiana law (“Petitioner brought a suit against the buyer of the Slidell properties...”). She then says that Mr. Campbell won the suit in 2014 (“Petitioner received a favorable ruling allowing him to repurchase the properties for $1.5 million.”).
On the other hand, Judge Kerrigan’s opinion could also be read to say that it was Slidell that repurchased the properties. She writes that after winning the suit Mr. Campbell, “as sole member of Slidell, sold Slidell’s assets to Clairise Court, LLC for $1.5 million.”
If Mr. Campbell repurchased the properties himself, then Thwack! the tax lien attached to the properties and would continue to be attached no matter if he immediately transferred the properties back into Slidell. And the IRS could, even now, seize the properties to enforce that attached tax lien. McDermott.
But if Mr. Campbell transferred his right to repurchase to Slidell, or if Slidell was the party to the state lawsuit that won the right to repurchase then no thwack on the properties. The corporate entity shell would again shield the properties from the tax lien, unless Slidell was an alter ego or nominee of Mr. Campbell, but nothing in the opinion suggests that. What the tax lien would remained attached to, however, would be any right to property or power over property that Mr. Campbell either kept in Slidell or later created. For example, if he was still the sole member, then the IRS could seize his rights and powers over Slidell and exercise them for the government’s benefit.
If I were the Revenue Officer, I would sure want to know just who brought the state court suit to repurchase. If it was Mr. Campbell personally, and if he then gratuitously transferred his right to repurchase to Slidell, then I think a good case can be made that Slidell should be disregarded in determining what property the tax lien attached to. But if Mr. Campbell properly dotted and crossed his i’s and t’s, why then that’s again just an illustration of how a shell defeats the IRS.
We’re not done with the shells just yet. Slidell sold the properties to Clairise Court, LLC, which was another LLC whose only member was—you guessed it—Mr. Campbell. And where did the money come from to repurchase these properties? Why from ... the Trust! Yes, that strange “irrevocable grantor trust” in the West Indies. The Trust that is supposed to be completely independent from Mr. Campbell’s control. The Trustee, who is supposed to invest and conserve that $5 million for the benefit of Mr. Campbell and his family, but somehow decides that instead of putting the $5 million in a rational investment like a Vanguard index fund, the Trust should instead loan $1.5 million to Mr. Campbell’s shell to repurchase a development that already went bust once. Sounds prudent to me.
The Trust, however, did not directly loan money to Mr. Campbell’s second shell, Clairise Court. Nope. The Trust created its own shell, Liberty Mountain Corp. (Liberty) and funded it with some amount that Judge Kerrigan’s opinion does not disclose. Liberty then put $1.5 into a second shell, Antilles Master Fund (Antilles), which was partially owned by Mr. Campbell (who contributed $40,000 to it). Antilles then transferred the money to yet another shell, its wholly owned LLC, Antilles Offshore Investors, Ltd. (Antilles Offshore). So on paper Clairise Court was borrowing from Antilles Offshore the money to pay Slidell for the properties that either Mr. Campbell or Slidell had won the right to repurchase. In reality Mr. Campbell was using money from one pocket to put into another pocket. But the pockets were in different pants that he owned and that seems to have made the difference.
Shells within shells within shells. But the common pea beneath all of them is Mr. Campbell. And he has a legal interest in all of them to which the tax lien attaches. And, by gosh and golly, the IRS can seize that to which the tax lien attaches. For example, while it is not completely clear from the opinion, Clairise Court appears to be the nominal owner of the Slidell properties. Mr. Campbell appears to have the 100% ownership interest in Clairise. The tax lien is only attached to his interest but to the extent that there is any equity in the Slidell properties, the IRS can levy that interest and cash out the properties. I don’t know if there is any equity in the properties or, by extension, Clairise Court. But there could be. And if not now, there might be later. Mr. Campbell is a developer and it would be unlikely that he would raid his Trust to fund a venture he did not think he could swing. As a creditor, it would appear quite reasonable to green-light the levy power in case Mr. Campbell’s interest in Clairise Court becomes worth seizing in the future.
2. The Trust.
As with the Slidell properties analysis, the IRS seems to have mis-directed the Court by focusing on its argument that the Trust was not a legit shell. The IRS argued that the Trust was Mr. Campbell’s nominee. Judge Kerrigan rejected the argument. She thought that the governing state law---of Connecticut (why, oh why, Connecticut??—anything to do with 679?)—“has not developed a body of law with regard to nominee theory.” She then cited to a federal district court case that also found Connecticut state law lacked a nominee theory. United States v. Snyder, 233 F. Supp. 2d 293 (D. Conn. 2002).
There are three difficulties with Judge Kerrigan’s response.
First, the district court in Snyder is an outlier. See Cody v. United States, 348 F.Supp.2d 682, 694 (E.D.Va.2004)(explaining that federal courts, with the one exception of Snyder, regularly use federal law when state law is undeveloped, because “federal and state standards for nominee ownership are generally so similar that the decision to look to federal or state law is of little moment.”).
Second, I don’t think the IRS tried hard enough to educate Judge Kerrigan about Connecticut law. Federal courts routinely apply nominee concepts even when the relevant state law does not have a well established body of law specifically called a “nominee doctrine.” That is because state courts always have and apply the basic concepts of equity that underlie the nominee doctrine. For example, in Nassar Family Irrevocable Tr. v. United States, 2016 WL 5793737 (SDNY 2016), the district court noted that “New York state courts have not explicitly applied the nominee theory of ownership in tax cases. However, courts have found that New York law recognizes the equitable principles that underlie the nominee theory.” The district court’s judgement in this regard was later affirmed by the Second Circuit in United States v. Nassar, 699 F.App'x 46 (2d Cir. 2017). Other federal courts have similarly had little difficulty filling in state law gaps. See e.g. LiButti v. United States, 968 F.Supp. 71, 75 (NDNY 1997)(“The Court has found no reported New Jersey cases addressing the factors relevant to nominee theory. Thus, the Court applies factors used by other courts that have considered the nominee theory.”)
Like New York courts, Connecticut state courts recognize the principles that underlie the nominee theory. They follow the maxim that “equity always looks to the substance of a transaction and not to mere form.” Connecticut National Bank v. Chapman, 216 A.2d 814, 816 (Conn. 1966). They recognize that that equity “can always look behind the technical legal title if necessary to work out under its principles the rights of the parties.” Home Owners' Loan Corporation v. Sears, Roebuck & Co., 193 A. 769, 775 (Conn. 1937). Well, if Connecticut courts can do all that, they should have no difficulties handling the idea of nominees.
Third, just because the Trust may not be a nominee does not end the tax lien analysis. The tax lien analysis looks to what rights or powers applicable state law gives a taxpayer in a trust of which the taxpayer is either a grantor or a beneficiary. It does not need to look at whether the taxpayer is an upstanding citizen or a fraudster. In both situations "the important consideration is the breadth of the control the taxpayer could exercise over the property." Drye, 528 U.S. at 61.
Here, the opinion has confusing language about what control Mr. Campbell had, as either grantor or beneficiary, over the trust. Judge Kerrigan writes that “the Trust document indicates that petitioner has no control over the trustee and cannot force the trustee to make distributions or investments.” That finding about the formalities of the Trust, however, seems undercut by (1) the nature of the Trust itself, and (2) some of the facts in the case.
First, Judge Kerrigan says this is a grantor trust. From my limited knowledge (I invite comments) a trust is a grantor trust when the grantor retains too much power over the trust assets to make for a successful assignment of income. I am cautious here, however, because I don’t know how §679 trusts work, or even if this was one. Still, any powers retained by Mr. Campbell can be seized by the IRS who can step into the shoes of Mr. Campbell and exercise the powers he could. National Bank of Commerce, supra, 472 U.S. 713 (1985). So just the fact that this is a grantor trust casts some doubt on the idea that Mr. Campbell has zero, zero, zero powers or rights.
Second, the facts suggest that Mr. Campbell actually exercised power over the Trust. Most importantly, the Trust gave him lots of money—via his shells—-to put into a real estate venture he wanted to rescue. This was far from an arms-length transaction as Judge Kerrigan notes in the opinion. It was, in effect, Mr. Campbell borrowing money from himself.
One additional problem here that might scare off the IRS is that the Trust is also a sprinkling trust. That is where the Trustees have, formally, total discretion on whether to make distributions, if ever. So I think the IRS was looking for some other hook into the Trust. But as I have explained in a long, boring paper, I do not think that sprinkling trusts are safe from IRS liens or levies. Bryan Camp, Protecting Trust Assets from The Federal Tax Lien, 1 Estate Planning and Community Property Law Journal 295 (2009). So much for thinking that my writing makes a difference!
The short of it is that the idea of “pure” discretionary trusts is nonsense. Restatement (Third) of Trusts §60 (2003) properly explains that all trusts have some combination of discretionary features and support standards. Even when no standards appear in the Trust instrument, courts will still apply—and indeed must apply—a general standard of reasonableness. The rights to that standard are legal rights given by state law.
For tax lien purposes, typing a trust as a sprinkling trust is not analytically useful. The relevant analysis remains: to what extent does a beneficiary have enforceable rights in trust assets? To the extent that courts in Connecticut would read this Trust document as providing enforceable rights, then those sticks in the bundle are “property or rights to property” for federal tax lien purposes. Drye.
In addition, it would be interesting to see if the Trust contained spendthrift provisions. Such provisions necessarily imply property rights in the trust assets. After all, without an ownership interest in trust assets, spendthrift provisions disabling beneficiaries from alienating that interest would be superfluous.
Trusts are a type of shell. Debtors see them as protecting assets. Creditors see them as debt avoidance devices. Attorneys see them as great business.
And business may get better after last week’s decision.
Coda: I emphasize again the narrowness of this opinion. It is a review of the IRS decision to green-light levies. It does not appear to touch the decision to file the three NFTLs. Nor does it force the IRS to accept what it believes is a lowball OIC. Given the large tax liability, it is possible the IRS may well start lien foreclosure proceedings if it ever finds sufficient assets to collect from. It can afford to wait and see. Even if there is no equity now, say, in the Slidell properties, the IRS may reasonably decide that there will be. The collection period has a long, long way to run. It started in 2010 but was suspended almost immediately by Mr. Campbell’s CDP request and has not yet started up again. So the IRS has at least until 2030 to keep collection options open.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech School of Law