Tax Lien Against Shareholder Prevails Against Creditor of His Single Member LLC (1/17/13)

In Berkshire Bank v. Town of Ludlow, MA, 708 F. 3d 249 (1st Cir. 2013), here, the First Circuit affirmed the district court's grant of priority to the IRS for its tax lien.  The facts may be summarized as follows.

An individual was a real estate developer.  He got a bank loan commitment for himself or "nominee," but requiring him to guarantee the loan if to a nominee.  I think this was simply to permit him to operate through an LLC which he then formed.  The LLC was a single member LLC with the individual as "owner, resident agent, and manager," and with the business address as his home address.  The resulting loan was to the LLC, with the individual guaranteeing the loan.

The individual thereafter incurred tax liabilities which he did not pay.  The development ran into financial difficulties, whereupon the loan became delinquent.  The IRS filed notice of federal tax lien against the individual (but not the LLC) in March 2009.

In August 2010, the bank foreclosed and sold the LLC's assets for an amount sufficient to pay the outstanding loan, leaving $92,703.94 surplus proceeds.  Apparently, since the loan was to the LLC and the foreclosed property was titled to the LLC, the bank held the surplus proceeds for the LLC.

The bank then interpled the surplus proceeds, naming the IRS, the Town of Ludlow (a judgment creditor who had obtained its judgment against the LLC in June 2010), another judgment creditor (who dropped out of the contest when the case was removed to federal court), and the LLC which disclaimed an interest.  So, as it was finally tried, the contestants were (i) the U.S. which had a tax lien against the individual and a notice of tax lien filed on the individual in March 2009 and (ii) the Town of Ludlow which had a judgment lien against the LLC dated June 2010 against the LLC.

The Town of Ludlow took the position that its judgment lien was against the LLC which was a separate entity that had no federal tax lien, so that the federal tax lien against the individual could not prime the Town's lien.  The U.S. took the position that its federal tax lien and notice of federal tax lien applied to the assets of the LLC because the LLC, as operated by the individual, was the individual's nominee.  Note that the U.S. never filed a notice of federal tax lien against the nominee.

The district court found that the LLC was the nominee of the individual and, as a result, the U.S. lien trumped the Town's lien.

I think this is a questionable case.  The only notice of federal tax lien filed was against the individual, not the LLC.  Hence, when the Town went to sue on its claim, it properly sued the LLC -- the only legal person it had a claim against.  But there was no notice of federal tax lien against the nominee, and the Town apparently had no reason to think that the LLC was not valid as a separate entity.

As between the IRS and the individual, I can see why the nominee rules would apply, where applicable, to protect the IRS tax lien against the individual.  But this was not a fight between the U.S. and the LLC and/or the individual.  The opponent was the Town of Ludlow whose judgment lien was prior to any filed lien of which it had notice against the LLC.  Note that the Government can file nominee liens against persons it deems to be nominees of a taxpayer, but it did not do so in this case.

Apparently,  the Town of Ludlow argued that a holding for the IRS would effectively mean that most single member LLCs are mere nominees, so that any person dealing with such LLCs must also be concerned about the creditors of the individual who may prime their claims.  The Court said:

We do not wish to suggest, as Ludlow [the Town] fears, that a single-member, single-purpose LLC can never escape nominee status for purposes of a federal tax lien. But under the circumstances presented here, there was simply too much intermingling of funds and too close of a relationship between Livermore [the individual] and WAL [the LLC] for us to conclude that WAL [the LLC] was anything other than "a legal fiction." Holman, 505 F.3d at 1065.

Like the district court, we take "very little pleasure in this ruling, which leaves Ludlow [the Town] with an unfinished subdivision." Berkshire Bank, 2012 U.S. Dist. LEXIS 44000, 2012 WL 1085568, at *3. However, the statutory language creating the federal tax lien "is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have." United States v. Nat'l Bank of Commerce, 472 U.S. 713, 719-20, 105 S. Ct. 2919, 86 L. Ed. 2d 565 (1985) (citation omitted). Accordingly, we affirm. 

 Creditors should take note of this risk and protect themselves accordingly.

Also, I mentioned the nominee lien that the IRS could have filed against the LLC.  Here is the discussion of the nominee lien from the current draft of my Federal Tax Procedure book:

The general federal tax lien attaches to the taxpayer’s property interest in the property titled to such a nominee.  Further, an IRS levy upon the nominee reaches that interest. n2030 Can the IRS protect itself as to such property short of a levy?  The general tax lien arising against the taxpayer and even a filed tax lien against the taxpayer would not put third parties on notice that the property appearing in the name of someone other than the taxpayer is subject to the tax lien.  Thus, given the other rules of priority discussed above, the IRS may not have protection solely based on the filed tax lien against the taxpayer’s property. n2031 In such cases, the IRS may file a tax lien identifying the third party title holder or possessor as acting on behalf of the taxpayer (a “nominee lien”). n2031
   n2030 G.M. Leasing Corp. v. United States, 429 U.S. 338 (1977); see also Oxford Capital Corp. v. United States, 211 F.3d 280 (5th Cir. 2001) (discussing differences between nominee and alter ego theories); Al- Kim, Inc. v. United States, 610 F.2d 576 (9th Cir. 1980); and United States v. Krause, 637 F.3d 1160, 1165-66  (10th Cir. 2011) (good summary of the differences).
   n2031 But see Berkshire Bank v. Town of Ludlow, MA, ___ F.3d ___., 2013 U.S. App. LEXIS 799 (1st Cir. 2013) (holding that the federal tax lien against the individual taxpayer primes a judgment lien against his sole member LLC that the Court found was his “nominee.”)
   n2032 IRM 5.17.2.5.7.2(1) (12-14-2007)(defining a nominee lien as a lien on property owned by the taxpayer as to which legal title is in another).  See United States v. Krause, 637 F.3d 1160, 1165-66  (10th Cir. 2011).  A nominee lien was used against a trust in Drye v. United States, 528 U.S. 49, 52 (1999). 

The nominee lien is not specifically authorized by the Code but is authorized administratively and recognized by the courts.  n2033 The nominee lien names the third party who the IRS has determined is acting as nominee for the taxpayer and is filed to preserve the IRS’s interest in the property allegedly so held.  The effect of the nominee lien is to put the public on notice that the IRS believes the property may be property of someone other than the nominal title owner, thereby clouding title of the third party (the putative nominee) and effectively preventing that third party from dealing with the property. n2034 Obviously, this could be a major problem to a third party who really owns the property and is not in fact acting as nominee.
    n2033 See G.M. Leasing, supra.
   n2034 See IRS Program Manager Technical Assistance  on Nominee Lien, 2009 TNT 67-36 (citing Elliot, William D., Federal Tax Collection, Liens & Levies § 9.10).