Most people believe that assets held in trust for their benefit, at least to the extent the trust assets were left in trust by a third party (such as, for example, a parent), to be exempt from the claims of their creditors. As a general rule, this belief is well founded. However, as for claims by the U.S. government, particularly the IRS, that basic idea may not be as clear-cut as often believed.
I previously wrote about the Hovnanian case from a U.S. District Court in New Jersey. In that writing, I noted concerns about the issues raised to support nominee liability. Specifically, many of the factors the court found to favor the IRS’ argument that the relevant trusts were the taxpayer’s nominee would be present in almost any trust established for a child by his or her parent (lack of full consideration for the property, intent to protect assets from creditors, close relationship between the parties, taxpayer’s enjoyment and/or possession of the property, etc.). If these factors open a trust up to claims, then well-established spendthrift protections can be avoided for perhaps most trusts established for family members.
At the time of that writing, the court merely had denied the taxpayer’s motion to dismiss the IRS’ foreclosure action. It remained possible that, upon a review of the facts and law, the court would not ultimately rule in favor of the IRS. However, recently, the court granted summary judgment to the IRS, allowing the IRS to foreclose on assets contributed to trusts by the taxpayer’s parent with the taxpayer not even being a beneficiary or trustee of at least one of the trusts. Since most of the court’s discussion is very similar to discussion in the previous order denying the taxpayer’s motion to dismiss, I simply refer back to my previous writing to address the facts and arguments as well as my thoughts. Here, I would like to address, generally, the notion of nominee liability as it relates to the IRS’ ability to levy on trust assets.
Spendthrift Trust Protections
As a general proposition, a “spendthrift provision” of a trust is “a term of a trust which restrains both voluntary and involuntary of a beneficiary’s interest” in the trust. These provisions are valid under long-standing common law – “Except with respect to an interest retained by the settlor, the terms of a trust may validly provide that an interest shall terminate or become discretionary upon an attempt by the beneficiary to transfer it or by the beneficiary’s creditors to reach it, or upon the bankruptcy of the beneficiary.”
When the terms of a trust contain a spendthrift provision, the provision generally is valid to prevent the beneficiary’s creditors from reaching trust assets provided the beneficiary is not also the settlor of the trust. As a result, assets contributed to a trust by a third party (such as a parent, grandparent, spouse, etc.) for a beneficiary can be held free from claims of the beneficiary’s creditors. Anecdotally, this is the reason many individuals leave assets in trust – the ability to have assets available to benefit their loved one without risk of loss to third parties whether as a result of lawsuit, divorce, bankruptcy, or otherwise. After all, if the assets never belonged to the beneficiary in any event, the settlor may decide to whom assets are transferred during lifetime or at death as well as what restrictions to place on those assets.
While spendthrift protection is powerful and well established, there may be certain exceptions. The model Uniform Trust Code provides exceptions for: (a) claims based on a “judgment or court order against the beneficiary for support or maintenance” of a child, spouse or former spouse; and (b) “claims of this State or the United States to the extent a statute of this State or federal law so provides.” The Restatement offers different potential exceptions relating to claims for: (a) “support of a child, spouse, or former spouse;” and (b) “services or supplies provided for necessities or for the protection of the beneficiary’s interest in the trust.” The Restatement comments go on to state that “it is implicit in the rule of this Section, as a statement of the common law, that governmental claimants, and other claimants as well, may reach the interest of a beneficiary of a spendthrift trust to the extent provided by federal law or an applicable state statute. Governmental claims and claims under governmentally assisted programs are often granted this special status.”
Notwithstanding these articulations, the law as to exception claims varies widely across the United States. As such, in evaluating spendthrift protections as applied to interests of a beneficiary in trust assets, it will be critically important to evaluate state law on the issue. Further, in many circumstances, this analysis will include questions about what state’s laws apply.
The IRS may pursue claims against assets of the taxpayer held by the taxpayer’s nominee when both: (a) a third party holds specific assets for the taxpayer; and (b) the taxpayer retains benefit, use, or control over the specific assets. Factors the IRS will consider in analyzing whether to issue a Notice of Federal Tax Lien to a purported nominee should include whether:
- The taxpayer is paying maintenance expenses;
- The taxpayer is using the property as collateral for loans;
- The taxpayer is paying state and local taxes on the property;
- The taxpayer has the use or benefit from the property; or
- Other factors such as:
- The taxpayer previously owned the property;
- The nominee paid little or no consideration for the property;
- The taxpayer retains possession or control of the property;
- The taxpayer continues to use and enjoy the property conveyed just as the taxpayer had before such conveyance;
- The taxpayer pays all or most of the expenses of the property; and
- The conveyance was for tax avoidance purposes.
State law spendthrift protections do not limit the IRS’ ability to levy upon assets held by a taxpayer’s nominee. However, the IRS must look to state law to determine a taxpayer’s rights or interests in property, with federal law determining whether those rights or interests constitute property of the taxpayer subject to collection. Ultimately, the court must find the taxpayer has property or a right to property under state law prior to pursuing collection under federal law.
When considering whether the IRS may collect against trust assets as the taxpayer’s nominee, therefore, the IRS must consider the beneficiary’s state law interests in trust property. In certain cases, this analysis has resulted in the IRS being unable to collect against trust assets prior to even beginning consideration of the factors cited above. As such, while federal law controls tax collection matters, the IRS and a reviewing court must first determine the taxpayer holds property rights to the trust’s assets prior to determining whether the IRS may collect against those assets as being held by the trustee as the taxpayer’s nominee.
Another consideration is the source of assets over which the IRS seeks to recover as being held by the nominee of the taxpayer. While some may believe the assets the IRS seeks to recover must have been transferred to the nominee by the taxpayer, this is not the case, rather the IRS looks to the taxpayer’s relationship to the property. That said, the Tenth Circuit has stated:
Although in many instances the delinquent taxpayer will have transferred legal title to a third party, an actual transfer of legal title is not essential to the imposition of nominee lien. A delinquent taxpayer who has never held legal title to a piece of property but who transfers money to a third party and directs the third party to purchase property and place legal title in the third party’s name may well enjoy the same benefits of ownership of the property as a taxpayer who has held legal title. In both instances, the third party may be the taxpayer’s nominee. (emphasis added).
The Tenth Circuit also stated that the real question is “whether the taxpayer has engaged in a legal fiction by placing legal title to property in the hands of a third party while actually retaining some or all of the benefits of true ownership” (emphasis added).
From this language, it appears that, while the property held by the nominee must not necessarily have been transferred from the taxpayer to the nominee, the property must have been acquired by the nominee through actions of the taxpayer. For example, the language specifically refers to a transfer of money to the nominee used to acquire assets that benefit the taxpayer or “placing” legal title to the property in the name of the nominee. The factors cited above and in my previous writing about the Hovnanian case appear to favor either a direct or indirect transfer of the property to the nominee – for example, the property “remains” in the taxpayer’s possession or the taxpayer “continues” to enjoy benefits from the property. Certainly, a review of nominee cases involving trusts appears to apply almost exclusively when the property was transferred into trust by the taxpayer (typically not a self-settled trust, but rather a trust for a third party where the taxpayer effectively continues to hold the benefits and burdens of ownership).
In the Hovnanian opinions, the court does not go through any particular state law analysis as to whether the taxpayer, Shant Hovnanian, held any interest in the property of the relevant trusts. Certainly, from the relevant law, that appears to be a prerequisite to moving into nominee analysis. At the relevant times, Shant was not a trustee or beneficiary of either trust. Additionally, Shant made no direct transfer of assets to either trust and there is nothing cited showing that he made any indirect transfer to the trust which could be used to deem him settlor. I question whether he would be found to hold any state law right or interest in trust property if the proper analysis was done.
Shant’s counsel argued that his failure of making contributions to the trusts precluded subjecting trust assets to IRS collection. This is not entirely conclusive. The law does not require Shant to have transferred assets to the trusts in order to find the trustee to be Shant’s nominee, but the law appears to at least require some indirect contribution or direction on Shant’s part resulting in the assets being held in trust. Nothing in that regard was cited by the court (other than possibly an error in funding the wrong trust which was corrected on the same day the incorrect deed was recorded and still may not have reached the level necessary to be deemed to have caused the property to have come from Shant).
Further, some of the relevant factors in determining whether the trustee is Shant’s nominee cite back to his “retention” of possession or “continued” benefits from the property, each seeming to indicate there must have been some preexisting interest in the property. Here, however, at all times relevant to the IRS’ collection action prior to ownership by the trust, the assets at issue were held by Shant’s parents. Beyond that, as cited in my previous writing about the Hovnanian case, many of the nominee factors would be present in almost all cases involving funding of a trust by parents for descendants.
Clearly, the law should look with disfavor on those who seek to hide assets from IRS collection efforts. Nominee liability allows the IRS to pursue assets held by a third party where relevant factors would deem the taxpayer to be the true owner of the property, with the nominee holding title in name only. However, while acknowledging the IRS is not strictly bound by state-law spendthrift protections offered to trust beneficiaries, the IRS should be required to show some state law interest in the property before moving on to analyzing nominee liability factors. Further, in evaluating those factors, I strongly believe that valid planning by parents in how they pass assets in trust for their children and further descendants should not be used to support nominee liability of a trustee.
If courts will easily skip over state law analysis in determining property interests, use commonplace facts to support nominee liability of trustees, and allow the IRS to seize assets held in otherwise valid spendthrift trusts for debtor-beneficiaries who made no direct or indirect contributions to the trust, then protections parents and other trust settlors legitimately seek for their beneficiaries may be less protective than many believe. It has long been recognized that a trust settlor has the power to determine to whom they leave assets and under what terms. Based on that theory, absent any ill intent or other factors that would allow creditors (including the IRS) to access trust assets, those assets may be protected from a beneficiary’s creditors. As stated above, the IRS has broader collection rights than most creditors. However, the Hovnanian opinions appear to go beyond what the law traditionally has supported.
Ultimately, if courts will interpret nominee liability as broadly in Hovnanian, then clients and their advisors would be well served to look for ways to limit applicability of the relevant factors. While certain of the factors will be present in almost any trust established for a beneficiary by a family member, it would be advisable to limit the beneficiary’s direct use or possession of trust property, payment of trust expenses (or other commingling of cash or other assets), avoidance of the taxpayer serving as trustee, etc. While there may be no way to guarantee avoidance of nominee liability, proactive planning to avoid that outcome for those with IRS tax liabilities seems advisable.
 U.S. v. Hovnanian, 2019 WL 1233082 (D.NJ. March 18, 2019); and Edmondson, Gray, “Court Finds IRS’ Attempt to Foreclose on Trust Property Plausible,” Apr. 9, 2019, https://esapllc.com/court-finds-irs-attempt-to-foreclose-on-trust-property-plausible/.
 U.S. v. Hovnanian, 2022 WL 17959583 (D.NJ. Dec. 27, 2022).
 Supra note 1.
 Uniform Trust Code (“UTC”) § 103(15).
 Restatement (Third) of Trusts § 57
 See Restatement (Third) of Trusts § 57 and UTC § 501.
 UTC § 503
 Restatement (Third) of Trusts § 59
 Id. at general comment a(1)
 For example, Mississippi’s UTC contains no exception creditors for claims against non-settlor beneficiaries. See Miss. Code Ann. § 91-8-501 et seq. Tennessee only excepts claims of the State of Tennessee. See Tenn. Code Ann. § 35-15-503.
 See, e.g., Restatement (Second) Conflict of Laws §§ 267-282
 It is worth noting that nominee liability is one of a number of theories which may be used to access assets of a trust. Other potential grounds may include fraudulent transfer claims or the trust serving as the taxpayer’s alter ego. Notably, in nominee or alter ego cases, the IRS would not be required to show intent to hinder, defraud, or delay, but rather merely may enforce collection where the separate standards for nominee liability or alter ego concepts would apply. While these arguments often arise in the same situations, the law under each is different. Here, I am limiting my discussion to nominee liability since that was the theory used in the Hovnanian case. For a discussion of some of these theories, see In re Blasingame, 920 F3d 384 (6th Cir. 2019), and Edmondson, Gray, “Sixth Circuit Approves Asset Protection Through Trusts,” March 12, 2020, https://esapllc.com/blasingame-asset-protection/.
 Internal Revenue Manual (“IRM”) 188.8.131.52.4
 See IRM 184.108.40.206.1 and 220.127.116.11.7.2
 See Bank One Ohio Trust Co. v. U.S., 80 F.3d 173 (6th Cir. 1996) and Drye v. U.S., 528 U.S. 49, 58 n. 5 (1999).
 Drye v. U.S., 528 U.S. at 52, citing U.S. v. Bess, 357 U.S. 51, 56-57 (1958).
 Id. See also LaSalle Nat. Bank v. U.S., 636 F.Supp 874, 877 (N.D. Ill. 1986).
 See, e.g., Texas Commerce Bank Nat. Ass’n v. U.S., 908 F.Supp. 453 (S.D. Tex. 1995) (not involving nominee liability, but rather the IRS’ ability to levy on the value of the beneficiary’s interest in trust distributions); Dominion Trust Co. of Tennessee v. U.S., 7 F.3d 233 (6th Cir. 1993) (determining that taxpayer’s contingent remainder interest in trust is not property or an interest in property under state law, precluding the IRS from levying upon trust assets); Duckett v. Enomoto, 2016 WL 1554979 (D.Ariz. 2016) (determining interests in trust by taxpayer-beneficiary did not rise to the level of creating a property right subject to IRS levy); and Dalton v. Comm’r, T.C. Memo 2008-165 (court held IRS allegation of trustee as taxpayer’s nominee failed without required state law inquiry into property interests of the taxpayer; citing Holman v. Commissioner, 505 F.3d 1060 (10th Cir. 2007) (vacating and remanding a case seeking to enforce a nominee tax lien for the IRS first to establish that the person held a beneficial interest in the property under State law); Spotts v. United States, 429 F.3d 248, at 251, 253–254 (6th Cir. 2005) (vacating and remanding a grant of summary judgment for the IRS in a case seeking removal of a nominee lien because the lower court did not first consider whether the person had a beneficial interest under State law); May v. A Parcel of Land, 458 F.Supp.2d 1324, 1334-1335 (S.D. Ala. 2006); and United States v. Krause, 386 Bankr. 785, 831 (Bankr.D.Kan. 2008)).
 Holman v. U.S., 505 F.3d 1060 (10th Cir. 2007) and Oxford Capital Corp. v. U.S., 211 F.3d 280, 284 (5th Cir. 2000).
 Holman, 505 F.3d. at 165.
 Restatement (Third) of Trusts § 58, note f., described a number of factual situations where someone other than the nominal settlor of the trust (i.e. the beneficiary) will be deemed the settlor. In such cases, a beneficiary-taxpayer could be deemed to have placed legal title in the trustee without an actual transfer of the property at issue.
 Supra note 14.
 Supra note 1.
 See Fed. Tax Coordinator, ¶ V-5950 (2d).
 And, here, I note the Sixth Circuit’s statement in the Blasingame opinion referenced in supra note 12 that “asset protection is a legitimate, legally sanctioned objective; though one that has limits of its own” in finding assets placed in trust by a debtor’s parent to be outside the reach of the debtor’s creditors.