Taxpayers often get into trouble with the IRS when they attempt to protect their assets by transferring them to a trusted family member, friend or business partner. Those who choose to undertake these transactions rarely do so on the advice of a tax professional and often claim they were utilizing tax, succession or strategic planning strategies. However, these transfers rarely succeed in keeping the IRS from seizing the assets. Sometimes they even lead to criminal prosecution.

While tax professionals should never advise their clients to transfer assets to avoid IRS seizure, they will sometimes get questions about how the government might respond. The following discussion is intended to provide an overview of the basic tools the IRS uses to combat such transfers, including subjecting the recipient of the assets to a nominee lien and taking legal action against participants in the transfer as a fraudulent conveyance.

Identifying Nominees

For the purposes of IRS nominee tax liens, a nominee is generally a third-party individual, trust or corporation that holds legal title to a taxpayer’s property while the taxpayer still enjoys full use of it. The IRS may subject any property held by a taxpayer’s nominee to a federal lien or levy if it finds the taxpayer actually owns the property even though someone else holds legal title as a nominee.

When determining whether a nominee relationship exists, the IRS and the courts usually weigh a number of factors, including whether:

• The property was transferred in anticipation of liability
• The alleged nominee paid an adequate amount of money for the property
• There was a close relationship between the taxpayer and the alleged nominee
• The transfer of the property was properly recorded
• The taxpayer either retained possession or continued to use the property following the transfer
• The taxpayer was continuing to pay the costs associated with maintaining the property

In cases where the IRS is attempting to impose nominee liability for the property at issue, it’s not uncommon to find that the property has been placed in a trust. In cases where the IRS is trying to impose nominee liability, the IRS and the courts will generally examine two factors:

• Whether any of the assets that were placed in the trust were used to pay the personal expenses of the taxpayer
• Whether there were sufficient internal controls in place for the proper management of the trust

Nominee Liens

The Internal Revenue Code (IRC) allows the IRS to satisfy a tax deficiency by imposing a lien on any property belonging to the taxpayer, including rights to property. The language of the statute is broad enough that it allows the IRS to impose a lien on almost any of the taxpayer’s property interests, including property that is held by a third party as a nominee of the taxpayer. A federal tax lien generally arises when a person or entity liable for federal tax fails to pay the tax after the IRS issues a demand for payment.

When the IRS proceeds against the nominee of a taxpayer to satisfy the taxpayer’s unpaid tax obligations, it will file a notice of federal tax lien (NFTL) with the nominee identified as the taxpayer. Since nominee liens usually involve specific assets that were conveyed to the nominee, the NFTL will specify the property to which the lien attaches.

An NFTL is a public document that is filed with state and local jurisdictions to put other creditors on notice that the IRS has a lien interest in the property. The NFTL does not create the tax lien; it serves to inform others that the lien exists.

Parties who have received NFTLs identifying themselves as nominees may ask the IRS for a hearing as part of its Collection Appeals Program (CAP) for liens, levies, seizures and installment agreements. Parties identified as nominees by the IRS have no collection due process (CDP) rights.

Fraudulent Conveyance

A fraudulent conveyance is when a person claims to have transferred property to another party without receiving adequate payment. If a transfer is found to have been fraudulent, the IRS is allowed to set it aside. When the IRS challenges a property transfer as a fraudulent conveyance, it must prove the taxpayer committed either constructive or actual fraud.

Taxpayers and transferees face the risk of civil fraud penalties or criminal prosecution if they are found to have participated in a fraudulent conveyance. IRC §7201 states that any person who willfully attempts to evade or defeat taxes can be charged with a felony and face fines of up to $100,000 ($500,000 for corporations), up to five years in prison, and repayment of the prosecution’s costs.

Additionally, the existence of a fraudulent transfer is usually enough to support an IRS claim of transferee liability where the person receiving the assets is held personally liable for the value of the transferred property.

Constructive Fraud

Taxpayers commit constructive fraud when they transfer property for less than its fair value and are either insolvent at the time of the transfer or become insolvent as a result of the transfer. Generally, a taxpayer will have received fair consideration if they have exchanged the property for a “fair equivalent” and the exchange was conducted in good faith. The taxpayer is presumed to be insolvent if the sum of their debts exceeds the fair valuation or fair salable value of the transferred assets.

A transfer can also be found to be fraudulent as to a current creditor. These are transfers made to an insider on account of a prior debt when the taxpayer is insolvent and the insider had reason to believe the taxpayer was insolvent when the transfer occurred. Insiders can include family members if the taxpayer is an individual, directors and officers if the taxpayer is a corporation, and partners if the transferor is a partnership.

Actual Fraud

Taxpayers commit actual fraud when they transfer property with the intention of hindering, delaying or defrauding the IRS’s efforts to collect a tax debt. To prove actual fraud, the IRS must prove the taxpayer intended to commit fraud. The federal Fair Debt Collection Practices Act (FDCPA) lists the factors the courts may consider when determining actual fraud, including whether:

• The transfer was made to an insider
• The transfer was nearly all of the taxpayer’s assets
• The value of the consideration the taxpayer received was reasonably equivalent to the asset’s value
• The taxpayer was insolvent or became insolvent shortly after the transfer was completed
• The transfer occurred shortly before or after the taxpayer incurred the tax debt

Many states also have statutes that are like the FDCPA, and the IRS has successfully used these statutes to set aside fraudulent conveyances made to avoid paying federal taxes.