IRS Liens Get Almost Everything Almost All the Time

By: A.J. Cook

The Internal Revenue Service whacked Mitchell W. Voelker with a lien on everything he owned -- even his Weedeater, his bow and arrows and all his clothes.

Judge Thomas S. Utschig, said the case reminded him of Hans Christian Andersen's fairy tale about an emperor who loved fine clothes. Two cunning weavers came to town. They convinced the emperor they could make the most beautiful clothes in the world, but the clothes would be invisible to those who were stupid or unfit for their jobs. No one, not even the emperor, wanted to appear ignorant or become unemployed, so everyone remarked how handsome the clothes were. This worked fine until one day a little boy, while watching a parade, gasped, "The emperor has no clothes." The emperor, of course, knew the boy was right, but continued to strut proudly in the procession.

Because Voelker refused to pay the $27,736 in taxes he owed, the IRS gave notice of the lien. To shield his $825 of exempt assets, Voelker filed for bankruptcy. He claimed the lien applied only to his pick-up truck, mobile home and Harley-Davidson motorcycle, his $2,471 of nonexempt items. The IRS insisted it also applied to his exempt assets: tools (Weedeater and lawn mower), weapons (bow and arrows) and clothes.

The agency acknowledged it couldn't take exempt assets, but it could place a lien on them. With a lien the debtor retains possession, and the IRS waits until the debtor sells the asset before it's paid. This is similar to the sale of your home. When you sell it, the mortgage company gets paid from the proceeds. With a levy, however, the IRS gets the asset immediately.

Judge Utschig said "The IRS portrays a debtor parading out of bankruptcy fully clothed and well prepared to make a fresh start in life. Voelker, on the other hand, tells a very diferent tale. He portrays himself as parading out of bankruptcy, but closely pursued by vigilant taxing authorities holding a lien on everything he owns, including the shirt on his back...."

Looking at the case realistically, the judge said, it made common sense that a debtor may retain a small amount of unencumbered assets. Permitting this does not significantly hinder the government's ability to collect taxes.

The judge said the IRS has no lien, no interest at all, in the exempt assets. "Let no one declaire, upon Voelker's exit from the court, 'the debtor has no clothes.' "

The Moral: Whether it's called a levy or a lien, the IRS can't disguise the naked truth.

Imagine that someone steals $20,000 from you and, after she's caught, you find she owns assets worth $5,000. It's not much, but it's something.

It's nothing, says the Internal Revenue Service. Because the $20,000 is taxable income to the thief, the IRS wants the $5,000 for taxes.

How can that be? That's just not fair.

Arlene Dohn, a bookkeeper for Atlas, Inc., altered some company checks and deposited them in her bank account. During three years she embezzled $390,723.

But now most of the money is gone, with little to show for it. She had added a patio and a fence to her Bismark, N.D., home and paid off the mortgage.

Atlas wanted her home. The IRS wanted it, too. The agency filed a lien, considering the embezzled funds income to Dohn.

Atlas, feeling the weight of the bureaucratic world bearing down, appealed to the court. The judge explained that general tax liens, like the one the IRS filed, attach to all of a person's assets. But the question here is: Was the home Dohn's asset?

Not completely. Money embezzled or stolen isn't owned by the thief who holds it; ownership remains with the victim. Where a thief buys assets with embezzled funds, the victim can follow the funds wherever they can be traced. Tracing is the key.

So the judge traced the proceeds this way:

The bookkeeper's home equity before the embezzlement was not paid for with stolen money. Nor did the equity increase from monthly mortgage payments come from this money; she continued these payments with her salary. But, the judge said, she could not have paid off her mortgage and purchased the expensive improvements on her salary. The court concluded that when the house is sold, the IRS will get the equivalent of Dohn's original down payment plus her monthly payments. The remainder goes to Atlas. As a side note, because the IRS wouldn't receive full payment, it will be a preferred creditor for Dohn's nonmortgaged assets. Once the debt to the IRS is satisfied, Atlas and other creditors can divide the remainder -- if there is any.

The Moral: Crimes doesn't pay -- unless you're the IRS.

A.J. Cook is a lawyer and CPA. His tax column appears weekly in numerous newspapers. Why isn't it published in your hometown newspaper? Ask its Business Editor to subscribe.

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