4.2 The Craft Aftermath

That the tax lien attaches to the debtor-taxpayer’s entireties interest does not sever the tenancy automatically.   It permits the Internal Revenue Service (“IRS”) to either (i) administratively seize and sell the taxpayer’s interest or (ii) foreclose the federal tax lien against the entireties property.   The administrative option is problematic for the IRS:

Because of the nature of the entireties property, it would be difficult to gauge what market there would be for the taxpayer’s interest in the property. The amount of any bid would in all likelihood be depressed to the extent that the prospective purchaser, given the rights of survivorship, would take the risk that the taxpayer may not outlive his or her spouse.   In addition, a prospective purchaser would not know with any certainty if, how, and to the extent to which the rights acquired in an administrative sale could be enforced … Levying on cash and cash equivalents held as entireties property does not present the same impediments as seizing and selling entireties property.^[1]

The most likely lien enforcement procedure is foreclosure.^[2]   Foreclosure is supervised by a court under Internal Revenue Code (“IRC”) section 7403 and any individual with an interest in the property must be joined and given an opportunity to be heard.   The court may order sale of the whole property and then distribute the sale’s proceeds as it sees fit, considering the parties’ interests and that of the Government.^[3]   The value of each spouse’s interest is an issue of fact.   This exchange from Craft‘s oral argument is illustrative:

Question (by the Court): “But in your review, you always value the taxpayer’s interest at 50 percent?”

Answer (by Mr. Jones): “No, I think in the Rodgers — well, if the property’s been sold, yes.   If the property hasn’t been sold, and we’re talking about in a foreclosure context, I believe the Rodgers court goes through the example of the varying life expectancies of the two tenants, and which one — and I believe what the Court in Rodgers said was that each of them should be treated as if they have a life estate plus a right of survivorship, and the Court explains how that could well — I think in the facts of Rodgers resulted in only 10 percent of the proceeds being applied to the husband’s interest and 90 percent being retained on behalf of the spouse, but –”^[4]

Craft did not address specifically how the debtor spouse’s interest should be valued.   Rodgers, the case referenced above, involved the judicial sale to enforce federal tax liens against a homestead property where a non-debtor spouse also held an interest.   In that case, the court ran calculations “only for the sake of illustration” that assumed the protected interest was the same as a life estate interest.^[5]   Based upon calculations of the terminated interest (the life interest) amount, a substantial part of the sales proceeds should be allocated to the non-debtor spouse (89% for a 50 year old).   This “illustration,” of course, focused on fully compensating the non-delinquent spouse for his or her potential loss without regard to a full valuation of the delinquent spouse’s property interest.

Courts have not followed the Rodgers approach when applying Craft.  A few courts have endorsed the use of comparable life expectancies.^[6]   Most courts, however, simply split the proceeds in half.   In Popky v. United States,^[7] the Third Circuit Court of Appeals relied upon the equal rights each spouse has to the “bundle of sticks” that constitutes entireties property to support a fifty percent-fifty percent split.   It also relied upon “sound policy” for such an approach to valuation, finding that “an equal valuation is far simpler and less speculative” than the valuation based on life expectancies.^[8]

By its terms, Craft is limited to federal tax cases. To quote one case, “Craft gives no indication that the reasoning therein should be extended beyond federal tax law.”^[9]     Although section 544 of the Bankruptcy Code accords a trustee the rights and powers of a hypothetical “creditor that extends credit to the debtor at the time of the commencement of the case,”^[10] courts have declined to extend such rights and powers to a trustee based on the Government being such a hypothetical creditor.^[11]   In refusing to extend Craft, courts reject empowering bankruptcy trustees to use the Bankruptcy Code’s “strong arm clause” to get at entireties property in non-tax cases.   Craft has been extended, however, to fines and forfeitures arising from federal criminal cases:   “Although Craft only dealt with tax liens, Congress has unequivocally stated that criminal fines are to be treated in the same fashion as federal tax liabilities.”^[12]

If the federal tax lien is not acted upon, and one spouse dies, the property goes to the survivor either free of the lien or not, depending on who is the survivor:

When a taxpayer dies, the surviving non-liable spouse takes the property unencumbered by the federal tax lien.   When a non-liable spouse predeceases the taxpayer, the property ceases to be held in a tenancy by the entirety, the taxpayer takes the entire property in fee simple, and the federal tax lien attaches to the entire property.^[13]

In Craft, the property was quitclaimed to the non-debtor spouse after the debtor spouse incurred the tax lien.     The lower courts held that no fraudulent conveyance was involved because no lien could attach.   This point was not preserved on appeal.   Justice O’Connor makes clear, however, that this issue will be present in future entireties tenancy cases involving federal tax liens: “Since the District Court’s judgment was based on the notion that, because the federal tax lien could not attach to the property, transferring it could not constitute an attempt to evade the Government creditor, in future cases the fraudulent conveyance question will no doubt be answered differently.”^[14]