Opinion
Case No. 95-12007-SSM
March 11, 1997
MEMORANDUM OPINION
This matter is before the court on the chapter 7 trustee's objection to the proof of claim filed by the Internal Revenue Service ("IRS"). The issue is whether the IRS has a valid lien against post-petition distributions made to the debtor from a testamentary trust. Following a hearing on February 25, 1997, the court took the matter under advisement.
Under F.R.Bankr.P. 7001, a proceeding to determine the validity, extent or priority of a lien is an adversary proceeding. For that reason, a challenge, not to the amount or validity of a creditor's claim, but rather to the security interest claimed by the creditor, cannot be raised simply by an objection to claim under F.R.Bankr.P. 3007, but requires the filing of an adversary complaint. In re Hill, 116 B.R. 444 (Bankr. D. N.M. 1993). In this case, however, the IRS has affirmatively waived on the record the requirement that the trustee bring an adversary proceeding. This court has previously held that "[t]he more formal requirements of an adversary proceeding are intended in large measure to protect the defendant, and . . . where no harm will result to the administration of justice, the defendant can waive those protections and consent to the issues being adjudicated under the less formal procedures applicable to contested matters." In re Wilkinson, 196 B.R. 311, 315 (Bankr. E.D. Va. 1996). Accordingly the court will rule on the issues framed and argued by the parties.
Findings of Fact
The relevant facts have been stipulated. An involuntary petition was filed against the debtor, Dwight E. Avis, under chapter 7 of the Bankruptcy Code in this court on May 10, 1995, and an order for relief was entered on August 3, 1995. At the time the petition was filed, the debtor was an income beneficiary of a testamentary trust created under the Last Will and Testament of Davis Weir. As discussed in more detail below, the trust contained a provision whereby it could be terminated on the death of Mr. Weir's wife, Maurine Weir, if she exercised a power of appointment in her will. Maurine Weir died on September 3, 1995, approximately four months after the commencement of the debtor's case. In her will, she exercised her power of appointment, resulting in the termination of the trust and the distribution of the trust corpus to various named beneficiaries, among them the debtor. The trustee filed a report of no distribution, the debtor received a discharge on December 13, 1995, and the case was closed on December 15, 1995.
Upon learning of the debtor's entitlement to the distribution of principal from the trust, the trustee moved to reopen the case to administer that distribution as an asset of the bankruptcy estate under § 541(a)(5), Bankruptcy Code. That statute brings into the bankruptcy estate "[a]ny interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date . . . by bequest, devise, or inheritance." The court granted the trustee's motion by memorandum opinion and order dated March 12, 1996. The trustee then liquidated the debtor's interest and is holding approximately $150,000 for distribution to creditors.
On June 6, 1996, the IRS filed a timely proof of claim in the amount of $127,306.37 for unpaid Federal income taxes for the years 1987 through 1993. Of this amount, $109,819.01 was claimed as secured, based on notices of Federal tax lien that had been filed in 1994 in Fairfax County and Shenandoah County, Virginia. On July 23, 1996, the trustee filed the objection that is now before the court. The trustee does not dispute the amount of the IRS claim. The dispute is only whether the funds held by the trustee are subject to the claimed IRS lien, and, if so, whether a portion of that lien may be avoided.
Under Article V of the Last Will and Testament of Davis Weir dated December 13, 1974, a testamentary trust was created. The trustees were granted complete discretion to distribute the income of the trust, in whole or in part, to the testator's wife, Maurine Sandahl Weir, or to Helen Weir Martin (whose relationship to Davis Weir is not stated). Any income not so distributed in a particular year, however, was to be distributed to 14 named beneficiaries, among them the debtor, in various shares. The debtor's share was fixed at 3%. During Maurine Weir's lifetime, she could, by a signed instrument delivered to the trustees, direct payments of principal out of the trust to the income beneficiaries, any of their spouses or children, or any charitable organization. Upon Maurine Weir's death, and if she had exercised a power of appointment in her last will and testament, the trustees were required to make distributions of principal and any accumulated income in accordance with the power of appointment (which could be exercised only in favor of the income beneficiaries, their spouses or children, or charitable organizations). If Maurine Weir did not exercise the power of appointment, the trust was to continue until the earlier of (1) 21 years after the death of the last named income beneficiary or (2) 25 years after the last to die of Davis Weir and Maurine Weir. Upon the ultimate termination of the trust, the entire corpus would be distributed to "those persons who shall then be eligible to receive the income of the Trust." Among the provisions in Davis Weir's will concerning the trust is the following:
ARTICLE XI
The interest of any beneficiary in the income or principal of any Trust created hereunder shall not, during the existence of such Trust, be anticipated, alienated, or in any other manner assigned or pledged or promised by such beneficiary and, during the existence of such Trust, shall not be reached by, or be subject to, any legal, equitable or other process, including any bankruptcy proceedings, or be subject to the interference or control of creditors or others in any way or manner.
As noted above, Maurine Weir died on September 3, 1995, approximately four months after the commencement of the debtor's case. In her will dated October 25, 1976, she exercised the power of appointment as follows:
ARTICLE XII
I am possessed of a special power of appointment conferred upon me by . . . the Will of my deceased husband, DA VIS WEIR, which will is dated December 13, 1974, and was admitted to probate by the Circuit Court of Broward County, Florida, by Order dated November 25, 1975. I hereby exercise such power of appointment in the following manner: I direct that the Trustees of the Weir Trust . . . shall pay over and distribute all of the principal and accumulated income of said Trust remaining at the time of my death . . . to the following persons in the percentages indicated:
* * *
8. DWIGHT E. AVIS, JR. (Lt. Commander) . . . 3%
It is this distribution that is the subject of the present dispute.
Separately from the exercise of the power of appointment, Maurine Weir's will created a testamentary trust with respect to her own residuary estate. Under the terms of this trust, the income of the trust is to be paid to 11 named beneficiaries, among them the debtor, in specified amounts. The debtor's share of the income is 3%. Upon termination of the trust, which would occur on the earlier of (1) 25 years after Maurine Weir's death or (2) the death of the last income beneficiary, the corpus of the trust is to be distributed "to those persons who shall then be eligible to receive the income of the Trust." The trustee did not dispute the debtor's claim of exemption in the trust created under Mrs. Weir's will, and no issue with respect to that trust is before the court.
Conclusions of Law and Discussion
This court has jurisdiction of this controversy under 28 U.S.C. § 1334 and 157(a) and the general order of reference from the United States District Court for the Eastern District of Virginia dated August 15, 1984. Venue is proper in this District under 28 U.S.C. § 1409(a). Under 28 U.S.C. § 157(b)(2)(K), this is a core proceeding in which final orders and judgments may be entered by a bankruptcy judge.
The questions before the court may be simply stated. Does a pre-petition Federal tax lien, notice of which was properly filed prior to the taxpayer's bankruptcy, attach to the bankruptcy estate's interest in a post-petition distribution from a spendthrift trust? If so, may that portion of the lien representing penalties be avoided?
I.
Under 26 U.S.C. § 6321, the failure, after demand, to pay any tax due the United States creates a lien in favor of the United States for the amount of the unpaid tax "upon all property and rights to property, whether real or personal, belonging to [the taxpayer]." Such lien is not effective, however, against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor until public notice of the lien has been filed. 26 U.S.C. § 6323(a) and (f). Reid v. IRS (In re Reid), 182 B.R. 443, 445-446 (Bankr. E.D. Va. 1995). Although the trustee initially objected that a notice of Federal tax lien had not been properly filed with respect to 1991 taxes, he now concedes that notices were properly filed with respect to the 1987, 1988, 1989, and 1991 tax years. Accordingly, there is no dispute that any interest in property that the debtor possessed on the date of filing is subject to a lien for the unpaid 1987, 1988, 1989, and 1991 Federal income taxes.
The issue, in a nut-shell, is whether the distribution triggered by Maurine Weir's death post-petition was a property interest of the debtor at the time the petition was filed or was instead, as the trustee argues, a mere expectancy. In this connection, there can be little doubt that where a debtor's rights to future payments are fixed at the time the bankruptcy petition is filed, a Federal tax lien, notice of which had been properly filed prior to the bankruptcy, extends to post-petition payments. See, Connor v. United States (In re Connor), 27 F.3d 365 (9th Cir. 1994) (pre-petition Federal tax lien attached to debtor's interest in retirement plan, and since debtor's right to receive the payments had vested prior to his bankruptcy, payments made post-petition were not "after acquired property.") It is also clear, however, that "[a]lthough the reach of the [Federal tax] lien is very broad, it does not apply to property acquired after bankruptcy." Id. at 366; In re CS Associates, 161 B.R. 144, 148 (Bankr. E.D. Pa. 1993) (insurance proceeds for vandalism to debtor's real estate not subject to pre-petition IRS lien where the policy was purchased by the trustee post-petition).
At the time the debtor's petition was filed, he had an interest in the trust as income beneficiary. As discussed above, the trustees of the Davis Weir trust had complete discretion to distribute the income of the trust to Maurine Weir or Helen Martin. Any income not so distributed would go to the 14 named income beneficiaries. The debtor was one of those beneficiaries and entitled to a three percent distribution. Although in any given year the amount of that distribution might be zero (if the trustees distributed all the income instead to Maurine Weir or Helen Martin), nevertheless to the extent income was available, the debtor's right to 3% of that amount was vested and could be defeated only if Maurine Weir died and exercised her power of appointment in favor of beneficiaries other than the debtor. If Maurine Weir did not exercise her power of appointment in his favor, the debtor would have been entitled to a distribution of principal only if Maurine Weir did not exercise a power of appointment at all and only if the debtor were still living 25 years after Maurine Weir's death.
Although the debtor was a member of the restricted class in whose favor the power of appointment might be exercised, nothing in Davis Weir's will required that the power of appointment be exercised in favor of any particular member of that class.
Maurine Weir's will, which was the vehicle by which the power of appointment was exercised, was signed more than fifteen years prior to the filing of the bankruptcy petition. As the trustee correctly points out, however, under Florida law, "[a] proposed devise contained in a will conveys no interest to the devisee so long as the testatrix is alive." Bowman v. Yelvington (In re Estate of Yelvington), 280 So.2d 497, 499 (Fla.Dist.Ct.App. 1973). See, Galey v. Sharp, 113 So.2d 267, 269 (Fla.Dist.Ct.App. 1959) ("`As no right under a Will vests until the death of the testator, a Will is said to be an ambulatory instrument; and is entirely inoperative during the lifetime of the testator. . . .' The mere fact that one executes a Will, which is later probated, does not preclude the maker of that Will from otherwise disposing of any of the properties bequeathed or devised in said Will, during testator's lifetime."). Since Maurine Weir remained free to change her will at any time prior to her death, the language in the will exercising her power of appointment in favor of the debtor could have no legal effect, and conveyed no interest in the principal of the trust, until she died.
Consequently, the court concludes that the pre-petition IRS lien does not attach to a distribution of principal occurring as a result of a post-petition exercise of a power of appointment. That conclusion, however, does not end the inquiry. On the date the debtor filed his petition, he was entitled to receive income distributions from the trust and, if he lived long enough, to a distribution of principal. Although both the right to receive income and the right to an eventual distribution of principal were subject to contingencies that could in fact have resulted in the debtor's receiving no distributions at all, the court cannot say that the debtor's interest had no value. See, Richardson v. Richardson, 524 So.2d 1126, 1127 (Fla. Dist. Ct. App. 1988) (although interest of contingent beneficiary of testamentary trust "may never `vest in possession or enjoyment,' it is already `vested in interest' and in legal contemplation"; hence contingent beneficiary had standing to challenge administration of the decedent's estate). The fact that the value of the debtor's interest may be difficult to calculate and may require expert testimony by an actuary does not mean that a value cannot be assigned. See, In re Lyons, 148 B.R. 88, 91 (Bankr. D.C. 1992) (Teel, J.), where the court held that although the debtor could not assign or prematurely withdraw funds in an exempt retirement account, a pre-petition IRS lien attached to the present value of the debtor's future retirement benefits. As in Lyons, no evidence has been presented concerning the present value of the debtor's interest in the Davis Weir trust as of the filing date. Accordingly, the court will schedule an evidentiary hearing on that issue.
II.
Since the court has determined that the IRS has a lien in some amount against the funds held by the trustee, the court must address the trustee's argument that such lien, to the extent it secures penalties, is avoidable. Under § 724(a), Bankruptcy Code, a trustee "may avoid a lien that secures a claim of a kind specified in section 726(a)(4) of this title." That section in turn refers to
This is an entirely separate question from whether the IRS lien, if established, may be subordinated under § 724(b), Bankruptcy Code, to the payment of certain priority claims. The issue may be significant in this case because the debtor's former spouse has asserted a large claim for support that might, if allowed, be entitled to be paid ahead of the IRS. Neither party has raised or argued this issue, however, and it is not presently before the court.
any allowed claim, whether secured or unsecured, for any fine, penalty, or forfeiture, or for multiple, exemplary, or punitive damages, arising before the earlier of the order for relief or the appointment of a trustee, to the extent that such fine, penalty, forfeiture, or damages are not compensation for actual pecuniary loss suffered by the holder of such claim[.]
In this case, the proof of claim filed by the IRS reflects that $18,148.64 of its $109,819.01 secured claim consists of penalties. While the record does not disclose the exact nature of the penalties, there is no assertion by the IRS that the penalties in question are "compensation for actual pecuniary loss." Accordingly, while the actual amount of the IRS secured claim cannot be determined until such time as the court determines the value, as of the filing date, of the debtor's interest in the Davis Weir trust, to the extent that such value exceeds $91,670.37 (representing the tax due and interest to the filing date), the IRS lien will be avoided.
III.
A separate order will be entered consistent with this opinion setting an evidentiary hearing to determine the present value, as of the filing date, of the debtor's interest in the Davis Weir trust. The lesser of the amount so determined, or of the filed secured claim (less the $18,148.64 in claimed penalties) will be allowed as a secured claim, and the balance as unsecured.