The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By David I. Kempler, Esq. and Elizabeth Carrott Minnigh, Esq.
Buchanan Ingersoll & Rooney PC, Washington, DC
In Adam v. U.S. , No. 8:05-cv-00987 (C.D. Cal. 12/28/11), the U.S. District Court for the Central District of California, in a case remanded by the Ninth Circuit, dismissed two siblings' suit for quiet title to property, holding that they only held bare legal title to the property as nominees for their parents under California law and, therefore, lacked standing under 28 USC §2410 (Judiciary and Judiciary Procedure) to challenge federal tax liens filed against their parents that attached to the property. This case serves as an important reminder that the courts will look beyond the form, especially in related party transactions.
Dino and Trina Adam purchased a property located in Yorba Linda, California ("Property") in 1982. Property was subsequently sold at a foreclosure sale on September 13, 1994, to Great Western Bank. Property was then transferred to EMC Mortgage Corporation (EMC). On January 31, 1996, Property was purchased from EMC by a business partner of Dino's brother, but using funds provided by Dino. Thereafter, in October 1996 and November 1996, the IRS recorded a Notice of Federal Tax Lien with respect to the federal income tax liabilities owed by Dino and Trina for the years 1989, 1991 and 1993. Under §6321, a federal tax lien arises when any person liable to pay any federal tax fails to pay the tax after a demand by the IRS for payment. While the IRS is not required to file a Notice of Federal Tax Lien in order for the tax lien to attach, the IRS may elect to file a Notice of Federal Tax Lien in order to have priority over the taxpayer's other creditors.
After these tax liens were recorded, Property was subject to several transfers, each of which involved relatives of Dino and Trina, and, ultimately, Property was transferred to the children of Dino and Trina (the "Children"). Each of these transactions was consummated with less than full and adequate consideration and sometimes with no consideration whatsoever. However, despite the multiple transfers of legal title, Dino and Trina continued to reside at Property since 1982. Although the Children claimed to have received rent from Dino and Trina, neither reported any rental income from Property on their federal income tax returns.
On March 7, 2001, Dino and Trina filed a bankruptcy petition under Chapter 7 of the Bankruptcy Code. The bankruptcy proceeding resulted in a discharge of personal liability for Dino and Trina with respect to their income tax debts to the IRS for the years 1989, 1991 and 1993. On November 29, 2004, the IRS re-filed its Notice of Federal Tax Lien, previously recorded in 1996. Subsequently, on January 12, 2005, the IRS recorded two Notices of Federal Tax Lien, one against each of the Children, identifying them as "nominees" of their parents.
On October 11, 2005, the Children filed a Complaint challenging the IRS liens recorded against them. In July 2007, the U.S. District Court for the Central District of California held a three-day trial on the matter, after which it concluded that the Children held title to Property as nominees for their parents. On appeal, the Ninth Circuit concluded that the district court had erred by not analyzing California law in determining whether the Children held title to Property as nominees for their parents and remanded the case.
The Children argued that California did not recognize a nominee theory of ownership. However, noting that several California courts had identified and discussed a nominee theory of ownership, the district court concluded that California recognizes such a theory.1 Moreover, because the California courts had not dictated a standard of how to conduct a nominee analysis,2 the district court determined that it should look to decisions of the federal courts,3 and apply the following six factors in determining nominee status: (1) whether there was no consideration or inadequate consideration paid by the purported nominee; (2) whether the property was placed in the name of the purported nominee in anticipation of a suit; (3) the close relationship between the transferor and the purported nominee; (4) whether there was a failure to record a conveyance; (5) the retention of possession by the transferor; and (6) whether the transferor maintained continued enjoyment of the benefits of the transferred property.4
In applying the six-factor test, the district court determined that five of the six factors weighed in favor of the finding that Dino and Trina held a beneficial interest in Property, and the Children held only bare legal title. As to the first factor, the district court noted no consideration was paid by the Children for Property. As to the second factor, the district court concluded the facts indicated that Property was likely placed in the name of the purported nominee in anticipation of a suit. As to the third factor, the district court noted that all transferees were relatives or business associates of Dino and Trina. As to the fifth and sixth factors, the district court noted that Dino and Trina retained physical possession of Property and maintained continued enjoyment of the benefits of the transferred Property. The district court noted, however, that because all of the conveyances had been properly recorded with the county recorder's office, the fourth factor weighted in favor of the Children.
The district court then examined whether, as holders of bare legal title to Property, the Children had standing to challenge the procedural validity of the IRS's tax liens. The district court concluded that the Children had failed to show an injury in fact, and, therefore, did not have standing to assert their parent's rights to challenge the IRS tax liens. In support of their conclusion the district court cited U.S. v. One Parcel of Land, Known as Lot 111-B, Tax Map Key 4-4-03-71(4) , 902 F.2d 1443, 1444 (9th Cir. 1990), wherein the Ninth Circuit held that, in certain circumstances, "possession of mere legal title by one who does not exercise dominion and control over the property is insufficient to … establish standing… ."
This case serves as an important reminder that bad facts will generally result in the courts looking to the substance of the transaction over the form, especially when examining related party transactions. Although Property was transferred multiple times, the transactions were done with less than full and adequate consideration, many times with no consideration whatsoever, and beneficial use of Property at all times remained with the original owners.
Moreover, it appeared from the record that beneficial use continued without the payment of any rent. In intrafamily transactions, it is even more important than in arm's-length transactions that all formalities be observed. In the instant case, the result would have likely been different if the transfers between parties had been for valid consideration and Dino and Trina had paid market rent for use of the property.
For more information, in the Tax Management Portfolios, see Mather and Weisman, 637 T.M., Federal Tax Collection Procedure - Liens, Levies, Suits and Third Party Liability, and in Tax Practice Series, see ¶3870, Collection of Tax.
1 See Leeds v. U.S., No. 08-cv-100-BTM (S.D. Cal. 8/5/10) (discussing several California cases that recognize nominee status, including Lewis v. Hankins, 214 Cal. App. 3d 195, 201-02 (1989); Parkmerced Co. v. City & County of San Francisco, 140 Cal. App. 3d 1091, 1095 (1983); Baldassari v. U.S., 79 Cal. App. 3d 267, 272, (1978)).
2 Cal Fruit Intern. Inc. v. Jeanne Spaich, No. Civ. 04-2494 (E.D. Cal. 9/21/06) ("There appear to be no reported California decisions which address the issue of what factors are relevant in determining whether an individual is a nominee of a taxpayer.").
3 See Aug. Entm't, Inc. v. Philadelphia Indem. Ins. Co., 146 Cal. App. 4th 565, 577 (Cal. Ct. App. 2007) (with few California decisions relating to D&O policies that court looked to California federal court and out-of-state cases in resolving coverage issues and interpreting policy provisions); Lealao v. Beneficial Cal., Inc., 82 Cal. App. 4th 19, 38 (Cal. Ct. App. 2000) (stating that "when there is no California precedent on point, federal precedent should be consulted").
4 See, e.g., U.S. v. Beretta, No. C-07-02930-SI (N.D. Cal. 11/11/08); Leeds LP v. U.S., No. 08-CV-100 (S.D. Cal. 8/5/11); U.S. v. Washington, No. H-09-3996 (S.D. Tex. 6/20/11); U.S. v. Wolff, et al., No. 09-cv-238J (D. Wyo. 5/18/10); U.S. v. Fields, No. 3:06-CV-697-DPJ (S.D. Miss. 3/9/09); Sharp Management, LLC v. U.S., No. C07-402-JLR (W.D. Wash. 5/8/07).
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