The debtor could not exempt property of the estate which he owned as a tenant in the entirety with his non-filing spouse with respect to a debt he owed to the IRS where section 522(b)(3)(B) exempts such property only to the extent it would be exempt under nonbankruptcy law and the Tax Code permits the IRS to collect against the property. Morgan v. Bruton (In re Morgan), No. 21-891 (N.D. N.C. Aug. 12, 2022).
At the time the debtor filed for chapter 7 bankruptcy, he owed $18,000 to the IRS. He and his non-filing wife owned a fully-encumbered home valued at $313,500 as tenants by the entirety. The debtor’s spouse was jointly liable for the home loan but not the IRS loan.
In his bankruptcy, the debtor claimed an exemption in the home under section 522(b)(3)(B) which exempts “any interest in property in which the debtor had, immediately before the commencement of the case, an interest as a tenant by the entirety or joint tenant to the extent that such interest as a tenant by the entirety or joint tenant is exempt from process under applicable nonbankruptcy law.” The trustee objected to the exemption and the bankruptcy court disallowed it as to the tax debt. The debtor appealed.
On appeal the district court observed that North Carolina law prohibits creditors of one debtor from collecting against property the debtor co-owns with a non-debtor. However, section 6321 of the Tax Code provides that failure to pay federal taxes creates “a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person,” and, in United States v. Craft, 535 U.S. 274, 283 (2002), the Supreme Court held that the lien attaches to entireties property even if only one owner is liable on the debt. Under this framework, the district court found that IRS could have attached the property even though it was jointly owned and only the debtor was liable for the tax debt.
The debtor pointed out that the creation of a lien under section 6321 is conditioned upon the IRS making a demand of the taxpayer to pay the delinquent taxes, and the IRS had made no such demand. The court found the failure to create a lien under the statute was irrelevant to the issue of the exemption under section 522(b)(3)(B) as the debt existed with or without the lien and, upon the proper demand, the property would have been subject to collection from the IRS under the Tax Code.
The debtor next argued that even if the property was subject to the IRS tax liability, the bankruptcy trustee did not have the authority to “assume the collection powers of the IRS.” The debtor maintained that under section 544(a) the trustee may stand in the shoes of a hypothetical judicial lien creditor but not the shoes of a statutory lien creditor like the IRS.
The debtor pointed to Schlossberg v. Barney, 380 F.3d 174 (2004), and In re Knapp, 285 B.R. 176 (Bankr. M.D.N.C. 2002), where the trustee had attempted to expand his strong-arm powers under section 544 by including the IRS among the hypothetical creditors whose shoes the trustee could inhabit. The courts in those cases rejected the trustee’s argument, finding that where the IRS was not an actual creditor, allowing the trustee to use the expanded sovereign power of the IRS to circumvent the exemption for entireties property would “eviscerate” that exemption.
The court here found that the trustee’s strong-arm power under section 544(a) had no bearing on the issue of whether property of the estate is exempt. “Nothing in Section 544(a) exempts otherwise nonexempt property from the bankruptcy estate or limits the power of the trustee to ‘collect and reduce to money’ the nonexempt property of the estate to pay actual creditors.” In this case, unlike those cases relied on by the debtor where the trustee sought to expand his strong-arm powers, the IRS was an actual creditor.
The court found the property was not exempt under section 522(b)(3)(B) as to the tax liability and affirmed.
Tags: Exemptions, tenancy by entirety
