IRS Successfully Liens Beneficiary’s Interest in Support Trust

There is the understandable perception that by establishing a trust for your beneficiary which contains substantial restrictions on distributions and gives a trustee discretion to determine the timing and amount of distributions that creditors of the beneficiary cannot access trust assets. However, in the recent Arizona case of Duckett v. Enomoto, the IRS was able to attach a federal tax lien to assets held in a discretionary support trust.

The facts are straight-forward. The beneficiary of the trust owed substantial funds to the IRS. One of the IRS’ enforcement tools is the right to impose a lien on any property or rights to property belonging to the taxpayer. The issue in this case, raised in motions for summary judgment, focused on whether the assets held in a discretionary support trust constitute property or rights to property of the delinquent taxpayer rendering them subject to the IRS lien. Property rights are a matter of state law so the analysis began with a determination of the beneficiary’s rights in and to the trust assets. The court recognized there are different types of trusts that can be established and that the specific terms of each trust will be dispositive as to whether the beneficiary is determined to have property rights in the assets for IRS lien purposes.

The court observed that where a trustee has absolute discretion to pay to the beneficiary any part or none of the income or principal of the trust, the IRS federal tax lien cannot attach to the assets. This is the expected result with these terms because under Arizona law the beneficiary cannot compel a distribution and therefore has no property rights in the trust from an IRS lien perspective. On the other hand, in the case of an Arizona support trust where the trustee is required to pay to the beneficiary an amount subject to an ascertainable standard, even though the amount of the payment is discretionary, the beneficiary does have a legal right to force a distribution. Because the beneficiary can go to court and petition for a distribution the court concluded there is sufficient control over the property such that it can be characterized as property or a right to property subject to the IRS lien.

However, the IRS in this case was seeking more than just a lien against the assets of the trust. The IRS’ motion sought a transfer of the entirety of the trust funds to the United States to be applied against the beneficiary’s tax deficiency. The court denied this motion. The record before the court did not indicate what the beneficiary’s support needs were and, therefore, without such information to allow the court to determine the amount of funds the trustee could be compelled to distribute to the beneficiary, it could not authorize any turnover of assets to the government.

The decision leaves it unclear as to what limitations now apply to the trust assets. What is known is that under debtor creditor law the government now has a priority claim against the trust assets. But what else has it achieved? There is no court order freezing the assets. There is no court order requiring that funds properly distributable to the beneficiary be paid to the government which would, interestingly enough, be similar to the effects of a charging order. So can distributions still be made to the beneficiary? Can the trustee pay ordinary fees and expenses with trust assets? Can the trustee make a loan to the beneficiary?

Comparison with Michigan Law:

MCLA 700.7503 of the Michigan Estates and Protected Individuals Code deals with support trusts and states that the interest of a trust beneficiary subject to a support provision may not be transferred and the trust property is not subject to the enforcement of a judgment until income or principal, or both, is distributed directly to the trust beneficiary. Indeed, even after the distribution, the distributed amount is only subject to the judgment to the extent the distribution exceeds the amount necessary for the health, education, support or maintenance of the trust beneficiary.

MCLA 700.7504(1)(c) provides that the interest of a trust beneficiary that is subject to a support provision may be reached in satisfaction of an enforceable claim against the trust beneficiary by any of the following: … (c) this state or the United States.  Therefore, in Michigan, as in Arizona, the IRS has rights to access assets in a support trust.

The Michigan statutory scheme, despite the above, does not deprive the client or planner of ample opportunity to protect trust assets from a beneficiary’s creditors. MCLA 700.7505 is quite clear that a creditor of the beneficiary of a discretionary trust does not have a right to any amount of trust income or principal that may be distributed only in the exercise of the trustee’s discretion. Therefore, clients having asset protection as their primary goal, may be inclined to cede control over distributions to their trustees by establishing discretionary trusts rather than creating trusts with an ascertainable standard.