Tax News: IRS and Spendthrift Trusts

Trusts have been utilized in estate and tax planning for ages. Among the most common is the spendthrift trust, aptly named from the inclusion of a spendthrift provision in a trust instrument. Typically, spendthrift provisions prohibit most third-party creditors from reaching a beneficiary’s interest in income and/or corpus of the trust until the trustee distributes such interest outright to the beneficiary.  

So, what, if any, power does the Internal Revenue Service (“IRS”) have to spendthrift trusts? Under the extensive jurisdiction and reach of IRS collections actions (discussed below), the IRS may reach spendthrift trusts under their Federal Tax Lien or Federal Tax Levy powers.

Tax Lien

The scope of the tax lien is very broad:  it generally attaches to all property and property rights of the taxpayer.  IRC § 6321. Although spendthrift provisions protect against most third-party creditor claims, federal courts have held that such provisions do not prohibit the federal tax lien from attaching to the taxpayer-beneficiary’s interest in the spendthrift trust.  See Bank One Ohio Trust Co. v. U.S., 80 F.3d 173 (6^thCir. 1996) (spendthrift trust does not defeat federal tax lien); U.S. v. Grimm, 865 F. Supp. 1303 (N.D. Ind. 1994) (concluding a valid spendthrift trust does not defeat attachment of the federal tax lien); U.S. v. Riggs Nat’l Bank, 636 F. Supp. 172 (D.D.C. 1986) (spendthrift trust does not prevent federal tax lien from attaching to a beneficiary’s interest in a trust).

Tax Levy

The Internal Revenue Code also permits the IRS to collect unpaid taxes through levy actions.  See IRC § 6331.  Similar to the federal tax lien, the IRS may levy upon all property and property rights of the taxpayer at the time the levy is made.  Id.

Generally, federal courts have held that the IRS may levy upon a taxpayer-beneficiary’s interest in a spendthrift trust.  See Lasalle Nat’l Bank v. U.S., 636 F. Supp. 874 (D. Ct. Ill. 1986) (concluding that trustee of spendthrift trust was required to pay IRS in response to IRS levy); Cohen v. U.S., 82 AFTR 2d 98-6487 (D. Ct. C.D. Cal. 1998).

For more information or questions, please contact the Tax Attorneys at Fazzio Law Offices, we're in your corner!