A benefit of giving assets in trust, instead of outright, is the "spendthrift" protection often accorded by State law. This protection has the objective of protecting a beneficiary from himself - by insulating the trust assets from claims of the creditors of a beneficiary the trust assets are protected for future use of the beneficiary or successor beneficiaries of the trust.
In asset/creditor protection planning, the IRS is something of a supercreditor, since it often has powers superior to regular creditors. A recent IRS Internal Legal Memorandum (ILM 200614006, April 7, 2006) is illustrative of this special status, wherein the IRS analyzes its powers to reach trust property held in a spendthrift trust.
In the situation that is analyzed, an individual dies and pursuant to his estate planning documents a trust is established for his daughter. The trust has spendthrift provisions. The daughter is also trustee of the trust, and provides for the payment of current income to the daughter, and fixed distributions of portions of the principal of the trust at specified times in the future. The daughter has delinquent tax obligations to the IRS.
The ILM determined that a federal tax lien applies to the daughter’s interests in the trust as a beneficiary since a tax lien attaches to all property and rights to property of a delinquent taxpayer. Citing case law, the ILM provides that spendthrift provisions, which are state-created exemptions, cannot defeat a federal tax lien, even if effective against the claims of other creditors.
In regard to enforcing the lien, the ILM provides that the IRS can levy upon and seize the entire stream of income payments that are due to the daughter (including future income payments, presumably as and when they are due to be paid). It further provides that the IRS can levy on the future mandated principal payments, but the IRS cannot accelerate the time of payment.
It is interesting to note that the ILM did not address what would occur if the payments to the daughter were to be made only in the discretion of the trustee. In the facts given, both the income and future principal distributions involved MANDATORY distributions.
It is interesting to note that the ILM did not address what would occur if the payments to the daughter were to be made only in the discretion of the trustee. In the facts given, both the income and future principal distributions involved MANDATORY distributions.
As an alternative to a levy, If a trustee ignores a tax lien on the trust assets and makes distributions to a delinquent taxpayer, the ILM notes that the IRS can sue the trustee for conversion.
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