Discretionary Trust Interest Held Subject to Federal Tax Lien

Code Section 6321 imposes a federal tax lien for unpaid taxes upon “all property and rights to property, whether real or personal” that belong to the delinquent taxpayer. Is a beneficiary’s interest in a trust a property right that the IRS can lien?

This turns on state law, and the rights of a beneficiary and the obligation of the trustee under that law. However, there are some general rules. If amounts are distributable only in the discretion of the trustee, the lien will not usually attach. If the trust provides for mandatory distributions or distributions required under a discretionary standard, then the lien probably applies.

Oftentimes, trusts will be halfway between a wholly discretionary trust and one that requires distributions under an ascertainable standard. In a recent case, the distribution language provided:

The Trustee shall pay to DENNIS MASAKI ENOMOTO so much or all of the net income and principal of the trust as in the sole discretion of the Trustee may be required for support in the beneficiary's accustomed manner of living, for medical, dental, hospital, and nursing expenses, or for reasonable expenses of education, including study at college and graduate levels.

So the trustee is obligated to distribute under an ascertainable standard, but only in his or her “sole discretion.”

The court noted that the case law is mixed on whether a lienable property interest arises from such a clause. In the end, it concluded that there was an interest that could be liened.

The court noted some criteria in these cases that favor the finding of a lien. The first is that there is mandatory language in the clause, such as use of the word “shall.” More particularly, courts note that such clauses often require payment (“shall pay”) and then leave the amount up to the discretion of the trustee. While I do not follow the logic, somehow this favors a lien arising more than if the trustee was given discretion on whether to pay – although the practical result as to the trustee’s authority is probably about the same. Having more than one current beneficiary is a fact that does not support the imposition of the lien.

If there is a lien, how can the IRS enforce it? Some possibilities include waiting around until the trustee makes a distribution and then attaching the distribution, compelling the trustee to make regular distributions under the standard and then attaching those, or attempting to attach and receive the entirety of the trust corpus immediately. The IRS sought the latter. Noting the difficulty of this question, the court did not fully resolve the issue – at this point it only denied the IRS motion for summary judgment on the issue.

Duckett v. Enomoto, U.S. District Court, D. Arizona (April 18, 2016)