CorporateDIrect FullLogoWhiteLetter
Document Portal
Schedule a Consultation

800-600-1760

Pay an Invoice

Pay an Invoice    Document Portal     Schedule

800-600-1760

[email protected]

Incorporate First – Deduct Second

by | Mar 27, 2021 | Case Law, Forming an LLC, STARTING A BUSINESS

Should you set up a corporation or LLC before you start trying to deduct expenses? A recent case suggests you should.

Many think that they can deduct all of their start up expenses before formally incorporating a business. But in Carrick v. Commissioner of Internal Revenue (T.C. Summ. Op. 2017-56, July 20, 2017) the Tax Court ruled otherwise.

The Facts of Carrick

The taxpayer had a bachelor’s degree in electrical engineering. For approximately 15 years, he was employed in the oceanographic industry. Before the years in issue, and during 2013 and 2014, he was employed by Remote Ocean Systems (ROS), building underwater equipment such as cameras, lights, thrusters, control devices, and integrative sonar.

During the years in issue, ROS was experiencing financial difficulty. The taxpayer was provided some flexibility in his work schedule, and he began exploring business ventures with other individuals, using the name Trifecta United as an umbrella name for the activities, which he named Local Bidz and Stingray Away.

The Local Bidz activity involved creating a website with features similar to those of the websites of Angie’s List, Yelp, and eBay, which would permit people to bid on hiring contractors for products and repairs. The taxpayer first had the idea for Local Bidz in 2012, and he went “full force in the beginning of 2013,” spending time accumulating data and developing software and the website.

At some point in 2013 the web developer moved to Los Angeles and other individuals left the project. For some unspecified period in 2013, the taxpayer traveled weekly from his home in San Diego to Los Angeles to consult with the web developer. The taxpayer abandoned the Local Bidz activity before the end of 2013. Sometime in 2014, the taxpayer began the Stingray Away activity, which involved researching and developing a device to prevent surfers and swimmers from being injured by stingrays.

The taxpayer initially noticed that sonar devices might affect the behavior of sharks and other species, so he conducted research at beaches in La Jolla, where swimmers and surfers often were stung and bitten by stingrays. The taxpayer did not fully develop any devices nor list any devices for sale in 2014. He had had no gross receipts during 2013 or 2014 from either the Local Bidz activity or the Stingray Away activity.

The Decision in Carrick

In Carrick, the taxpayer asserted that his reported expenses were deductible as ordinary and necessary business expenses relating to the activities of Local Bidz and Stingray Away. The Tax Court noted that 26 U.S.C. § 162(a) provides the general rule that a deduction is allowed for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” The Tax Court stated that it was clear that the taxpayer was not “carrying on” a trade or business in 2013 or 2014 when the expenditures for the Local Bidz and Stingray Away activities were made.

Carrying on a trade or business requires more than preparatory work such as initial research or solicitation of potential customers; a business must have actually commenced. Expenses paid after a decision has been made to start a business, but before the business commences, are generally not deductible as ordinary and necessary business expenses. These preparatory expenses are capital expenditures.

The Tax Court pointed out that, while the taxpayer may have been conducting research in 2013 with respect to Local Bidz, or in 2014 with respect to Stingray Away, neither activity reached the point of actually commencing. There was neither sales activity nor evidence of the offering of products or services to the public. The taxpayer was still in the very early stages of research and development in each of these activities.

The Tax Court observed that there was nothing in the record indicating that the taxpayer had commenced any business activity as a sole proprietor. The taxpayer had not set up a formal business entity. Therefore, the Tax Court concluded that the taxpayer was not “carrying on” a trade or business in 2013 or 2014. See, 26 U.S.C. § 162(a); Frank, supra, 20 T.C. at 513-14 (1953); Shea, supra, T.C. Memo. 2000-179, 2000 WL 688593, at *5n. 10; Christian, supra, T.C. Memo. 1995-12, 1995 WL 9151, at *5.

Brief Discussion

If you’re preparing to open a new business, then you need to make certain that you understand the tax rules. It is crucial that you offer the product or service to the public and that you begin sales activity, because start-up expenditures, i.e., expenditures paid before a business begins, are not deductible in the years they are actually incurred. Instead, they are capital expenditures, which generally must be amortized over a 15-year period, once business begins, meaning gradually write off the cost over 15 years. See, 26 U.S.C. § 195. Thus, in order for an expenditure to be an ordinary and necessary trade or business expense, it must be related to more than a preparatory expenditure.

So, if the taxpayer in Carrick had opened his business first, then he might have been able to deduct his expenditures in the years they were actually incurred, instead of amortizing them over a 15-period.

Conclusion

The moral of the story is: Open your business first, and deduct later.

Courts Limit Pension Payouts

by | Mar 27, 2021 | ASSET PROTECTION RESOURCES, Case Law

Is Your Retirement Safe?

Are you certain of your pension? Can you count on Social Security to pay you in the future?

A recent case allowed the State of Rhode Island to unilaterally – and retroactively – reduce public employees’ pension benefits.

The case, Cranston Firefighters vs. Gina Raimondo, governor of Rhode Island, was decided by the U.S. Court of Appeals for the First Circuit on January 22, 2018.

The unions claimed they had a binding contract. They had put in their time. The state claimed they faced ‘fiscal peril’. There was no way to pay. The lower court decided the state was not obligated to pay out as ‘promised.’

The public employees claimed: “But we had a deal!” They appealed to a higher court.

The Appeals Court responded:

“A claim that a state statute creates a contract that binds future legislatures confronts a tropical-force headwind in the form of the ‘unmistakability doctrine’.” Parker, 123 F. 3d at 5. This doctrine precludes finding that a statute creates a binding contract absent a clear and unequivocal expression of intent by the legislature to so bind itself. Nat’l R.R. Passenger Corp. vs. Atchison, Topeka & Santa Fe Ry. Co., 470 U.S. 451, 465-66 (1985). The doctrine recognizes that “the principal function of a legislature is not to make contracts, but to make laws that establish the policy of the state.” Id. At 466. It also serves “the dual purposes of limiting contractual incursions on a State’s sovereign powers and of avoiding difficult constitutional questions about the extent of state authority to limit the subsequent exercise of legislative power.” United States v. Winstar Corp. 518 U.S. 839, 875 (1996) (plurality opinion).

Never once has our court found that state or federal legislation clearly and unequivocally expressed a legislative intent to create private contractual rights enforceable as such against the state.”

In other words, the court ruled that the primary function of those who pass laws is not to create contracts and comply with them, but to legislate.

How does this case affect you?

Are you counting on Social Security?

The Social Security Board of Trustees has stated that their trust funds will “become depleted and unable to pay scheduled benefits in full on a timely basis in 2034.”

In 16 years, Social Security will not be able to pay out all that they’ve promised.

And now we have a federal case saying they won’t have to do so. More such cases will likely follow. The courts can’t print money. But they can limit what is paid out. They can limit previous government promises made to anyone.

The real issue in all of this is: are you prepared for the coming pension crisis?

Mom’s Mistake is No Excuse – You Need a Professional Registered Agent

by | Feb 13, 2021 | ASSET PROTECTION RESOURCES, Case Law, Maintaining Your LLCs, RUNNING A BUSINESS

Mom’s Mistake Is No Excuse!

Do you have your registered agent service properly in place?

A recent Ohio case illustrated the significant pitfalls of lax procedures.

Your registered agent’s job is to accept service process, meaning notice of a lawsuit. If you don’t receive that notice the persons suing you can get a default judgment – meaning, since you didn’t respond to the charge in time, they win by default. You’ve just lost a case you had no idea was even brought against you!

The new case is John W. Judge Co. v. USA Freight, L.L.C, 2018-Ohio-2658 (Ohio App., July 6, 2018). The facts are that Judge alleged USA Freight owed them $4,405.05. They served their complaint by certified mail upon the registered agent and service was accepted by the mother of USA Freight’s owner. The mother didn’t speak much English, didn’t know the U.S. legal system and didn’t give the lawsuit papers to anyone.

By not responding to the lawsuit USA Freight had a default judgment entered against them. This is when they first learn of Mom’s mistake. They immediately tried to vacate (set aside) the judgment on the basis of “excusable neglect.”

But the Court concluded that when a company is required by law to maintain a statutory agent for service of process, and when certified mail service is successful at the statutory agent’s address that is on record with the Ohio Secretary of State, then the subsequent mishandling of the served documents by the person who signed for and received the documents at the statutory agent’s listed address did not amount to “excusable neglect.”

A full discussion of the case follows. Know that the lesson here is that you want a professional resident agent service to accept important notices for you. Excuses for not responding – even an excuse involving dear ol’ Mom – will not pass muster in the courts.

The Facts of Judge

Judge filed a complaint against USA Freight for money damages arising from alleged unpaid engineering services in the amount of $4,405.05. Judge requested that the complaint and summons be served upon USA Freight via certified mail at the address of USA Freight’s registered statutory agent, Mukhabbat Vasfieva. The trial court received the certified mail receipt, showing that the complaint and summons had been delivered and signed for by “Mukhabbat Koch” on March 24, 2016. USA Freight failed to file a response to Judge’s complaint; accordingly, Judge moved the trial court to enter a default judgment in its favor. The trial court granted Judge’s motion and entered a default judgment against USA Freight for the amount requested plus interest and costs.

After obtaining a certificate of judgment, Judge obtained a writ of execution ordering the court bailiff to levy on the goods and chattels owned by USA Freight.

Three weeks after the writ of execution was filed, USA Freight filed a Rule 60(B) motion to vacate the default judgment on grounds that it never received the complaint and summons, and was otherwise unaware of who signed for the certified mail service. USA Freight attached a supporting affidavit from Baris Koch, who averred that he was the General Manager of USA Freight and that his father was the owner. Koch also averred that he did not receive notice of Judge’s complaint until the court’s bailiff contacted him regarding the writ of execution. Koch further averred that he spoke with the members and employees of USA Freight to ascertain if anyone affiliated with the company had signed for service of the complaint and that he was unaware of anyone who had. Lastly, Koch averred that USA Freight had meritorious defenses to Judge’s lawsuit, which included a claim that USA Freight had paid Judge in full for its services and that any unpaid amounts were owed by Garrett Day, LLC, and/or Mike Heitz. In addition to the affidavit, USA Freight attached several invoices from Judge and copies of checks that USA Freight made payable to Judge. USA Freight also attached a written description and map of the property on which Judge provided its engineering services, indication that Garrett Day, LLC owned part of the property on which Judge’s services were rendered.

Judge filed a response opposing the motion to vacate on grounds that USA Freight failed to establish the necessary elements for such relief under Rule 60(B). The trial court then held an evidentiary hearing on the motion to vacate. At the hearing, the parties submitted no additional evidence, but simply gave oral arguments.

During that time, USA Freight explained that the certified mail receipt was signed by the mother of USA Freight’s owner. USA Freight explained that the owner’s mother was not part of the company or involved in its day-to-day operations, but that she happened to be present when the complaint was served and did not provide it to any of the members of the family who were involved in the business. USA Freight further explained that the owner’s mother understood and spoke very little English, and had very little knowledge of the legal system. USA Freight therefore claimed it was entitled to relief under Rule 60 (B)(1) for excusable neglect.

At the close of the hearing, the trial court invited the parties to submit post-hearing memoranda in support of their position. After receiving the parties’ memoranda, the trial court issued a decision and entry granting USA Freight’s motion to vacate. In granting the motion, the trial court found “excusable neglect,” noting that USA Freight’s conduct was not willful and that it did not exhibit a disregard for the judicial system. The trial court further found that USA Freight had demonstrated that it had a meritorious defense to Judge’s claim for money damages. Judge appealed from the trial court’s decision granting USA Freight’s motion to vacate.

The Decision in Judge

On appeal, Judge argues that the trial court erred in granting USA Freight’s motion to vacate the default judgment under Rule 60(B), because USA Freight failed to establish that it was entitled to relief under Rule 60(B). More specifically, Judge claimed that USA Freight failed to establish that it did not respond to Judge’s complaint due to excusable neglect.

After reviewing the necessary requirements for USA Freight to obtain relief from a final judgment under Rule 60(B), the Ohio Court of Appeals noted that, because Judge did not dispute the existence of a meritorious defense or that USA Freight filed its motion to vacate within a reasonable time, the only issue before the Court was whether it was an abuse of discretion for the trial court to conclude that USA Freight was entitled to relief under Rule 60(B)(1) on grounds of “excusable neglect.” The Court noted that, in considering whether neglect is excusable under Rule 60(B)(1), a court must consider all the surrounding facts and circumstances. The Court pointed out that the phrase, “excusable neglect” in Rule 60(B)(1) is an elusive concept which has been difficult to define and to apply.

The Court observed that the Ohio Supreme Court had determined that neglect is inexcusable when the movant’s inaction revealed a complete disregard for the judicial system and the right of the appellee. The Court also observed that the Ohio Supreme Court had held that “excusable neglect” in the context of a Rule 60(B)(1) motion generally means the failure to take the proper steps at the proper time, not in consequence of the part’s own carelessness, inattention, or willful disregard of the processes of the court, but in consequence of some unavoidable or unexpected hindrance or accident, or reliance on the care and vigilance of his counsel or no promises made by the adverse party. The Court explained that courts generally find “excusable neglect” in those instances where there are unusual or special circumstances that justify the neglect of a party or the party’s attorney. That said, the Court cautioned that the concept of “excusable neglect” must be construed in keeping with the proposition that Rule 60(B)(1) is a remedial rule to be liberally construed, while bearing in mind that Rule 60(B) constitutes an attempt to strike a proper balance between the conflicting principles that litigation must be brought to an end and justice should be done.

After discussing the conflicting principles that must be borne in mind in ruling upon a Rule 60(B) motion, the Court pointed out that the supporting affidavit signed by USA Freight’s General Manager, Baris Koch, averred that he first learned of Judge’s lawsuit against USA Freight when he trial court’s bailiff notified him that a writ of execution had been filed against the company. The Court noted that the record indicated that the bailiff was ordered to levy execution against USA Freight, and that USA Freight filed its motion to vacate approximately three weeks later. The Court further noted that Koch has averred in his affidavit that he was unaware of any member or employee of USA Freight who had signed for or received service of the complaint; and that, as of the date he signed the affidavit, Koch claimed he did not know who signed for the complaint; and that it was not until the hearing on the motion to vacate that USA Freight explained, through counsel, that service of the complaint and summons was signed for by the mother of the owner of USA Freight. USA Freight explained that the owner’s mother had no role within the company and that she happened to be present when the complaint was delivered by certified mail. USA Freight further explained that the owner’s mother understood and spoke very little English, and that she did not provide the complaint to any of the family member who were involved in USA Freight’s business operations. Although no testimony or affidavits were submitted to verify this information, the trial court found USA Freight’s explanation credible and that it constituted “excusable neglect” under Rule 60(B)(1).

Judge argued that the trial court’s decision was an abuse of discretion because USA Freight failed to provide any evidence establishing that the person who received and signed for the complaint was the non-English speaking mother of USA Freight’s owner. The Court noted that the owner’s mother did not appear at the hearing; that her name was never disclosed on the record; and that USA Freight also never disclosed what the owner’s mother did with the complaint after she received it. In an effort to establish that the person who signed for the complaint was not the owner’s mother, Judge provided the trial court with two prior certified mail receipts with signatures that matched the signature on the receipt at issue. Judge pointed out that one of the prior receipts indicated that the signatory was an “Agent” of USA Freight.

Judge further argued that it was USA Freight’s responsibility to maintain a valid statutory agent who is designated to receive service of process at the agent’s listed address; that it was indeed neglectful for USA Freight to use an address where certified mail could be received and mishandled by a non-English-speaking individual who was not affiliated with USA Freight’s business; and that such conduct did not constitute “excusable neglect.” In support of this claim, Judge cited the following three unpublished decision, providing that insufficient or negligent internal procedures in an organization may not comprise “excusable neglect” and that, therefore, may not support vacation of a default judgment: (1) Middleton v. Luna’s Resturant & Deli, L.L.C., 201-Ohio-4388, 2011 WL 3847184 (Ohio App., Aug. 29, 2011) (unpublished decision); (2) LaKing Trucking, Inc. v. Coastal Tank Lines, Inc., 1984 WL 6241 (Ohio App., Feb. 9, 1984) (unpublished decision) (summons received in a corporate mail room but lost before being brought to the attention of the proper office does not rise to excusable neglect); and (3) Miller v. Sybert, 1975 WL 7351 (July 25. 1985) (unpublished decision)(ordinary mail delivered to defendant when mail is accessible to other persons and where it was never picked up by defendant’s friends while he was out of the state does not constitute “excusable neglect”). The Ohio Court of Appeals noted that the above-cited three unpublished decisions were in accord with the following two decisions: (1) Andrew Bihl Sons, Inc. v. Trembly, 67 Ohio App.3d 664, 667, 588 N.E2d 172 (Ohio App. 1990) (ignoring mail for more than three months due to illness and failing to delegate a competent agent to handle business affairs does not constitute “excusable neglect”); and (2) Meyer v. GMAC mtge., 2007-Ohio-5009, 2007 WL 2773653 (Ohio App., Sept. 25, 2007) (unpublished decision) (employee’s failure to forward the complaint to the appropriate corporate department does not constitute “excusable neglect”).

Finally, Judge argued that the mother’s ignorance of the legal process did not amount to “excusable neglect.”

The Rationale of Judge

Having reviewed the record, the Ohio Court of Appeals found that Judge had presented strong arguments in support of its position that the trial court had abused its discretion in finding “excusable neglect,” especially with regard to USA Freight’s responsibility to maintain a valid statutory agent. The Court cited the Ohio Revised Code for the proposition that “[e]ach limited liability company [such as USA Freight] shall maintain continuously in this state an agent for service of process on the company.” See, R.C. 1705.06(A). The Court pointed out that a limited liability company is required to provide the Ohio Secretary of State with a written appointment of its statutory agent that sets forth the name of the agent and the agent’s address in this state. See, R.C. 1705.06(B)(1)(a), (C); and that the Ohio Secretary of State then kept a record of the statutory agent’s name and address. See, R.C. 1705.06(C). The Court noted that Rule 4.2(g) of the Ohio Rules of Civil Procedure provided that, to serve a limited liability company, a plaintiff may direct service of process to “ the agent authorized by appointment or by law to receive service of process”’ that [c]ertified mail service upon such an agent is effective upon delivery, if evidenced by a signed return receipt”; and that Rule 4.1 (A)(1)(a) provided that “[s]ervice is valid if ‘any person’ at the address signs for the certified mail, whether or not the recipient is the defendant’s agent.”

Applying these principles to the facts and circumstances of Judge, the Ohio Court of Appeals noted that Judge had served its complaint on USA Freight’s statutory agent via certified mail at the address on record with the Ohio Secretary of State and that the certified mail was received at the address of USA Freight’s statutory agent and signed for by the mother of the owner of USA Freight. Under these circumstances, the Court concluded that service of the complaint, because the mother of USA Freight’s owner mishandled the complaint, this type of scenario had not been found to constitute “excusable neglect.”

In support of its conclusion, the Court cited the following decision of the United States District Court for the Northern District of Ohio: Chicago Sweetners, Inc. v. Kantner Group, Inc., 2009 WL 1707927 (N.D. Ohio, June 17, 2009) (unpublished decision) (finding no “excusable neglect” where a defendant company was properly served with a complaint via certified mail to its statutory agent’s address, the certified mail was received and signed for by an administrative assistant of the defendant company, who was also the mother of the defendant company’s president, and the mother thereafter mishandled the complaint so that the defendant company never received the notice of it).

In reaching its decision, the Ohio Court of Appeals agree with Judge, that insufficient or negligent internal procedures in an organization may not compromise excusable neglect and that, therefore, they may not support the vacation of a default judgment,” citing, Middleton, supra, and Denittis v. Aaron Costr., Inc., 2012-Ohio-6213, 2012 WL 6738472 (Ohio App., Dec. 31, 2012) (unpublished decision). In so agreeing, the Court stressed that USA Freight was, by law, responsible for maintaining a valid statutory agent that was calculated to receive service of process at the agent’s listed address; that USA Freight has chosen a statutory agent address where it was possible for a non-English-speaking person who was unaffiliated with the company to receive important documentation that was served at the address; and that, due to USA Freight’s negligence in choosing its statutory agent and/or failure to implement internal procedures to ensure that documentation served at the statutory agent’s address was directed to the appropriate person, the complaint at issue was mishandled by the owner’s mother.

The Court emphasized that “excusable neglect” does not result from the party’s own carelessness, inattention, or willful disregard of the processes of the court, but in consequence of some unavoidable or unexpected hindrance or accident; and that, had USA Freight chosen a better statutory agent, or had better procedures in place for receiving service of process at the statutory agent’s address, then the mishandling of the complaint would likely have been avoided.

Accordingly, the Ohio Court of Appeals concluded that the circumstances in Judge did not constitute an unavoidable or unexpected hindrance or accident. In addition, the Court pointed out that, while abuse of discretion was an extremely high standard of review that required the Court to find the trial court’s “excusable neglect” decision unreasonable, the Court, nevertheless, had reached that conclusion. The Court reiterated that the trial court’s decision was unreasonable, because the mishandling of the complaint was the result of USA Freight’s own negligence, and stated that, a company should be adequately prepared to receive service of process at the statutory agent’s address.

Although the Court recognized that Rule 60(B) motions are to be liberally construed in favor of the movant, the Court, nevertheless, found that USA Freight’s negligence in choosing its statutory agent and its procedures for receiving service of process was in willful disregard of the processes of the Court. Therefore, the Court narrowly held that, when a company is required by law to maintain a statutory agent to receive service of process, and when there is successful service of process via certified mail at the statutory agent’s address that is on record with the Ohio Secretary of State, the subsequent mishandling of served documents by the person who signed for and received the documents at the statutory agent’s listed address does not amount to “excusable neglect.”

Conclusion

The Ohio Court of Appeals decision in Judge should serve as a warning to companies and LLCs to check their statutory agent procedures in order to ensure that documents served at their statutory agent’s address are directed to the appropriate person(s); otherwise, they may by subject to enforceable default judgments against them in lawsuits of which they were entirely unaware.

Don’t let this happen to you!

Schedule a Consultation

Six Ways Joint Ownership Could Cost You

by | Jan 6, 2020 | REAL ESTATE, Real Estate Information

Many people use joint ownership (the holding of title by two or more people), without really thinking about it. It is often used as a substitute for estate planning because it is cheaper, which is why some call it the “poor man’s will”. It may seem like a simple and inexpensive way to avoid probate (the costly court review of your transfers at death), but it is not a good idea in most cases, and can be fraught with unexpected peril. Joint property ownership disputes can really cost you.

What Is Joint Ownership?

Joint ownership occurs when the names of two or more people are placed on bank accounts, stocks, bonds, or deeds to real property. Then, when one of the joint tenants die, the surviving joint tenants own the entire property automatically by operation of law, meaning it happens without going to court or requesting any change. When the first joint owner passes, the survivors own it all regardless of the will of the deceased joint tenant.

The Disadvantages of Joint Ownership

  1. Vulnerable to Creditors
    Joint ownership property is subject to the claims of a joint owner’s creditors. If one joint owner experiences financial difficulties, then his creditors may be able to reach into his interest in the joint ownership property, creating an unexpected co-owner. This new co-owner could, if they wished, file a partition action to force a sale of the property.
  2. Unexpected Use of Joint Ownership Property
    There is nothing to prevent one joint owner from unexpectedly using the joint ownership property for his or her own benefit, thereby eliminating or reducing the value of the joint ownership property to the other owner. For example, you may show up to your vacation home one day and find some unsuspecting B&B guests had it rented to them by the other owner.
  3. Unequal Distributions Among Children
    If the parent of three children adds the name of one of her children to a joint ownership property before passing away, the entire property will pass solely to that one child. What starts out as a matter of convenience (i.e. being able to sign on a bank account), could lead to a family battle royale.
  4. Reconveying Joint Ownership Property is Difficult
    In order to convey joint ownership property back to the original owner, both joint owners must agree, and must be willing to sign the deed and all of the paperwork. If one owner refuses to do so, then reconveying the property to one owner may require a court order.
  5. The Incapacitation of a Joint Owner Could be Devastating
    If one joint owner becomes sick or mentally incapacitated, then it may not be possible to sell the property without the appointment of a guardian and the approval of a probate court. If the sale is approved, the probate court could order that the incapacitated joint owner’s share of the sale be placed in a separate guardianship account to pay for their care, effectively leaving the seller with only one half of the sale proceeds.
  6. Divorce Divisions
    If a joint owner is married, then it is possible that a divorce court might regard the joint ownership property as marital property and award all, or a portion of it, to a joint owner’s soon-to-be ex-spouse.

Examples of Joint Ownership Gone Awry

Case No. 1

John and Martha had been married for many years, but John was in the early stages of dementia. He and Martha began drifting apart. They both agreed that John would live in their marital home for the rest of his days and that Martha would live in another state until John died. Then, after John died, Martha would come back to live in their home. This might well have worked out all right for John and Martha, except that, after Martha was gone, John’s neighbor, Willie, saw a way to make some easy money.

Willie befriended John, and eventually talked John into divorcing Martha. Willie kindly helped John fill out all of his divorce paperwork, and convinced John to swear (falsely) in his affidavit that Martha had deserted him and that he did not even know where she was. The divorce court accepted John’s (Willie’s) lies and granted John a divorce from Martha. John was awarded all of the parties’ martial property, including John and Martha’s marital home.

John’s health steadily deteriorated, and a few weeks before John’s death, Willie convinced John to make him a joint owner of his home, so that he could better help John take care of it.

When John died, Willie became the sole owner of the home automatically, and, being the weasel that he was, Willie immediately borrowed $100,000 from a local bank by mortgaging John and Martha’s home, which was now his.

You can imagine Martha’s surprise when she returned to her marital home and discovered that not only was Willie it’s sole owner, but he was now living in it.

Case No. 2 — The Bad Actions of One Joint Owner Costs Both

After Joyce’s husband passed away, her son Dan offered to help her take care of her home. She made him joint owner of the property so that he could do things like pay utilities. Well, Dan was an idealistic man and held many strong beliefs, including that federal income tax was unconstitutional. True to his convictions, and unbeknownst to Joyce, Dan had not paid any federal income tax for the last ten years. Unfortunately for Joyce, the Internal Revenue Service (IRS) got around to investigating Dan’s finances and discovered his joint property interest in Joyce’s home. The IRS asserted a tax lien against Dan’s interest in the jointly owned property and Joyce was forced to pay back all of Dan’s back taxes to the IRS, together with interest and penalties, in order to continue living undisturbed in her own home.

Case No. 3 — The Need for Guardianship Costs Both

Bill and Mary had been married happily for 58 years. They had always owned their home jointly with the understanding that when one of them passed away, the other would receive the home. Unfortunately, a little after her 87th birthday, Mary was diagnosed with Alzheimer’s disease. Bill wanted to do what was best for his wife, so he decided to sell their home so he could provide care for Mary. It would not be that simple. Because Mary was considered mentally incapacitated, Bill had to hire a probate attorney to set up guardianship for Mary and her estate, and appoint himself as the guardian. He then had to hire the attorney again so he could sell the house. When the house was sold, the probate court ordered Bill to set up a separate account for Mary’s half of proceeds, and every time he wanted to use that money for something, he had to hire his expensive probate attorney and petition the court for approval. This was certainly not what Bill and Mary had in mind for their last few years of life.

CONCLUSION

Although joint ownership seems like a simple and inexpensive way to avoid probate, it is littered with traps. Luckily, there are other options such as using a living trust or an LLC for asset protection. Call 800-600-1760 to learn more about protecting your property the right way.

IRS Liens Don’t Die

by | Jan 1, 2020 | REAL ESTATE, Real Estate Information

Beware of Purchasing Real Estate with Unpaid Liens on It

Can the Internal Revenue Service (“IRS”) collect a prior owner’s delinquent federal income taxes from the subsequent purchaser of real property?

Yes.

In Shirehampton Drive Trust v. JP Morgan Chase Bank, N.A., 2019 WL 4773799 (D.Nev., Sept. 29, 2019) (unpublished decision) (Case No. 2:16-cv-02276-RFB-EJY), the United States District Court for the District of Nevada concluded that the IRS was entitled to enforce its federal income tax liens against the new owner of real property.

The Course of Proceedings in Shirehampton

Plaintiff Shirehampton Drive Trust (“Shirehampton”) sued Defendant, United States of America Treasury Department, Internal Revenue Service (“IRS”), and Defendant, JP Morgan Chase Bank, N.A. (“Chase”), seeking a declaration that from the Court that a Las Vegas property that it had obtained at a foreclosure sale in 2013 was not encumbered by Chase’s deed of trust.  To that end, Shirehampton asserted claims for injunctive relief, quiet title, and declaratory relief.  The IRS removed the case to federal court, and answered and counterclaimed against Shirehampton, and crossclaimed against Chase and other Defendants, to enforce federal tax liens pursuant to 26 U.S.C. §§ 6321, 6322 and 7401.  Chase answered the complaint and asserted counterclaims for quiet title under NRS 40.010, declaratory relief under NRS 30.010 and 28 U.S.C. § 2201, and unjust enrichment.  Shirehampton answered the counterclaims, and the Court dismissed the other Defendants without prejudice.  All three remaining parties then moved for summary judgment.  The Court administratively stayed the case pending the Nevada Supreme Court’s decision in SFR Investments Pool 1, LLC v. Bank of New York Mellon, 134 Nev. 438, 422 P.3d 1248 (2018), but then lifted the stay.

The Facts in Shirehampton

This matter concerned a nonjudicial foreclosure on a property located at 705 Shirehampton Drive, Las Vegas, Nevada 89178 (the “property”).  The property was located in a community governed by a homeowners’ association (“HOA”) that required its community members to pay dues.

Louisa Oakenell (“Oakenell”) borrowed funds from MetLife Home Loans, a Division of MetLife Bank, N.A. (“MetLife”) to purchase the property in 2008.  To obtain the loan, Oakenell executed a promissory note and a corresponding deed of trust to secure repayment of the note.  The deed of trust listed Oakenell as the borrower, MetLife as the lender, and Mortgage Electronic Registration Systems, Inc. (“MERS”), as the beneficiary.  In May, 2013, MERS assigned the deed of trust to Chase.

Oakenell fell behind on her HOA payments.  The HOA, through its agent Red Rock Financial Services, LLC (“Red Rock”), sent Oakenell a demand letter by certified mail for the collection of unpaid assessments on June 26, 2009.  On July 21, 2009, the HOA, through its agent, recorded a notice of delinquent assessment lien.  The HOA sent Oakenell a copy of the notice of delinquent assessment lien on July 24, 2009.  The HOA subsequently recorded a notice of default and election to sell on October 21, 2009, and then a notice of foreclosure sale on September 18, 2012.  Red Rock mailed copies of the notice of default and election to sell to Oakenell, the HOA, the IRS, and Metlife Home Loans.  Red Rock did not mail a copy of the notice of default and election to sell to MERS.  On January 28, 2013, the HOA held a foreclosure sale on the property under NRS Chapter 116.  Shirehampton purchased the property at the foreclosure sale, and a foreclosure deed in favor of Shirehampton was recorded.

In addition to falling behind on her HOA payments, Oakenell also stopped paying federal income taxes.  The IRS subsequently filed notices of federal tax liens against Oakenell at the Clark County Recorder’s office on May 1, 2009, and June 24, 2009.  As of October 1, 2018, Oakenell had accrued $250,953.37 in income tax liability plus daily compounding interest.

The Decision in Shirehampton

The Court concluded that the IRS was entitled to enforce its federal income tax liens against Shirehampton, the new owner of real property, but that Shirehampton acquired the property free and clear of Chase’s deed of trust.

The Rationale of Shirehampton

Chase Deed of Trust.

The Court first addressed whether Shirehampton purchased the property subject to Chase’s deed of trust, and concluded that it did not.

Chase argued that the foreclosure sale was void because the HOA, through its agent, did not comply with the notice requirements of the version of NRS 107.090 in effect at the time by serving a copy of the notice of default and notice of sale on MERS, its predecessor-in-interest.  See, NRS 107.090(3)(b) (requiring that any person recording a notice of default mail a copy of the notice within ten days of recording to “[e]ach other person with an interest whose interest or claimed interest is subordinate to the deed of trust.”). The Court disagreed, and found the facts to be substantially similar to the Nevada Supreme Court’s decision in West Sunset 2050 Trust v. Nationstar Mortgage, LLC, 134 Nev. 352, 354-55, 420 P.3d 1032 (2018) (concluding that “Nationstar’s failure to allege prejudice resulting from defective notice dooms its claim that the defective notice invalidates the HOA sale”).

The Court next considered Chase’s argument that the HOA did not intend to foreclose on the superpriority portion of the lien, because the assessment lien notices did not specify that the sale was a superpriority sale.  The Court disagreed, and distinguished the Shirehampton case from the recent decision of the Nevada Supreme Court’s in Cogburn Street Trust v. U.S. Bank, N.A., as Trustee to Wachovia Bank, N.A., 2019 WL 2339538 (decided May 31, 2019) (concluding that HOA properly nonjudicially foreclosed on subpriority portion of lien after bank’s tender satisfied superpriority portion of the lien).  The Court concluded that Chase’s evidence was insufficient to find that the HOA intended to foreclose on the subpriority portion of the lien as a matter of law, and did not establish fraud, oppression, or unfairness sufficient to void the sale.  In addition, the Court noted that it had previously addressed Chase’s further argument regarding the facial unconstitutionality of NRS Chapter 116, and thus incorporated by reference its reasoning in Carrington Mortgage Services, LLC v. Tapestry at Town Center Homeowners Association, 381 F. Supp. 3d 1289, 1294 (D.Nev. 2019).  Thus, the Court finds that Chase’s deed of trust was extinguished by the HOA foreclosure sale.

IRS Tax Lien.

The Court next addressed the priority of the IRS tax lien versus that of the HOA’s lien, and concluded that, because the HOA lien was not perfected at the time that the IRS recorded its notice of tax liens, the IRS tax liens had priority over the HOA lien

The Court initially noted that, when the IRS assesses a person for unpaid federal taxes, a lien is created in favor of the United States as a matter of law, citing, 26 U.S.C. § 6321.  While the lien is automatically created when the assessment occurs, the lien is not valid against purchasers, holders of security interests, mechanic’s liens, or judgment lien creditors until notice of it has been filed, citing, 26 U.S.C. § 6323(a).  Federal tax liens do not automatically have priority over all other liens.  Absent a provision to the contrary, priority for purposes of federal law is governed by the common-law principle that the “the first in time is in the first in right”; and a competing state lien exists for “first in time” purposes when it has been perfected, meaning that the identity of the lienor, the property subject to the lien, and the amount of the lien are established, citing, U.S. v. McDermott, 507 U.S. 447, 449, 113 S.Ct. 1526, 123 L.Ed.2d 128 (1993).

Applying these principles to the Shirehampton case, the Court observed that the IRS first assessed Oakenell for lack of income tax payments on November 7, 2005, and July 3, 2006; and that the IRS then recorded its notice of tax liens with the Clark County recorder on May 1, 2009, and June 24, 2009.  The Court further observed that Oakenell first became delinquent on her HOA dues on March 1, 2009; that the HOA recorded its notice of delinquent assessment lien on July 21, 2009; and that the HOA mailed Oakenell a copy of the notice of delinquent assessment lien on July 24, 2009.

Despite these facts, Shirehampton argued that the HOA lien was first in time.  Shirehampton claimed that, because the notice of delinquent assessment recorded in July, 2009, incorporated delinquent assessments that had been owed since January, 2009, it was technically first in time.  Shirehampton pointed to the language of NRS 116.3116 at the time, which stated that the “association has a lien…from the time the…assessment or fine becomes due.”  Oakenell did not become delinquent until March 1, 2009, so Shirehampton argued that the HOA lien was perfected on March 1, 2009.  The Court disagreed, and found that the HOA lien was not perfected until the notice of delinquent assessment lien was sent to the unit owner, citing, In re Priest, 712 F.2d 1326, 1329 (9th Cir. 1983) (“[A] lien cannot arise prior to the taking of any administrative steps to establish the lien.”).  The Court emphasized that the Nevada Supreme Court has held that the mailing of the notice of delinquent assessment lien to the delinquent homeowner pursuant to NRS 116.31162(1)(a) “institutes proceedings to enforce the lien,” quoting, Saticoy Bay LLC Series 2021 Gray Eagle Way v. JPMorgan Chase Bank, N.A., 388 P.3d 226, 231 (2017) (“A party has instituted ‘proceedings to enforce the lien’ for purposes of NRS 116.3116(6) when it provides the notice of delinquent assessment.”).  Thus, the Court stressed that providing notice of delinquent assessment is the first administrative step to perfecting a superpriority lien, because “no action can be taken unless and until the HOA provides a notice of delinquent assessments pursuant to NRS 116.31162(1)(a),” quoting, Saticoy Bay LLC Series 2021, supra, 388 P.3d at 231.  The Court pointed out that the notice of delinquent assessment also establishes, pursuant to NRS 116.31162(1)(a), the amount of the lien as is required under federal law before a lien can be perfected, citing, Loanstar Mortgagee Services, LLC v. Barker, 282 Fed.Appx. 572, 573 (9th Cir. 2008).  While assessments and related fees may be delinquent prior to this mailing, they are not set until the mailing, citing, NRS 116.31162(1)(a) (explaining that notice must contain a set “amount” for the delinquency).  The Court reasoned that the mailing of the notice of delinquent assessment was the first administrative step to establish a superpriority lien, and was the first time that the amount of this lien was fixed and set.  Thus, the Court found that an HOA lien cannot be perfected under federal law until at least the notice of delinquent assessment lien has been provided to the unit owner.  The Court stated that, it is only with this notice that the identity of the lienor, property subject to the lien, and, most significantly, the amount of the lien are sufficiently established.

Applying these principles to the Shirehampton case, the Court observed that Red Rock sent the notice of delinquent assessment lien pursuant to NRS 116.31162(1)(a) to Oakenell on July 24, 2009, which was after the IRS recorded its notice of tax liens.  As such, the Court concluded that, because the HOA lien was not perfected at the time that the IRS recorded its notice of tax liens, the IRS tax liens had priority over the HOA lien, citing, LN Management LLC Series 31 Rue Mediterra v. United States Internal Revenue Service, 729 Fed.Appx. 588 (9th Cir. 2018) (finding no record evidence that identity of HOA lienors, property subject to lien, and amount of lien were established before notice of federal tax lien was recorded).  The Court concluded that was IRS was entitled to enforce its tax liens against the new owner of the property, citing, U.S .v. Bess, 357 U.S. 51, 57, 78 S.Ct. 105, 42 L.Ed.2d 1135 (1958) (noting that “[t]he transfer of property subsequent to the attachment of [a federal tax lien] does not affect the lien”).

Thus, the Court held that the IRS could enforce its tax liens against Shirehampton, but that Shirehampton acquired the property free and clear of Chase’s deed of trust.

BRIEF DISCUSSION

            This case is fairly straightforward; however, it does illustrate the potential difficulties that may ensue from purchasing real property at a foreclosure sale.  Obviously, a purchaser of real property at a foreclosure sale must be careful in doing so, because the IRS potentially can collect the prior owner’s federal income taxes from the subsequent purchaser of the real property. 

            It should be noted that Shirehampton filed a Notice of Appeal to the Ninth Circuit on November 5, 2019.

CONCLUSION

Under some circumstances, the IRS can collect a prior owner’s delinquent federal income taxes from the subsequent purchaser of real property.