Major Development in Spendthrift Trust Law

In connection with Spendthrift Trusts, the right of a creditor to reach the beneficiary/debtor’s interest in the Trust are limited to the rights possessed by the beneficiary-debtor. For example, creditors of such a beneficiary can reach the trust interest if, and only to the same extent, that the beneficiary can compel payment of income or corpus to himself. Unless such a demand right exists, the trust interest is protected against creditors of the beneficiary.

In IRS Internal Legal Memorandum 200614006, the IRS reached the conclusion that the IRS may levy on a spendthrift trust and sue the trustee for conversion. Here the IRS concludes that where a delinquent taxpayer was a successor trustee and beneficiary of a trust and who as beneficiary has a fixed and determinable right to a stream of payments, the levy will seize not only the payments currently due but also the payments to be made in the future. Thus, if a taxpayer has a fixed right under a trust to receive periodic payments or a lump sum distribution from a trust, the levy seizes the right to such payments or distributions. According to the IRS, spendthrift provisions, which are state-created exemptions, cannot defeat a federal tax lien. The Memorandum cites authority that the federal tax lien overrides a state statute providing for exemptions. Accordingly, the spendthrift provision of the trust, however effective against certain creditors' claims, is ineffective at insulating assets of the trust from the levy of the IRS, provided that such assets are first found to constitute "property" or "rights to property" of the taxpayer. Not only is the income subject to the levy but mandatory distributions of principal at future determined dates are also considered property or rights to property and subject to seizure by the levy although the levy cannot accelerate the right to payment. Typically, a levy only extends to property possessed and obligations existing at the time of the levy (except for salary and wages). However, the IRS takes an aggressive position in claiming that future distributions of income and principal to a beneficiary from a trust are considered in existence if at the time of the levy they are fixed and determinable.

The Memorandum further states that as an alternative or supplement to a suit to enforce a levy, the federal government may sue the holder of the taxpayer's property for tortious conversion of the federal tax lien. Thus, a trustee is vulnerable if it makes a distribution to a beneficiary from a spendthrift trust after a levy has been served or if the trustee was aware of the levy or a federal tax lien affecting the property.

Howard B. Young, Esq.
Weisman, Young & Ruemenapp, P.C.
30100 Telegraph Road, Suite 428
Bingham Farms, MI 48025
Phone No.: (248) 258-2700
Fax No.: (248) 258-8927
E-Mail: hyoung@wyrpc.com