IRS may enforce lien to pay off deceased life partner’s tax debts

A district court held that the IRS can enforce a tax lien against a house a taxpayer owned and resided in to satisfy the tax debts of her deceased life partner because the IRS had a property interest in the house under state law.

Background

Laura Dombrowski and Ronald Matheson were life partners, having what was described as a "personal, loving relationship" for three decades. The two lived together in Michigan for the latter portion of this relationship, from 2006 until Matheson's death in 2022.

After the couple moved in together in 2006, Dombrowski was either unemployed or underemployed and for the most part relied on Matheson for support. Matheson made his living carrying on a series of what might charitably be described as "questionable" business enterprises.

While Matheson earned considerable income from his business activities, he did not pay tax on all the income he earned. This led the IRS to assess deficiencies against Matheson for 2001, 2003, 2004, 2007, and 2010. Matheson tried to avoid paying the taxes he owed by filing offers in compromise and contesting his liabilities in Tax Court, but he had little success convincing either the IRS or the court that he should not have to pay the full amount of the deficiencies. When he finally consented to judgment on the outstanding assessments against him in 2013, he owed over $3.2 million in taxes and interest. However, the judgment was not of much immediate use to the IRS, and at the time of Matheson's death, none of that amount had been collected.

In 2006, Dombrowski transferred the entirety of her retirement account, $171,000, to Matheson, purportedly as a loan. The loan was evidenced by a promissory note, under the terms of which Matheson was required to pay back the money with 100% interest in one year. Later in 2006, Dombrowski wrote Matheson checks for $50,000 and $10,660, which were also purportedly loans.

In 2006, when Matheson and Dombrowski moved in together, Matheson borrowed $1.7 million to purchase a home in Goulette, Mich. Although the mortgage was in Matheson's name, the couple jointly owned the Goulette house. In 2013, with the bank preparing to foreclose on the house, Matheson transferred $300,000 to Dombrowski indirectly, through a transfer from one of his business entities and a separate transfer through Dombrowski's brother. She used this money to purchase another house in her name in Stillwater, Mich., for her and Matheson to live in. They moved into the Stillwater house in the fall of 2012 after being evicted from the Goulette house. Matheson and Dombrowski lived at the house until his death in 2022, and Dombrowski continued living there afterward.

At the time of the $300,000 transfer, Dombrowski (according to the district court) knew or had reasonable cause to know that Matheson owed millions of dollars in tax debts and that he was insolvent. Dombrowski claimed that the $300,000 was transferred to her as a payment on the over $400,000 Matheson owed her for the 2006 loans and the interest on the original loan.

In July 2017, the IRS, looking to make good on some of what Matheson owed, filed a Notice of Federal Tax Lien in the name of "Laura Dombrowski as nominee of Ronald Matheson," purporting to attach to all Dombrowski's "property and rights to property," including specifically the Stillwater property. In response, Dombrowski brought an action in district court to quiet title to the Stillwater property and asked the court to hold that the IRS's lien was invalid. The IRS counterclaimed under Sec. 7403 to enforce the tax lien.

The district court's decision

The district court held that under Michigan law, the IRS had a property interest in the Stillwater property that could be used to satisfy Matheson's tax debts. Therefore, it could enforce its lien against the Stillwater property.

As the court explained, although federal law governs federal income tax liabilities, state law determines the property interests of a taxpayer upon which those tax liabilities attach. Once it has been determined that state law creates sufficient interests in a taxpayer that owes a federal tax liability to satisfy the requirements of a state statute, state law is inoperative, and the tax consequences are dictated by federal law. Thus, because Dombrowski and Matheson lived in Michigan, the court determined that if the IRS could prove under Michigan law that Matheson's indirect $300,000 transfer to Dombrowski, which she used to buy the Stillwater property, was a voidable transfer or was a fraudulent conveyance that created a trust in the IRS's favor, the IRS had an interest in the Stillwater property to which his tax debts attached. As a result, it would be able to enforce its lien against the property to satisfy Matheson's tax debts.

The IRS argued four theories under which the $300,000 transfer would, under Michigan law, be a voidable transfer or a fraudulent transfer that created a trust. Under the Michigan Uniform Voidable Transfers Act (MUVTA), the IRS asserted the transfer was a voidable transfer because Dombrowski was an "insider" of Matheson and the transaction met the requirements of a voidable transfer to an insider, or, alternatively, Matheson did not receive reasonably equivalent value in exchange for the money. It further argued that under Michigan law, the transfer resulted in a statutory trust in favor of the IRS or a common law constructive trust.

Dombrowski argued that Matheson had received reasonably equivalent value for the $300,000 transfer because it was in payment of the 2006 loans made to Matheson by Dombrowski. The court found that the IRS had proved that these loans were not genuine and were instead capital investments in one of Matheson's business entities, so the transfer could not be a loan payment. Further, Matheson had not received any ownership interest in the Stillwater house, which was purchased with the money transferred. Thus, the court determined that Matheson did not receive reasonably equivalent value for the $300,000 transfer and, consequently, it was a voidable transfer under the MUVTA.

Even if Matheson had received reasonably equivalent value, the court concluded that the transfer was voidable by the IRS, a creditor of Matheson, because Dombrowski was an "insider" of Matheson and the transfer met the requirements to be a voidable transfer to an insider. Under the MUVTA, she was an insider of Matheson because she was his "affiliate" or a "relative."

An affiliate of a debtor transferor under the MUVTA is a person substantially all of whose assets are controlled by the transferor. At the time of the $300,000 transfer, other than the over $400,000 in purported loans owed to her by Matheson, Dombrowski's only asset was $10,427 in cash in a bank account. The court found that because Matheson had sole control over whether the purported debt to Dombrowski was paid and over the years had made no real attempt to pay the debts, he controlled the loans. The loans constituted approximately 97% of Dombrowski's assets, so he controlled substantially all of her assets.

"Relative," like "affiliate" has a specific definition under the MUVTA. Dombrowski did not technically fit under this definition, which includes a spouse of a debtor transferor, because she and Matheson were not married. However, the court reasoned that based on their extremely close relationship, which the court described as being "on par with that of a married couple," Dombrowski was also an insider as a relative.

The court further found that a statutory resulting trust in favor of the IRS arose out of the $300,000 transfer. Under Michigan Comp. Laws Section 555.8, a trust in favor of creditors, to the extent needed to pay the amounts owed to them, results when a debtor makes a fraudulent conveyance of consideration and fraudulent intent cannot be disproved. The court found that the IRS had proved that Matheson's $300,000 transfer was a sham transaction, made with the intent of avoiding payment of the large tax debts he owed. Therefore, the $300,000 transfer created a statutory resulting trust for the Stillwater property in favor of the IRS under Michigan law.

Finally, the court determined that it did not need to reach the question of whether the IRS's constructive-trust theory applied. However, it noted that the record in the case demonstrated that a constructive trust in the IRS's favor arose when Matheson essentially acquired the Stillwater property through Dombrowski's purchase of it.

Reflections

Initially, the IRS had also claimed that it could enforce the lien on the Stillwater property because Dombrowski was Matheson's nominee. The IRS argued that its lien would attach under the federal law nominee liability standard articulated in Porta-John of America Inc., 4 F. Supp. 2d 688 (E.D. Mich. 1998).

On motion for summary judgment by Dombrowski, the court refused to apply the Porta-John nominee liability standard (Dombrowski, 461 F. Supp. 3d 575 (E.D. Mich. 2020)). Because the IRS's rights to property must rely on state law, not federal law, the court found the IRS could not rely on a standard foreign to Michigan jurisprudence to support its nominee theory. The Porta-John standard, which was set out in a federal case, was not Michigan law because it had not been endorsed or applied in tax cases arising under Michigan property law. Accordingly, the court held that the IRS could not prove it had an interest in the Stillwater property under its theory that Dombrowski was Matheson's nominee.

Dombrowski, No. 3:18-cv-11615 (E.D. Mich. 6/8/22)