The IRS can assert tax liens against properties held by two trusts to satisfy the tax debts of a taxpayer because the trusts were nominees of the taxpayer.
Background
In the early 2000s, taxpayer Shant Hovnanian engaged in certain tax shelter transactions structured and marketed by tax lawyer Lance O. Valdez. The IRS determined that the shelters were illegal and denied Shant the losses he claimed associated with the shelters. The Tax Court upheld the IRS’s determination, and its decision was affirmed by both the Second and Third Circuits. By 2018, the IRS claimed that Shant owed federal tax liabilities in excess of $16 million related to his participation in the shelters.
As part of its efforts to collect the taxes Shant owed, the IRS sought to attach federal tax liens and foreclose on two pieces of real property it attributed to him: 520 Navesink River Road, Middletown Township, N.J. (Navesink property), and 1 Dag Hammarskjold Blvd., Freehold, N.J. (Village Mall property).
At this time, legal title to the Navesink property was owned by the Pachava Asset Trust. Shant (as well as his ex-wife and children until 2015) lived at the property after it was built in 2008, and Shant was responsible for paying the expenses of the property. The house was previously owned by Shant’s mother, but in 2012 she transferred the property to Pachava for $1. In 2018, Nina Hovnanian, Shant’s sister, was the sole trustee of Pachava.
Legal title to the Village Mall property was held by the VSHPHH Trust. The property was a two-story office complex, partially rented out to tenants and partially used rent-free by Shant. Shant’s parents previously owned the property but transferred it to Shant in 2015 for $1. Nina was also the sole trustee of VSHPHH in 2018.
In 2018 the IRS filed a notice of tax lien against the properties, which listed both Pachava and VSHPHH as Shant’s nominees with respect to the properties. Later that year, the IRS filed an action in district court seeking an order that it had valid federal tax liens against the Navesink property and the Village Mall property and that it could foreclose the liens against the properties.
In district court, the IRS moved for summary judgment, arguing that based on the facts of this case, under the six-factor test from Patras, 544 F. App’x 137 (3d Cir. 2013), both Pachava and VSHPHH were Shant’s nominees and that the tax liens assessed against him consequently attached to the Navesink and Village Mall properties.
The district court’s decision
The district court held that both Pachava and VSHPHH were nominees of Shant Hovnanian. Thus, the properties were subject to the IRS’s tax liens, and the IRS could foreclose on and sell the properties.
In Patras, the Third Circuit held that “[w]hen there is a tax lien on a taxpayer’s property, the [IRS] may seek to satisfy it by levying upon property the taxpayer controls” (Patras, 544 F. App’x at 140). A third party is a taxpayer’s nominee (and thus the taxpayer controls property owned by the third party) where “the taxpayer has engaged in a legal fiction by placing legal title to property in the hands of [that] third party while actually retaining some or all of the benefits of true ownership” (id. at 141). The court formulated a six-factor test to use in determining whether a nominee relationship existed under both federal and New Jersey law:
- Whether the nominee paid adequate consideration for the property;
- Whether the property was placed in the nominee’s name in anticipation of a suit or other liabilities while the taxpayer continued to control the property;
- Whether there was, and the extent of, a relationship between the taxpayer and the nominee;
- Whether the conveyance of the property was recorded;
- Whether the property remained in the taxpayer’s possession; and
- Whether the taxpayer continued to enjoy the benefits of the property.
The first, second, and fourth factors focus on the mechanics of the transfer. The other three factors examine the relationship between the nominee and taxpayer, as well as whether the taxpayer retained possession and enjoyed the benefits and bore the burdens of owning the property.
With respect to Pachava, the IRS argued that the trust simply held title of the Navesink property and Shant actually had control over the property, as evidenced by his paying the property’s bills, living on the property, and being the decision-maker for anything that had to do with the property. The court applied the Patras test to determine whether Pachava was Shant’s nominee.
The court found that the first factor was satisfied for Pachava because the transfer of the Navesink property from Shant’s mother to Pachava was for only $1. Citing Coles v. Osback, 92 A.2d 35, 36 (N.J. Super. Ct. App. Div. 1952), the court stated that under New Jersey law, the sale price of the property was not adequate where it was below market value. Also, it reasoned that the second factor was satisfied because his mother recorded the transfer of the Navesink property after Shant lost a case before the Tax Court with regard to his tax liabilities. Again, the court cited Coles v. Osback for support, in this instance because the Coles court held in that case that the second factor was satisfied because the debtor in that case placed the property in question in his son’s name after a suit was filed against him. The district court found that the fourth factor weighed against a nominee finding for Pachava because the transfer had been recorded. Nonetheless, in the court’s view, on balance, these three factors favored a conclusion that Pachava was a nominee of Shant.
The court then looked at the relationship factors. It found that factor three was satisfied because Shant was so closely intertwined with everyone involved in Pachava; i.e., he settled the Pachava Trust, his mother contributed the property to it, his ex-wife and cousin had served stints as trustee, his sister was the current trustee, and his children were the sole beneficiaries.
It also determined that factors five and six were met. In support of this determination, the court pointed to the unrebutted deposition testimony of Shant’s ex-wife, which was corroborated by the testimony of an employee of Morgan Stanley, the firm that managed Pachava’s financial account. Specifically, the ex-wife testified that the Navesink property was Shant’s primary residence starting in 2008, where he, she, and their children all resided, he did not pay rent while living there, and he paid for all of the property’s expenses.
Having found that out of the six factors of the Patras nominee test, five favored a finding that Pachava was a nominee, the court concluded that there was no genuine dispute that the trust was Shant’s nominee and Shant was the beneficial owner of the Navesink property, effectively subjecting the Navesink property to the tax lien.
With respect to VSHPHH, the IRS again argued that the trust simply held title of the Village Mall property and Shant actually had control over the property. The court found that his control was evidenced by his paying the property’s real estate taxes and other expenses from his personal business account, by his living on the property, by the fact that rent from the property’s tenants was deposited or transferred to the bank account of one of Shant’s other businesses, by the fact that Shant did not pay any rent for the space he used at the property, that he used the rental income from the property to pay personal expenses, and that none of the Village Mall’s funds were distributed to VSHPHH’s beneficiaries.
Applying the Patras test, the court came to the same conclusions for each factor as it had in the analysis of Pachava. As the Village Mall property had been transferred for $1 and the transfer took place after Shant lost his Tax Court case, the first two factors of the test were met, while the fourth was not because the transfer had been recorded. The third factor was met because Shant and Nina were co-trustees at the time of the transfer of the Village Mall property, Nina was later the sole trustee after Shant resigned as trustee, and Shant’s children were the beneficiaries of the trust. The fifth and sixth factors were met for the same reasons the court cited in support of its conclusion that Shant had control of the property. As with Pachava, having found five of the six Patras factors weighed in favor of a nominee finding, the court held that VSHPHH was a nominee of Shant and, therefore, the tax liens against Shant attached to the Village Mall property.
Reflections
Besides arguing that the Patras test was not met, Pachava argued that the IRS’s claims fell under the New Jersey Fraudulent Transfer Act, which has a four-year statute of limitation and that the nominee lien was barred by the running of that four-year limitation period. Pachava also, curiously, argued that the IRS’s alter ego claim failed. However, the court noted that the IRS did not bring any claims under the New Jersey Fraudulent Transfer Act or regarding alter ego liability. Therefore, the court rejected these arguments.
Hovnanian, No. 3:18-cv-15099 (D.N.J. 12/27/22)
