Bankr. E.D.N.C.: In re Smith- Tax Lien attachment to Tenancy by the Entirety Property in Chapter 13

Summary:

Following the 4th Circuit decision in In re Morgan a Chapter 7 trustee can reach entireties property to pay IRS debt even without a pre-existing tax lien. 

The Trustee's  calculation: 

After subtracting the statutory exemption of $70,000 (comprising the $35,000 homestead exemption that would be available to both Mr. Smith and his non-filing spouse under N.C. Gen. Stat. § 1C-1601(a)(1)), the Trustee contends that there is $90,456.90 in equity above exemptions. To reach the value that would be paid to the IRS in a hypothetical liquidation under chapter 7, the Trustee subtracts from that figure $6,838 in attorney's fees, a priority claim of $18,152.50, and the chapter 7 trustee's fee of $15,542. The Trustee maintains that the remainder, $49,924.40, would be paid to the IRS as the only general unsecured creditor that could reach the tenancy by the entireties property. 

The Debtor's calculation:

Mr. Smith's calculation of non-exempt equity also starts with a property value of $336,000 and factors in liquidation costs and total liens to reach the property's net value, but diverges from the Trustee's calculation by dividing the net value in half, providing Mr. Smith's non-filing spouse with one-half of the value, and leaving Mr. Smith with an interest of $80,557.78. From there, he subtracts his homestead exemption of $35,000, the priority claim of $18,152.50, attorney's fees of $6,838, and the hypothetical chapter 7 trustee's fee of $15,542, leaving $4,645.54 in non-exempt equity to be paid to the general unsecured claim of the IRS.

Judge McAfee recognized the Morgan holding, but found that in Chapter 13, a debtor can still propose a plan that only commits the value of their 50% interest in the entireties property, noting that  pursuant to N.C.G.S. §§ 41-58, -59, -63,  spouses have  clearly recognized equal ownership and distribution rights in entireties property, including upon sale or conversion to personal property. Accordingly, the court found that under both state and federal law, the IRS lien should be treated as attaching only to the debtor’s one-half share.

Commentary:

Though rooted in statutory interpretation, the court’s decision was bolstered by equitable considerations: The debt was incurred before the marriage, the property was originally owned by the now-wife, and it would be unjust to use her equity to pay the debtor’s prior tax liability. While the court emphasized it was ruling on law, this factual backdrop underscores the fairness of its outcome and the "equity of mercy is not strained"  either,  rather than merely a doctrinaire reliance on the Code.

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