Understanding Federal Tax Liens When A Deceased Taxpayer Possesses A Power of Appointment - Anderson & Jahde (2024)

A federal tax lien is the government’s legal claim against a taxpayer’s property when the taxpayer neglects or fails to pay a tax debt. The lien protects the government’s interest in all the taxpayer’s property, including real estate, personal property, and financial assets. So what happens when a taxpayer who possesses a power of appointment[1] passes away owing federal income taxes? The following explains how tax liens arise, what they attach to, and their impact on a decedent’s estate.

A federal tax lien exists after the IRS puts the taxpayer’s balance due on the books (i.e., assesses the liability) and sends a bill explaining how much is owed (the Notice and Demand for Payment). IRC § 6321. The lien “relates back,” and is thus effective from the date of assessment, and it continues in force until the assessment is paid in full or becomes unenforceable by lapse of time. “Lapse of time” means 10 years, during which the IRS has not attempted to collect the tax either by suit or distraint. IRC § 6322. The lien itself is not extinguished by a taxpayer’s death. Therefore, an issue arises as to what assets are subject to the tax lien relating to the income taxes the decedent had owed before he passed away.

The federal tax lien attaches to “all property and rights to property” of the person liable for the tax. This broad statutory language has been interpreted to include real, personal and intangible property of greatly varying natures, as well as future interests, and even property acquired by the taxpayer after the lien has come into existence. Thus, the initial inquiry in determining whether something is encumbered by a tax lien is whether the decedent had an “interest” in the property sufficient to support the attachment of the lien. The question of the nature and extent of the decedent’s interest in property is one which turns on the law of the state in which the property is located. Aquilino v. U.S., 363 U.S. 509 (1960). See also United States v. Durham Lumber Company, 363 U.S. 522, 60-2 USTC ¶ 9539; and Morgan v. Commissioner, 309 U.S. 78, 82 (1940).

Thus here, the only property the IRS has authority to collect against for a deceased’s unpaid income taxes (under IRC § 6321) is that property owned by his estate, pursuant to Colorado law. Generally, that means the assets of the probate estate. It would not include assets held jointly or assets with POD designations. Nor would it include trust assets subject to a taxpayer’s power of appointment, because the decedent did not have an “interest” in such property sufficient to support the attachment of the lien. Under Colorado law, a power of appointment is neither property nor a property right. Rather, it is a mere right or power, a personal privilege or authority. University Nat. Bank v. Rhoadarmer, 827 P.2d 561 (Colo. Ct. of App. 1991). See also Krausse v. Barton, 430 S.W.2d 44 (Tex. Civ. App. 1968); and Windscheffel v. Wright, 360 P.2d 178 (Kan. 1961).

By contrast, the federal estate tax lien provided by IRC § 6324 can reach the assets subject to a decedent’s general power of appointment. This lien is a second and separate federal tax lien unrelated to the lien under IRC § 6321. The lien under IRC § 6324 comes into existence on the day someone dies. Unless the estate tax is sooner paid in full, the lien attaches to all assets of the decedent’s gross estate that are required, by federal law, to be reported on Form 706, United States Estate Tax Return. Pursuant to IRC § 2041, the holder of a general power of appointment is treated for federal estate tax purposes as if he or she is the owner of the property subject to the power, whether or not the power is exercised. Thus, the property which is subject to the power is includable in the power holder’s gross estate for federal estate tax purposes. Of course, the special estate tax lien provided by IRC § 6324 will not arise against a decedent’s gross estate if any estate taxes owed are timely paid.

To aid collection, the IRS has levy power, and it can seize any property owned by a taxpayer to satisfy outstanding income tax liabilities. IRC § 6331. The lien itself is not extinguished by a decedent’s death, nor is the IRS’ authority to collect the decedent’s property by levy. However, the IRS levy would only reach the probate assets which do not include the assets under any power of appointment. Although the IRS has authority to issue a levy at any time in connection with a decedent’s income taxes, its policy is that it will not do so if the taxpayer’s estate is working with the IRS to resolve outstanding tax liabilities.

Federal tax issues can be technical and complicated. If you have any questions regarding tax liens or need other tax assistance, please do not hesitate to contact Anderson & Jahde, PC.

[1] A power of appointment is a term most frequently used in the law of wills to describe the ability of the testator to select a person who will be given the authority to dispose of certain property under the will. Note that a power of appointment is different from a power of attorney, which gives someone the authority to make financial decisions for you while you are alive.