In the recent Tax Court opinion, Campbell v. Commissioner, T.C. Memo 2019-4, the Court held that assets in a self-settled offshore asset protection trust were not includable in assets collectible by the IRS to satisfy the taxpayer’s assessed income tax liabilities. The case involved John Campbell’s request for an Offer in Compromise, offering $12,603 to satisfy an assessed liability of over $1.2 million. Central to the calculation of whether Campbell’s offer would be acceptable to the IRS was whether assets held in the Trust (defined below) are countable in determining Campbell’s reasonable collection potential. The Tax Court found that the Trust assets were not countable.
Facts and Timeline
The facts of the case involve numerous years of transactions, tax controversy, and failed investments. A timeline of the more important events can be summarized as follows:
- 2001: Campbell invested in the CARDS tax shelter transaction.1
- July 2002: Campbell engaged an estate planning attorney to establish a family trust.
- April 26, 2004: Campbell formed the First Aeolian Islands Trust (the “Trust”) in Nevis, West Indies.
- November 2006: Campbell and his family returned to the U.S. to invest in GO Zone properties in Alabama, Louisiana, and Mississippi. His initial investment was $27 million consisting of equity and debt. The debt was personally guaranteed by Campbell. At this time, Campbell’s net worth was approximately $19 million. This investment left Campbell with approximately $6.5 million in liquid net worth.
- July 2, 2007: The IRS issued a statutory notice of deficiency assessing Campbell with income tax and penalties based on adjustments to the participation in the 2001 CARDS transaction.
- Summer 2009: Campbell learned that many of the GO Zone investment properties contained Chinese drywall, leaving the properties uninhabitable.
- March 11, 2010: The Tax Court entered a decision determining Campbell was responsible for $1,135,192 in tax for 2001 as well as an additional $113,519 in penalties. The IRS timely assessed this tax and penalty.
- August 31, 2010: The IRS issued a final notice of intent to levy on Campbell’s assets.
- September 14, 2010: Campbell responded to the IRS notice requesting a collection due process hearing under IRC §6330.
- 2011: Campbell’s GO Zone lender foreclosed, selling the properties for $1.35 million at a time when the remaining debt was $4.5 million.
- January 31, 2012: The IRS issued a notice of determination upholding the proposed levy, after which Campbell timely filed a Tax Court Petition.
- March 2014: Campbell, through a wholly owned LLC, reacquired the GO Zone properties for $1.5 million after a Louisiana state court action. This purchase was funded largely through investments from a subsidiary largely owned by the Trust.
- March 28, 2014: After the Tax Court remanded the matter to the Appeals Office, Campbell submitted a request for an Offer in Compromise in the amount of $12,603 on the basis of doubt as to collectability.
- June 11, 2018: Appeals issued a notice of determination rejecting Campbell’s proposed Offer in Compromise. Appeals determined that Campbell’s reasonable collection potential equaled more than $19.5 million after adding the value of dissipated assets and assets of the Trust. Campbell timely appealed this determination.
As indicated above, central to the Court’s opinion was whether the Trust assets should be includable in Campbell’s reasonable collection potential. Important facts regarding the Trust in that regard include:
- When the Trust was formed, Campbell funded the Trust with $5 million at a time when his net worth was approximately $25 million. This transfer was the only transfer to the Trust.
- Meridian Trust Co., Ltd. was appointed as the original trustee of the Trust. The trustee was later changed to Southpac Trust Nevis, Ltd. by action of the trust protector.
- Peter Meara was appointed as the trust protector, with the power to remove and replace the trustee.
- Campbell retained no control over the trustee’s right to make distributions or invest assets.
The Court’s Opinion
The Court began its discussion recognizing the right of a taxpayer under §6330 to a collection due process hearing before IRS Appeals before formal levy action is taken (a “CDP Hearing”). In such a hearing, Appeals is to consider: (1) whether the requirements of applicable law or administrative procedure have been met, (2) any relevant issues raised by the taxpayer, and (3) whether the proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that the collection action be no more intrusive than necessary. When a taxpayer seeks a CDP Hearing, the taxpayer may seek to have the IRS compromise the tax liability as allowed under §7122, and the regulations thereunder, on the grounds of: (1) doubt as to liability, (2) doubt as to collectability, or (3) promotion of effective tax administration.
Campbell sought to compromise his tax debt on the basis of doubt as to collectability. In such cases, the IRS is to determine whether the taxpayer’s assets and income are less than the full tax liability. If the taxpayer’s offer reflects the IRS’ reasonable collection potential, the offer typically will be accepted. According to the Internal Revenue Manual (“IRM”), the IRS should consider: (1) assets, including dissipated assets, (2) future income, (3) amounts collectible from third parties, and (4) assets available to the taxpayer but beyond the reach of the government. In this case, the Court analyzed considerations (1), (3), and (4).
The IRS argued that Campbell’s investments in GO Zone properties which ultimately lost money constituted dissipated assets. The Court, however, noted that the IRM instructs that assets transferred in an attempt to avoid payment of tax liability are typically considered dissipated. Here, there was no evidence that Campbell’s GO Zone investments were made with the intent to avoid tax payment. He had no idea about the Chinese drywall issues when making the investments.
Regarding funding the Trust, the IRS argued that the $5 million contributed constituted dissipated assets. However, the IRM states that Appeals should look at assets dissipated for the three years before the offer was made and six months before or after the assessment of tax. Campbell funded the trust in 2004, six years before the assessment and ten years before the offer. As such, even if those had constituted dissipated assets otherwise, the transfer was well outside of the periods the IRS should have considered.
Amounts Collectible from Third Parties
The IRS argued that Trust assets were recoverable because the Trust was a transferee, nominee, or alter ego of Campbell. The Court considered relevant state law (Connecticut) and determined there was little developed law regarding these theories which would give the IRS the right as a state law creditor to pursue the Trust assets. While the Court did not spend much time on the federal law analysis of these concepts which would have presented another alternative to the IRS, the Court noted that Campbell retained no control over the trustee, cannot force the trustee to make distributions, and cannot control the Trust’s investments. As such, the Court found that the IRS abused its discretion in including the Trust assets under this test.
Assets Available to the Taxpayer but Beyond the Reach of the Government
Here, again, the IRS argued that Campbell had access to the Trust assets. This was because he appointed the trust protector who controls the trustee. Also, the trustee invested in Campbell’s GO Zone ventures. These factors show that Campbell had access to the funds in the Trust. However, the IRS presented no proof that showed any investments or distributions made by the trustee were done under the direction or control of Campbell. Rather, in accordance with the Trust document, the Court found that the trustee exercised its discretion in handling these matters. Campbell did not, and could not, control these items.
The implications of this decision are significant. While this case did not necessarily make new law, it illustrates how asset protection planning can work. Here, before any liability was assessed, when the taxpayer was not insolvent, well before any offer in compromise was made, etc., the taxpayer funded an asset protection trust. He did not retain control over the Trust assets or distributions. Given those facts, the IRS could not consider the Trust’s assets as available to satisfy the taxpayer’s tax liabilities. Where clients engage in asset protection planning before liabilities arise, make transfers which do not make them insolvent, and do not retain control over transferred assets, asset protection trusts can shield assets not only from judgment creditors but also the IRS.
While the issues of this case concern self-settled asset protection trusts (i.e. trusts where the grantor is a beneficiary), the implications may extend to other trusts. Any trust which is ignored for income tax purposes may raise similar issues as the income of such trusts is taxed to the grantor (a “grantor trust”). Many clients fund trusts for their spouse and children while continuing to be taxed on trust income. What if, many years after funding the trust, through funding that did not make the client insolvent, the client has a turn of fortunes and no longer has the resources to pay tax generated by the trust’s income? Is there income that goes completely untaxed when there are plenty of assets in the trust to pay the tax liability? Absent the ability of the IRS to prevail on theories of transferee liability, fraudulent conveyance, nominee liability, alter ego, etc., it appears this could occur.
Of course, under §6321, the IRS’ lien attaches to all property and rights to property belonging to the taxpayer. Therefore, the IRS should have the ability to attach a taxpayer’s rights to distributions from a trust. However, unless trust distributions are made to the taxpayer, the IRS may be empty handed. Further, in cases like the Campbell case, even if the IRS could use its lien to recover distributions actually made to the taxpayer, it may not be permitted to consider trust assets available to the taxpayer in determining whether to accept an Offer in Compromise or installment agreement request.