Matthew Luxton v. United States

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
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No. 02-2464
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Matthew Luxton, et al., *
*
Plaintiffs - Appellants, *
* Appeal from the United States
v. * District Court for the
* District of Minnesota.
United States of America, *
*
Third Party *
Defendant - Appellee. *
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Submitted: March 14, 2003
Filed: August 22, 2003
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Before HANSEN,* Chief Judge, JOHN R. GIBSON and LOKEN, Circuit Judges.
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LOKEN, Chief Judge.
Following Beverly Luxton’s death, her three children as named beneficiaries
commenced this action against State Farm Life Insurance Company to recover the
proceeds of three life insurance policies. State Farm interpleaded the United States
because, some years before her death, Luxton had executed Collateral Assignments
*
The Honorable David R. Hansen stepped down as Chief Judge at the close of
business on March 31, 2003. The Honorable James B. Loken became Chief Judge
on April 1, 2003.
providing that the Internal Revenue Service as assignee may claim the policy
proceeds to pay Luxton’s outstanding tax liabilities. State Farm paid the proceeds
into court and was dismissed from the case. After a trial, the district court1 upheld the
Collateral Assignments and awarded the policy proceeds to the IRS. The named
beneficiaries appeal. We affirm.
I. Background
In February and March 1994, the IRS assessed Luxton $793,301.39 for unpaid
federal employment and unemployment taxes, penalties, and interest. At that time,
Luxton’s assets included three life insurance policies in which State Farm agreed to
pay a total of $327,000 upon Luxton’s death. Each policy granted Luxton the right
to change beneficiaries, to demand the policy’s cash surrender value, and to assign
the policy by a writing filed with State Farm. The policies’ Assignment clause
provided that “[a]n assignment may limit the interest of any beneficiary.”
When the substantial unpaid taxes were assessed, Luxton was undergoing
extensive cancer treatments and was having difficulty meeting her medical and living
expenses. In September 1994, after discussions with IRS agent Lloyd Fritsvold,
Luxton submitted to the IRS a written offer of compromise in which she offered to
pay “327,000 upon my death” in return for reducing her tax liability to that amount.
The IRS rejected the offer because, although Luxton was not expected to live more
than three years, the offer did not include a fixed date for payment.
After further discussions with Agent Fritsvold and Luxton’s State Farm agent,
Luxton executed the Collateral Assignments here at issue. The Collateral
Assignments are standard-form State Farm documents with handwritten entries
1
The HONORABLE DAVID S. DOTY, United States District Judge for the
District of Minnesota.
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identifying the IRS as assignee, the policy number, and Luxton as the person whose
life was insured. State Farm recorded the Collateral Assignments in its policy files
and forwarded them to the IRS where Agent Fritsvold noted them on an IRS Form
2276 Collateral Deposit Record.
When it received the Collateral Assignments, the IRS did not compromise or
otherwise reduce Luxton’s outstanding tax liability. Indeed, five months after the
Collateral Assignments were executed, the IRS filed notices of its tax liens against
Luxton’s property for the entire amount of her tax liabilities. However, consistent
with an informal understanding between Agent Fritsvold and Luxton, the IRS made
no further collection efforts prior to Luxton’s death. In addition, in 1995 the IRS
allowed $17,000 of proceeds from the sale of Luxton’s residence to be used to prepay
premiums on the life policies; in late 1997 the IRS allowed Luxton to borrow $5,000
of accumulated policy dividends to pay medical expenses; and in 1999 the IRS
authorized the use of policy dividends to pay premiums.
Though Luxton survived her cancer longer than initially expected, she died in
September 1999. Shortly before her death, she named her son Matthew beneficiary
on two of the policies. The other two plaintiffs, Luxton’s daughters, became the
named beneficiaries of the third policy in 1994.
II. Discussion
In United States v. Bess, 357 U.S. 51, 55-57 (1958), the Supreme Court held
that a federal tax lien entitles the IRS to recover only the cash surrender value of a life
insurance policy, not the policy proceeds, because a federal tax lien is limited to the
taxpayer’s “property and rights to property,” 26 U.S.C. (IRC) § 6321, and under state
law a policyholder has no interest in life insurance proceeds before her death.
Consistent with Bess, IRC § 6332(b) now permits the IRS to levy on a life insurance
policy only to the extent of its cash surrender value. Therefore, the beneficiaries
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argue, it would “frustrate the intent of Congress” to permit the government to recover
more than the cash surrender value of the policies in this case. We disagree.
The government’s claim to the policy proceeds is based on its rights under the
Collateral Assignments, not on its tax liens. Nothing in Bess or § 6332(b) suggests
that those authorities limit the IRS to enforcing its tax liens. Therefore, the primary
issue in this case is whether the Collateral Assignments entitle the government to
recover the policy proceeds under Minnesota law.2 In addition, the beneficiaries
argue that the Internal Revenue Code did not authorize the IRS to accept the
Collateral Assignments and to collect the policy proceeds (in effect, that Agent
Fritsvold’s arrangement with Luxton was ultra vires).
A. The Effect of the Assignments under Minnesota Law
The district court held that Luxton made a valid assignment of the policy
proceeds to the IRS which “limit[ed] the interest of the beneficiaries to the amount
remaining after payment of the existing liabilities to the IRS.” We review the court’s
interpretation of state law de novo. See Jeanes v. Allied Life Ins. Co., 300 F.3d 938,
940 (8th Cir. 2002) (standard of review).
Assignments of insurance policies as collateral securing the policyholder’s
debts to the assignee are not uncommon. See Meyer, 375 U.S. at 235; All Am. Life
Ins. Co. v. Billingsley, 122 F.3d 643, 650 (8th Cir. 1997); Graves & Christensen,
McGill’s Legal Aspects of Life Insurance 210-12 (2d ed. 1997). Unlike an absolute
assignment, which permanently transfers all rights in the policy to the assignee, a
collateral assignment transfers only those rights necessary to secure the assignor’s
debt and extinguishes the named beneficiary’s interest only to the extent of the
2
The parties agree that state law defines the extent of the government’s rights
under those instruments. Cf. Meyer v. United States, 375 U.S. 233, 236 (1963).
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assignor’s debt to the assignee. See Westchester Enters., Inc. v. Swartout (In re
Swartout), 123 B.R. 794, 799-800 (Bankr. S.D. Ohio 1991); Succession of Goudeau,
480 So. 2d 806, 808 (La. 1985).
The Supreme Court of Minnesota has long acknowledged that a life insurance
policy may be assigned as collateral without the consent of the beneficiary, if the
policy reserves that right to the insured. See Janesville State Bank v. Aetna Life Ins.
Co., 274 N.W. 232, 233 (Minn. 1937); Hale v. Life Indem. & Inv. Co., 68 N.W. 182,
185-86 (Minn. 1896). Here, the policies issued to Luxton contained a provision
allowing assignments, and she signed Collateral Assignments that assigned specific
policyholder rights to the IRS, including “[t]he sole right to collect from the insurer
the net proceeds of the policy,” and “[t]he sole right to surrender the Policy and
receive the surrendered value thereof at any time.” The beneficiaries argue that the
Collateral Assignments are nonetheless defeated by the policy provision that, upon
Luxton’s death, the proceeds will be paid “to the primary beneficiaries living when
payment is made.” We disagree. The policies expressly authorized assignments that
“limit the interest of any beneficiary.” Though the Collateral Assignments reserved
Luxton’s “right to designate and change the beneficiary,” they provided that “any
designation or change of beneficiary . . . shall be made subject to this assignment and
to the rights of the Assignee hereunder.”
The beneficiaries further argue that payment of the policy proceeds to the IRS
would violate MINN. STAT. § 61A.12, which provides that, “[w]hen any insurance is
effected in favor of another, the beneficiary shall be entitled to its proceeds against
the creditors and representatives of the [policyholder].” Again, we disagree. The
purpose of this statute is to exempt a debtor’s life insurance policies from the reach
of her creditors. See Murphy v. Casey, 184 N.W. 783, 784 (Minn. 1921). The
beneficiaries cite no case in which § 61A.12 or a similar statute has been held to
preclude an assignee’s claim, as opposed to an ordinary creditor’s claim. The few
courts that considered the question have held that identical laws in other States did
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not bar the insured from limiting or defeating the beneficiary’s interest by assignment.
See Kash’s Ex’r v. Kash, 86 S.W.2d 273, 276 (Ky. 1935); Ferris v. Phoenix Mut. Life
Ins. Co., 272 N.Y.S. 781, 783-84 (App. Div. 1934), aff’d, 195 N.E. 184 (N.Y. 1935).
We conclude that the Supreme Court of Minnesota would follow this consistent
authority. That Court decided Janesville over forty years after the enactment of
§ 61A.12 and did not even mention the statute.
B. The IRS’s Authority to Accept the Assignments
The Internal Revenue Code provides that the IRS may compromise a federal
tax liability. The statute and implementing Treasury Regulations specify in detail the
documentary record that must be compiled and the agency approval that must be
obtained for a compromise agreement to be valid. See 26 U.S.C. § 7122 (1994); 26
C.F.R. § 301.7122-1(d)(3) (1995). This statutory procedure is “the exclusive method
by which tax cases could be compromised.” Botany Worsted Mills v. United States,
278 U.S. 282, 288-89 (1929). In this case, the IRS rejected Luxton’s formal offer-in-
compromise, and Agent Fritsvold then proceeded to fashion an informal
understanding with her. The beneficiaries argue that, even if collateral assignments
of policy proceeds are valid under Minnesota law, the IRS is only authorized to
accept collateral for a tax liability as part of a formal offer-in-compromise.
In this case, the IRS did not compromise Luxton’s tax liability, that is, agree
to reduce her tax liability in exchange for partial payment or other consideration. See
BLACK’S LAW DICTIONARY 281 (7th ed. 1999). Indeed, after receiving the Collateral
Assignments, the IRS filed notices of tax liens for the full amount, confirming that
Luxton’s tax liability had not been compromised. Rather than formally compromise,
Agent Fritsvold did what many prudent creditors would have done under the
circumstances, accepting an assignment of the right to insurance policy proceeds that
exceeded Luxton’s available assets, paying premiums to keep the policies in force,
and deferring more aggressive collection actions. Luxton benefitted from the
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arrangement, at least to the extent she was permitted to borrow against the policies
to pay medical expenses. The beneficiaries were not harmed because the IRS could
have effectively cancelled the policies by foreclosing on their cash surrender values
before Luxton’s death.
Thus, the beneficiaries’ contention boils down to the unsupported assertion that
the IRS has no authority to take informal actions of this kind to enhance its prospect
of collecting unpaid taxes, interest, and penalties. It is counterintuitive to posit that
Congress would arm the IRS with a powerful tax lien and other formidable collection
tools, but would deny the agency the authority to employ other devices commonly
used by creditors to improve their position, such as securing interests in collateral by
means other than a lien. And in fact, the Internal Revenue Code refutes the
beneficiaries’ contention, expressly authorizing the agency to employ “such other
reasonable devices or methods as may be necessary or helpful in securing a complete
and proper collection of the tax.” IRC § 6302(b). Likewise, Part 5.6.1 of the Internal
Revenue Manual confirms that revenue agents are authorized to accept collateral
security from taxpayers when that is in the best interests of the government, and to
record the receipt of such collateral on IRS Form 2276, as Agent Fritsvold did in this
case.
For the foregoing reasons, we conclude that under Minnesota law the Collateral
Assignments granted the IRS an interest in the policy proceeds superior to that of the
named beneficiaries. Accordingly, the judgment of the district court is affirmed.
A true copy.
Attest:
CLERK, U. S. COURT OF APPEALS, EIGHTH CIRCUIT.
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