Dealing with a Federal Tax Lien
By Gary Bluestein
Being a tax column, the focus is usually on intricate tax issues of concern to the tax lawyer or perhaps an accountant. However, in the past, I have attempted to make the articles that I have contributed broader based, trying to provide relevant information to attorneys practicing in other areas. As I have stated in past articles, one would be hard pressed to find an area of practice that at some point is not touched by the IRS. Prior articles have tried to outline pitfalls that an unwary practitioner may face due to the uniqueness of the IRS as a creditor.
One key distinction in relation to IRS collection is the uniqueness of the federal tax lien. Unlike private creditors, the federal tax lien, which is created by the assessment of the tax, attaches to all real and personal property, wherever located. This assessment lien is referred to as a “secret” lien since there is no public notice of its existence. Nevertheless, once the lien is created, the IRS can start the collection process. There is often confusion between the term “lien” and “levy” in relation to the IRS. Service of a levy by the IRS actually involves the seizures of assets in a third party’s hands, such as a bank account. It is common to hear clients state that the IRS “liened” my bank account. Again, the lien attaches to everything. The levy involves the actual seizure of a specific asset.
Since the assessment lien is “secret”, in the interest of fairness, Congress protected certain interests by granting a priority under IRC §6323(a). These interests would include a properly perfected, secured creditor, judgment lien creditor, mechanic’s lien holder and bonafide purchaser. However, a party not falling under one of these enumerated interests, such as a donee, will not enjoy priority over the secret lien, even if the recipient of a gift was without knowledge of the lien.
The IRS does not have to wait for one of the protected interests referenced above to come into existence. The Service can immediately pursue collection since the creation of the assessment lien starts the collection process. Additionally, the Service can file what is referred to as a Notice of Federal Tax Lien. This is routinely filed in the County Clerk’s Office where the taxpayer resides and with the Secretary of State. This action will grant the IRS priority over the interests referenced above. The rationale being, that the world has now been put on public notice.
An unusual quirk can arise when property comes into existence after a creditor has protected its interest through proper recording, and after the filing of a federal tax lien. Under these circumstances, the concept of simultaneous attaching liens arises. Since the asset is after acquired property, both liens attach simultaneously, even though the federal tax lien was filed subsequent to the perfection of a lien held by another creditor. Unfortunately for a competing creditor, in a situation of simultaneous attachment, or a “tie”, the U.S. Supreme Court has held that the IRS wins, based on “sovereign supremacy”. See United States v. McDermott.
Although simultaneous attachment may not generally be that common, a common occurrence and a huge pitfall to financial lenders occurs with loans secured by accounts receivable and inventory. Financial lenders will protect their interests by filing a U.C.C.- 1 Financing Statement, normally attaching to all assets of the debtor. Two types of assets, however, continuously turn over accounts receivable and inventory. The U.C.C.-1 takes this into account by indicating that the lien will continue on future accounts receivable or inventory, and thus under state law, the creditor will continue to have a priority against future creditors. However, this rule does not apply to the Internal Revenue Service. Therefore, under “simultaneous attachment” for after acquired property, the IRS will automatically take a first position on any new asset that comes into existence, as is the case with new accounts receivable and inventory. Congress realized that this would cause problems to commercial financing, so under IRC §6323(c), what is referred to as the “45 day rule” was enacted. This provision generally provides that the IRS will have a first position on any new accounts receivable or inventory that comes into existence 45 days after their lien is filed, in relation to a competing U.C.C. holder. Thus, Congress has given financial lenders 45 days to take action once a Notice of Federal Tax Lien is recorded.
Obviously, this can be devastating to a troubled business since the lender will have no choice but to immediately pull their financing and take collection action against any accounts receivable or inventory to prevent the loss of their senior position to an IRS lien. It is often necessary to go to great lengths to attempt to prevent a federal tax lien from being filed since a filed lien will often threaten the survival of a business. Unfortunately, the IRS over the last several years has become much more aggressive and their standard policy is to file liens as quickly as possible. Although it is understandable that the government would take whatever action possible to protect its interest, there is often a lack of willingness to exercise discretion where it would be in the best interest of the government, the taxpayer and the taxpayer’s employees to refrain from filing a lien. Often, destroying the business will prevent the IRS from being paid and will obviously be devastating to the taxpayer. There are certain procedural and substantive remedies that can be pursued to defend against the filing of a lien if a client moves quickly enough. Again, however, these remedies are becoming more and more difficult as the government continues to become more aggressive.
Lastly, the statute of limitations for collection and correspondingly for the life of the tax lien often surprises practitioners. Under New York State law, a judgment can be recorded for 10 years and then be re-filed for another 10 years. This general rule is what often causes confusion since it is not applicable to the IRS. The duration of a federal tax lien is 10 years, running from the date of assessment, not the date the Notice of Federal Tax Lien is filed, which will always be later. It is a common mistake to think the statute of limitations has more time on it than it actually does, since attorneys will often look at the date the lien was recorded. Additionally, the IRS cannot automatically re-file a tax lien in the manner that a judgment can be re-filed. Although the IRS will often re-file a tax lien, they can only do this if some event occurred that tolled the statute of limitations. Examples of this would be a bankruptcy proceeding, which would toll the statue of limitations while the bankruptcy is in process and six months thereafter. Additionally, the submission of an offer in compromise, innocent spouse request, certain types of appeals and a consent to extend the statute would all give a basis for the re-filing of a lien beyond the 10 years. Absent an action that tolls the statute of limitations, the liability expires 10 years after assessment.
One notable and devastating exception to this 10 year rule would be the rare case in which the government sues an individual in District Court to reduce a lien to judgment. This action is normally saved for problematic taxpayers who have orchestrated fraudulent conveyances or owe a significant liability and have assets that could be distrainable beyond the statute of limitations. If this action is taken, the statute of limitations is extended for 20 years.
The above are just some of the unique nuances of a federal tax lien that could impact a wide array of practice areas.