Liens
Three events give rise to the creation of a federal tax lien. Those events are (1) the assessment of a tax, (2) notice and demand for payment, and (3) nonpayment. Once these events occur, the lien arises and relates back to the date of the assessment. The date the lien arises is relevant for determining the priority of the lien as it relates to other creditors, and also the property to which the lien attaches.
Assessments are usually made by the service center responsible for the region in which the taxpayer is located. Once an assessment has occurred, that service center is also usually responsible for the initial collection efforts. The service center will send a series of notices informing the taxpayer of the liability and requesting payment. However, it is only the first notice that is the pre-requisite to the creation of the federal tax lien. This notice is usually a Form 3446, Request for Payment of Balance Due, and must be mailed or hand delivered to the taxpayer within 60 days of the date of assessment. See IRC §6303. Prior to 1997 the taxpayer had 10 days to make full payment before interest began to accrue. After 1997, pursuant to the Taxpayer Bill of Rights 2, the taxpayer has a 21 day grace period. If the taxpayer fails to make full payment of the liability within the specified period of time, the lien arises and relates back to the date of assessment.
Once a lien arises, it attaches to all real and personal property owned by the taxpayer on the date of the assessment, or acquired after the date of assessment. This includes all interests in property proportionately belonging to the taxpayer as well as all rights to property that the taxpayer may hold on the date of assessment. IRC §6321.
Although the reach of the federal tax lien is broad and extensive, the IRS only acquires the rights to the property in issue held by the taxpayer. This means that the IRS acquires no greater interest than that of the taxpayer. While IRC §6321 gives the IRS rights to the property held by the taxpayer on the date of assessment, generally it does not give the IRS property interests subject to the taxpayer’s creditors. Therefore, if property is transferred by the taxpayer prior to the date of assessment, the lien does not attach to the transferee’s interest in the property. This, of course, assumes that the transfer was not made while the taxpayer was insolvent or to defraud any creditor, including the IRS. See Thomson v. U.S., 66 F.3d 160 (8th Cir. 1995).
The general rule is that state law defines the property to which the federal lien attaches, federal law defines the scope and priority of the lien. This means that state law determines the nature and extent of a taxpayer’s interest in property. However, once said determination is complete, federal law determines whether state-created rights are rights to which a federal tax lien can attach. It is also federal law that determines the priority given to the federal tax lien where other creditors are involved. See U.S. v. National Bank of Commerce, 472 U.S. 713 (1985).
Perfection of a Federal Tax Lien
A federal tax lien is perfected once the three events discussed above have occurred. The IRS need not take any additional steps to perfect its lien, i.e., the IRS does not have to file a Notice of Federal Tax Lien to perfect. However, there are four creditors against whom this “secret lien” is not valid. These five creditors are as follows:
- Purchasers - Full and adequate consideration or bona fide bargain purchaser.
- Holders of security interests - ex. mortgagee.
- Mechanic’s lienors - services, labor or materials for improvement of real property.
- Judgment Creditors.
- Purchase Money Mortgage.
For a federal tax lien to have priority over any of the above four creditors, the IRS must file a Notice of Federal Tax Lien pursuant to IRC §6323. Once the Notice of Federal Tax Lien in filed, priority is determined by time. This means, generally, the first creditor in time, is the first creditor in line.
Additionally, even if a Notice of Federal Tax Lien is filed, certain interests still enjoy priority over the tax lien. The protected parties are as follows:
- Purchaser or holder of securities (who did not have actual notice).
- Purchaser of a motor vehicle (who did not have actual notice).
- Retail purchaser.
- Personal property purchased at a casual sale (who did not have actual notice)(the dollar amount increased from $250.00 to $1,000.00 by the IRS Restructuring and Reform Act of 1998).
- Holder of personal property subject to possessory lien under state law (ex. - mechanic’s lien).
- Local governments with respect to taxes that attach to real property and have priority under state law.
- Holder of Mechanic’s lien on residential property for small improvements (the dollar amount increased from $1,000.00 to $5,000.00 by the IRS Restructuring and Reform Act of 1998).
- Attorneys with a lien for work performed, if under local law that attorney would hold a lien on the amount of the judgment or settlement to the extent of his/her reasonable compensation or settlement.
- Insurers of specific contracts under certain circumstances.
- A bank or building and loan association possessing a deposit secured loan who has been in continuos possession of the securing documents (who did not have actual knowledge).
IRC §6323(b)(1)-(10).
Additionally, certain security interests have priority over filed federal tax liens, even though the federal tax lien is filed first in time. Although the priority interests for each vary, all require the existence of a written agreement prior to the filing of the federal tax lien which is valid against other judgment lienors under state law. These security interests are as follows:
- Commercial transaction financing agreements (subject to the 45 day rule).
- Real property construction or improvement financing agreements.
- Obligatory disbursement agreements (third party in ordinary course of business).
- Security interests in existing property that are created by reason of disbursements made within 45 days after the tax lien is filed.
IRC §6323(c). See IRM Exhibit 5300-3 contained in your materials.
Simultaneous Attaching Liens
Where a taxpayer aquires property after a federal tax lien and the previous perfection of a secured interest, an issue arises as to who has priority in the subject property. United States vs. McDermott, 507 U.S. 447 (1993) provides that the IRS prevails and has priority where there is a simultaneous attachment of competing liens because of federal supremacy.
Relief from a Federal Tax Lien
Relief from a federal tax lien can be achieved in one of five ways. The taxpayer can receive a release of lien, a withdraw of lien, a discharge of lien, the lien can be subordinated, or the lien can not attach to certain property. The relief requested or required depends upon the facts and circumstances of the case and, in some situations, the willingness of the IRS to work with the taxpayer to achieve the desired result.
Release of Lien
The IRS’ ability to release a federal tax lien is strictly governed by statute. IRC §6325(a). The IRS can only release a lien in three situations. They are as follows:
- The taxpayer fully satisfies the liability (this includes the Service’s acceptance of an offer in compromise).
- The liability is unenforceable (passage of time or invalid assessment).
- The taxpayer posts a bond which guarantees full payment.
When any of the above events occur, the IRS has thirty days from the date of the event to issue a Certificate of Release of Federal Tax Lien. If the IRS fails to timely release the federal tax lien, the taxpayer can make a written Request for Release of Lien to the chief of Special Procedures. The request must identify the taxpayer and contain the taxpayer’s current address. The request must also include a copy of the lien and provide the basis or grounds upon which the taxpayer is seeking the release. IRC §401.6325-1(f). Once a proper request is filed, the IRS has thirty days to file the Certificate of Release. An improperly filed request does not trigger the 30 day period.
Withdraw of Federal Tax Lien
Although the IRS has discretion in filing a notice of federal tax lien, as stated above it may release a filed notice only if the notice (and the underlying lien) was erroneously filed or if the underlying lien has been paid, bonded, or become unenforceable. The Taxpayer Bill of Rights 2 allows the IRS to withdraw a public notice of tax lien prior to payment in full by the indebted taxpayer without prejudice, if the Secretary determines that one of the following circumstances exists:
- The filing of the notice was premature or otherwise not in accordance with the administrative procedures of the IRS.
- The taxpayer has entered into an installment agreement to satisfy the tax liability with respect to which the lien was filed.
- The withdrawal of the lien will facilitate collection of the tax liability.
- The withdrawal of the lien would be in the best interests of the taxpayer (as determined by the Taxpayer Advocate) and of the Government.
The IRS must provide a copy of the notice of withdrawal to the taxpayer. The new law also requires that, at the written request of the taxpayer, the IRS make reasonable efforts to give notice of the withdrawal of a lien to creditors, credit reporting agencies, and financial institutions specified by the taxpayer. The provision is effective on the date of enactment. (TPBR2 §501(a). IRC §6323(j)).
Discharge of Lien
The difference between a release of lien and a discharge of lien is that the release is appropriate when the lien is no longer valid, while a discharge is not contingent on the validity of the lien. Instead, a discharge is appropriate where the lien is still valid, but the lien is discharged as to a specific piece of property. Generally, there are four instances when the IRS will issue a Certificate of Discharge. IRC §6325(b). They are as follows:
- The value of the taxpayer’s other property is at least twice the value of the tax liability.
- The taxpayer pays the IRS an amount equal to the value of the tax lien filed against said property.
- The IRS’ interest in the property is valueless.
- The taxpayer sells the property and the proceeds of the sale are substituted and encumbered.
A taxpayer seeking a Certificate of Discharge must file a written application with the district director’s office for the territory in which the property is located. The request must be in writing, in duplicate, under penalty of perjury, and following the Form contained in Publication 783. See Rev. Proc. 68-9, 1968-1 C.B. 756.
Subordination of Lien
IRC §6325(d) states that the IRS can issue a Certificate of Subordination if one of the two following circumstances exist.
- The taxpayer pays an amount equal to the amount of the lien or interest to which the certificate subordinates the tax lien.
- The amount of tax that is ultimately collected from the property will be increased and facilitated by the issuance of the Certificate of Subordination.
To apply for a Certificate of Subordination the taxpayer must file a written application with the lien advisor of the Special Procedures Division for the District where the lien is filed. For instructions on the required contents of the request, and how to apply, see Rev. Proc. 68-8, 1968-1 C.B. 754 and Publication 784, How to Prepare Application for Certificate of Subordination.
Certificate of Nonattachment
If a valid federal tax lien is filed against a debtor taxpayer, but appears to attach to the property or rights to property of an innocent third party, a Certificate of Nonattachment can be filed to provide the innocent party with evidence that the property is not subject to the lien in issue, i.e. the lien is not attached. Generally, the Certificate of Nonattachment is used to correct confusion attributable to a similar name, or some other comparable situation.
To apply for a Certificate of Nonattachment, the person desiring the certificate must file a written application with the chief of the Special Procedures Division in the district where the lien is filed. The application must contain the grounds for the request. See Publication 1024, How to Prepare Application for Certificate of Nonattachment.
Bluestein & Muhlbauer, P.C.
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Williamsville, NY 14221
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