Due Diligence and Federal Tax Liens: Is Filing IRS Form 8821 Enough? Published July 1, 2009
This article was originally posted in Commercial Factor and focuses on the importance of Due Diligence and the IRS form 8821 and the potential problems you can encounter.
When factoring a new or existing client, due diligence is extremely important, especially in this recessionary environment. Due diligence is important not only in the beginning of the life of a client, but also on an ongoing basis. Recently, a colleague at a factoring company asked me whether she was safe to factor her potential client’s receivables without fear of interference from the Internal Revenue Service (IRS). To answer that question, we had to look at more than the UCC search. In order to factor a client’s receivables, it is imperative the factor have senior position against the accounts receivable to be factored. A significant threat to the factor’s priority position is the IRS, especially in today’s economic climate. When businesses cannot borrow from traditional lenders, the “lender” of last resort is often the IRS. An IRS liability, and the resulting tax lien, constitutes a significant threat to the factor. As a result, it is important for the factor to be aware of any existing or potential tax liens. It is imperative the factor exercise due diligence when screening a potential client for funding. A UCC search is a prerequisite to the initial funding of a client to ensure the factor has a priority position as to the receivables. The UCC search should indicate whether a potential client has problem liens. If so, the factor can make an informed decision as to whether to pass on the client or factor the client once a subordination of federal tax lien is in place.
Today, in most cases, a Form 8821 Tax Information Authorization will be filed with the IRS as well. While filing Form 8821 with the IRS is a good first step, it is only as successful as the effort that goes in to sustaining that due diligence. The IRS Form 8821 allows any designated individual, corporation, firm, organization, or partnership to inspect and/or receive confidential information from any office of the IRS. The information provided is limited to the type of tax and the years or periods listed on Form 8821. Essentially, Form 8821 enables a factoring company to obtain important tax information regarding a potential or existing client.
However, it is important to note Form 8821 does not authorize the appointee (the factoring company) to advocate the client’s position with respect to the federal tax laws, to execute waivers, consents, or closing agreements, or to otherwise represent the client before the IRS. The factoring company cannot use Form 8821 to negotiate on behalf of the client, e.g., to secure an Installment Agreement. If the client wants to authorize an individual to represent the business, the representative must use Form 2848 Power of Attorney and Declaration of Representative. Only attorneys, certified public accountants, and enrolled agents may represent clients and negotiate resolutions to tax liabilities pursuant to Form 2848. This is vital in cases where a liability exists, liened or not, because a resolution to the liability will be required for the factoring company to continue its relationship with the client. In addition to the fact that Form 8821 will not allow the appointee to negotiate with the IRS on behalf of the client, there is another limitation of the form. By filing Form 8821 with the IRS, the appointee is supposed to receive the same documentation from the IRS as the client. For example, if the client receives a notice of deficiency, a tax lien, or a final notice of intent to levy, the appointee listed on Form 8821 should, in theory, receive the notice as well. In practice, this is rarely the case. In this sense, Form 8821 is a passive document.
To obtain the necessary information relative to a client, the appointee must actively pursue the information from the IRS. It must be assumed the IRS will not copy the appointee on the requisite notices. The Service Center and Automated Collection System (ACS) inconsistently copy the appointee on Form 8821. Despite the limitations of Form 8821, there is a solution to obtain the necessary information from the IRS to ensure the factor is still in a priority position, at least with respect to the IRS.
The factor can call the IRS Tax Practitioner’s Office on a regular basis, e.g., quarterly, at 800-866-4259 and ask the following questions:
Is there a tax liability and what is the amount of the liability?
Are there any missing returns?
Have any liens been filed?
Is the case currently in collections?
Has a Revenue Officer been assigned?
If there is a liability or there are missing returns, the factor will know there is a potential problem. If a lien has been filed, the factor will know it has 45 days from the date of the lien to obtain a subordination of federal tax lien in order to maintain its priority position on the receivables or to exit the relationship altogether. A factor should never contact ACS (800-829-3903) when inquiring about a potential or existing client. ACS is a collection function of the IRS. A call to ACS may enable the factor to obtain the information needed to make the determination as to whether to fund (or continue to fund) the client. However, because ACS’s role is collections, a phone call to ACS may trigger requirements for providing information that could result in levy of the client’s assets if the deadlines for the providing the information are missed. Information garnered in a call to ACS will be used to try to collect against a liability. By acting proactively, the factor can limit its exposure and substantially reduce the risk of losing its advances to an IRS levy. Merely filing Form 8821 and assuming the IRS will send the necessary notices is tantamount to playing Russian roulette with the factor’s advances.
More importantly, if the factor knows of a liability prior to a federal tax lien, the client can (1) negotiate an Installment Agreement and (2) obtain a subordination of federal tax lien so the factor can continue financing the client. After reviewing with my colleague at the factoring company the potential issues with the IRS, we contacted the IRS and asked the questions listed above. There were no existing liabilities or liens filed, but there were some missing returns. With this information, she was able to make a truly informed decision as to whether to factor the potential client. Ultimately, she decided to work with the client conditioned upon filing and paying the missing returns. More importantly, by contacting the IRS on a regular basis in the future, she will not be blindsided by any new developments.
Jason S. Peckham, Esq., is vice president of Resolutions for Tax Guard, Inc. Tax Guard monitors federal tax compliance, identifies risks before federal tax liens are filed and resolves federal and state tax liabilities. He can be reached at email@example.com or 303-953-6325.