Factoring and the IRS: Prevent your clients’ problems from becoming your problems Published March 1, 2011
A client’s liability to the Internal Revenue Service (IRS) poses some unique challenges to the Factor. As such, it is important to understand (1) the IRS collection process and (2) methods for protecting the Factor’s advances from IRS levy.
Initially, there must be a liability, which can arise in conjunction with any kind of federal tax, e.g., withholding, unemployment, or income (business or personal). If a return is filed and the taxpayer fails to pay the tax when due, the IRS will assess the liability and issue a notice and demand for payment. If the liability is not paid, the case goes to the Collections Division. There are two separate groups within Collections – the Automated Collection System (ACS) and Revenue Officers (RO). Business liabilities are generally addressed by ROs. Shortly after being assigned to the case, the RO will generally issue a Notice of Federal Tax Lien (NFTL) and / or a Final Notice of Intent to Levy (Final Notice), assuming these have not already been issued by ACS. A federal tax lien does not divest the taxpayer of his or her property or rights to transfer property. A levy does the divesting. Before an RO can issue a levy, the IRS must first issue a Final Notice and provide the taxpayer with 30 days to appeal. If 30 days pass without a resolution or an appeal by the taxpayer, the RO may proceed with enforced collection – levies on the taxpayer’s bank accounts and / or accounts receivable. Importantly, the IRS does not have to record a NFTL before it can pursue enforced collection activity. The Factor’s advances are not in jeopardy unless an NFTL was filed at least 45 days prior to the issuance of the levy. Generally, the basic priority rule of federal common law is “first in time, first in right.” However, Internal Revenue Code section 6323(c) governs priority between a filed federal tax lien and a security interest in property acquired by the debtor-taxpayer after the NFTL has been filed. Creditors are granted priority over the federal tax lien to the extent that the loan or purchase occurs within 45 days of the filing of the NFTL or before the lender or purchaser had actual knowledge of the filing, if earlier. This is the “45-day rule.” If receivables are purchased or used as collateral 46 days after the date of the NTFL, the Factor is in second position behind the IRS.
Factors can protect themselves from IRS levies through proactive monitoring, Installment Agreements, and subordination’s of federal tax lien (Subordination). Factors can monitor their clients’ condition with the IRS by filing a form 8821. However, simply filing the form 8821 is not sufficient protection. If the form is completed or signed improperly, the IRS will not copy the Factor on the requested information. Additionally, a 2009 TIGTA study reports that the IRS does not notify the representative of a lien filing 30 percent of the time. Proactive monitoring through periodic phone calls to the IRS is necessary to obtain the requisite information.
Early identification of a problem provides sufficient time to secure an Installment Agreement prior to the 45th day from the NFTL. The IRS’s Internal Revenue Manual (IRM) indicates no levies can be served while a proposal is pending, while the agreement is in good standing, or for a minimum of thirty days after the agreement defaults. During this time, the Factor would be protected and could continue to advance funds on the receivables while finalizing negotiations for a Subordination.
An Installment Agreement is a prerequisite for a Subordination. Despite the assumption that the IRS is looking for an arbitrary (and sometimes substantial) monthly payment, the IRM indicates Installment Agreements must reflect taxpayers’ ability to pay on a monthly basis throughout the duration of agreements. Therefore, the monthly payment should not be based upon an arbitrary figure, but upon what the taxpayer can actually afford. Although an Installment Agreement prevents the IRS from issuing levies, the Factor should also pursue a Subordination, which elevates the Factor’s lien ahead of the IRS’s position making the IRS’s lien junior to that creditor’s lien. Essentially, the junior lien holder and the IRS trade posi – tions. By subordinating the lien, the IRS allows a Factor to take a priority interest ahead of any IRS claims on value of the property. While the process seems straightforward, there are a number of pitfalls. Good decision-making stems from (1) access to information and (2) time to process information. The earlier a client’s issue with the IRS can be identified, the higher the likelihood of securing a proper resolution with the IRS that will protect the client’s business and the Factor’s advances.
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 firstname.lastname@example.org or 303-953-6325.