Five Key Things to Understand About the 45-Day Rule Published February 10, 2019
Most factors have heard of the 45-Day Rule, but the intricacies and complexity involved can certainly make it confusing. Given that there are a lot of aspects of the rule – Internal Revenue Code (IRC) sections 6323(c) and (d) with references to IRC section 6321, after-acquired interests, written agreement terms, state law, and more – it’s an understandable knowledge gap for commercial lenders.
WHAT IS THE 45-DAY RULE?
In summary, IRC sections 6323(c) and (d) grant lenders priority over the federal tax lien to the extent the loan or purchase is made (a) within 45 days of the filing of the notice of federal tax lien or (b) before the lender had actual knowledge of the filing, whichever comes first (45 days from filing or actual knowledge).
FIVE KEY THINGS TO UNDERSTAND ABOUT THE 45-DAY RULE
To understand the 45-Day Rule in even greater detail or to discuss specific examples, it is always helpful to consult a tax expert. However, some of the most critical aspects of the rule are broken down below (the following is not an exhaustive review or legal advice):
- The general rule for secured interests in property is “first in time, first in right”. The party that files a lien first has a right to the taxpayer’s property over those who file liens subsequently.
- The 45-Day Rule is an exception to the general rule of priority. The exception applies to revolving assets, e.g., accounts receivable and inventory (for non-revolving assets, e.g., real property and equipment, generally follow “first in time, first in right.”) This exception is what presents the unique risk that factors need to be aware of.
- The lender has a window of 45 days to discover the federal tax lien while continuing to fund before its lien becomes subordinate to the federal tax lien.
- If a lender funds beyond the 45th day (the 46th day or after), the lender would be subordinate to the IRS and risk loss of collateral (through IRS levy and/or a suit for tortious conversion of assets/”clawback”).
- A lender, whose collateral can be identified after the filing of a federal tax lien, maintains priority subject to the following:
- The security agreement must pre-date the federal tax lien filing;
- The holder of the secured interest, i.e., the lender, may make disbursements no more than 45 days after the federal tax lien is filed;
- The collateral securing those disbursements, e.g., receivables and/or inventory, must be acquired within those 45 days; and
- At the time of the disbursement, the lender cannot have “actual knowledge or notice” of the federal tax lien.
In upcoming posts, we’ll review some example scenarios in which the 45-Day Rule applies, the ramifications and risks to the lender, and how to avoid getting burned by the IRS.
Want to learn more? Check out our next blog in this three-part series, IRS 45-Day Rule Scenario For Commercial Lenders.