IRS 45-Day Rule Scenario For Commercial Lenders Published March 3, 2019

After reading our previous blog post, “Five Key Things to Understand About the 45-Day Rule,” you should have a good idea as to how the IRS’s 45-day rule works.  In this post we are going to explore an example factoring scenario to illustrate the rule in greater detail.

EXAMPLE OF A 45-DAY RULE SCENARIO 

In this scenario, you, the lender, have previously filed your UCC1 and are currently funding ABC Staffing. On February 28, the IRS files a federal tax lien, but you have no knowledge of it.  You go ahead and fund $100,000 on April 1.  You then acquire knowledge of the lien on April 2.  Despite knowledge of the federal tax lien, you fund another $100,000 on April 8, and yet another $100,000 on April 15 (which marks the 46^th day since the lien was filed).

Here’s the visual representation of the scenario we just laid out:

WHO MAINTAINS PRIORITY? THE IRS OR YOU?

April 1 Funding – You have priority.  The advance was made within 45 days of the date the federal tax lien was filed AND without actual knowledge of the lien.

If the IRS was to levy on those receivables, it would be considered a “wrongful” levy and you would have the right to recover those receivables (or the proceeds of those receivables) from the IRS.  The levy would be considered “wrongful” not because the IRS cannot levy, but because the IRS would not have a priority secured interest.  Instead, you would have the priority secured interest.

April 8 Funding – The IRS has priority.  Even though it has not yet been 45 days, the funds were advanced with knowledge of the federal tax lien.

The April 15 Funding – Again, the IRS has priority.  Let’s ignore the question of knowledge at this point because it is no longer relevant.  The transaction occurred beyond the 45^th day.

The IRS can levy the debtor directly and keep the proceeds from the April 8 and April 15 receivables.  If you collect the receivables before the IRS, the IRS still has the ability to pursue you for tortious conversion of assets at a later time because you would have collected receivables on which the IRS has a priority secured interest.

The example above is merely one possible scenario and should not be considered legal advice.  When faced with a borrower with a tax liability, please consult with a tax expert to determine the best course of action to mitigate risk and preserve the funding relationship.

Stay tuned for our upcoming post that will discuss how to get ahead of the federal tax lien so you can be aware of your borrower’s standing with the IRS well before the lien gets filed and destroys the funding relationship.  By understanding these ramifications, you can ultimately avoid getting burnt by the IRS.

Want to learn more? Check out our final blog in this three-part series 45-Day Rule: Proactive Approach to Avoid Getting Burned By the IRS.