IRS Liens vs. IRS Levies: It’s Time to Clear Up the Confusion Published June 16, 2014
Over our years of dealing with the IRS and working with lenders and small businesses, we’ve come across some common themes of misconception. One of the most prevalent is that there is an assumption that if no federal tax lien has been filed, the lender has no exposure to the IRS. This assumption is incorrect.
There is a considerable amount of confusion regarding the difference between a lien and a levy. (Hang with us here, this may get a bit technical. As always, either comment at the bottom or contact us with any questions.) A lien is a charge or an encumbrance that a person has on the property of another as security for a debt or obligation. The most common is a home mortgage. Generally, the lien determines priority. Internal Revenue Code Sec. 6323(c) grants creditors limited priority over the federal tax lien to the extent that the loan or purchase is made within 45 days of the filing of the notice of federal tax lien (NFTL) or made before the lender or purchaser had actual knowledge of the filing, if earlier. This is known as the “45-day rule.”
An NFTL does not divest the taxpayer of his or her property or rights to transfer property. (think of this like a security blanket). A levy does the divesting. A levy transfers constructive ownership to the government (the IRS takes the asset). There is no difference between a levy and seizure, other than the type of asset involved. Before the IRS can issue a levy, the Service must issue a Final Notice of Intent to Levy (Final Notice; IRS letter 1058 or LT11). If no appeal is filed within the 30 day window from the date the notice is issued, the IRS can begin levying bank accounts and accounts receivable.
For more information on levies, liens, and the IRS’s collection process in general, click here.
Contrary to popular belief, the IRS does not have to record an NFTL before it can levy bank accounts or receivables. Once the Final Notice has been issued and 30 days have passed, the IRS can levy bank accounts and/or accounts receivable. The IRS does not perform a lien search prior to issuing a levy. As such, the Service has no idea whether the assets on which it is about to levy are secured by another entity, e.g., a lender.
Let’s assume the IRS issues a levy to a receivable, but there is no NFTL. Let’s also assume that the receivable is collateral for which the lender has a perfected security interest. As long as the IRS follows its internal procedures (issues the Final Notice then waits the appropriate time frame or for the appeals process to run its course), there is nothing incorrect about the levy. The IRS did not make a mistake.
In our example, the levy is “wrongful” because the IRS’s levy attached to property belonging to a third-party, the lender. Internal Revenue Manual section 188.8.131.52.2(2) (08-24-2010) indicates “A ‘wrongful levy’ is one that improperly attaches property belonging to a third party in which the taxpayer has no rights.” Therefore, the IRS can levy on the receivable, but the levy is “wrongful” in that the lender has a security interest with priority over the IRS, who does not have a secured interest at all.
The question becomes: “how can I get my money back from the IRS?” Generally, there are two options – (1) ask the IRS for the money or (2) file a suit in federal district court. Over the past few years, the number of “wrongful” levies brought to Tax Guard’s attention have increased dramatically. This is likely a result of, at least in part, the IRS’s new “Fresh Start” program instituted in February 2011.
The Fresh Start program furthered a trend of pushing risk to the private sector by reducing the number of NTFLs. The program increased the threshold for filing a lien to $9,999. The IRS will not file (and in some cases may release) federal tax liens if taxpayers enter into Direct Debit Installment Agreements (DDIA). The DDIA provisions apply to individuals (sole proprietorships) that owe less than $50,000 and businesses that owe $25,000. If these agreements default, the IRS can levy bank accounts and receivables despite the fact there is no NFTL.
There are two divisions within the Collections System of the IRS – the Automated Collection System (ACS) and the field (Revenue Officers). Theoretically, ACS is designed to work liabilities less than $25,000. However, ACS has control over many cases where the liability is greater than $25,000, but a Revenue Officer in the field has yet to be assigned. ACS is a computer system and phone bank. Call 800-829-3903 and a different person answers the phone each time – it is impossible to speak with the same person more than once. ACS has a tremendous amount of power – it can file liens and issue levies. There is little oversight – if one asks to speak with a manager, a return call from the manager will never come. Without a conference with a manager, the IRS cannot entertain an administrative appeal of a “wrongful” levy.
Generally, it is a nightmare to work with ACS (or the IRS at all, depending on your perspective). Moreover, most “wrongful” levies are issued by ACS. Because of the administrative problems within ACS, it is highly unlikely that a “wrongful” levy can be resolved by ACS. The representatives within ACS know nothing of lien priority, the 45-day rule, factoring, etc. The response is typically – “the Service issued the Final Notice, there was no appeal, we issued a levy, your client should have paid its taxes.” Whereas ACS cannot typically resolve the “wrongful” levy it issued, the alternative is to file a lawsuit in federal district court. In most cases, this is not feasible or justifiable from a cost-benefit analysis perspective. The majority of “wrongful levies” issued by the IRS will be on liabilities of less than $25,000. However, so long as ACS retains authority over cases in excess of $25,000, the possibility of a wrongful levy of $50,000, $100,000, $250,000, etc., still exists.
In the case of the “wrongful” levy, an ounce of prevention really is worth a pound of cure. Tax Guard reports provides an complete solution to this problem. Throughout the entire funding cycle it’s important to be upstream from any tax liens that could jeopardize a lender’s collateral and have a plan in place to resolve any tax lien issues should they arise.