The IRS Collection Process: From Filing to Subordination Published March 14, 2011
Last year was tough on many businesses. The IRS’s 2009 statistics, which were released in January, bear this out. In 2009, the IRS collected $48.9 billion, which represents a 13 percent decrease in collections from 2008 when the IRS collected $56.4 billion. Although the amount collected in 2009 decreased, the level of enforced collection actually increased. The number of liens issued by the IRS increased approximately 25 percent from 768,168 in 2008 to 965,618 in 2009. Likewise, the number of levies issued by the IRS increased approximately 32 percent from 2,631,038 in 2008 to 4,478,181 in 2009…
As the effects of the economic downturn were felt by everyone, it appears the number of businesses and individuals that “borrowed” from the IRS increased. However, the ability to repay those liabilities decreased, despite the increase in enforced collection. It is likely that the number of taxpayers owing money to the IRS and the number of liens filed in response will remain high and may even continue to increase through 2010. Since Factors are more likely to encounter these issues in the near-future, it is important to understand the IRS’s collection process and what can be done to protect the Factor’s interests.
Before a lien appears, there must be a liability. A federal tax lien may arise in conjunction with any kind of federal tax, e.g., withholding, unemployment, or income (business or personal). Generally, the taxpayer must compute the tax due on the return and make the necessary payment on or before the due date for filing the return. If the taxpayer fails to pay the tax when due, the IRS will “assess” or formally record the tax in the official books and records of the U.S. Department of the Treasury (Code Sec. 6201).
After the assessment, the IRS will issue a notice and demand for payment within ten days from the date of the notice. If the taxpayer fails to pay the tax within the ten-day period, the tax lien arises statutorily by operation of law and is effective retroactively as of the date of the assessment (Code Sec. 6321). At this point, there is a statutory lien, which is effective between the IRS and the taxpayer. The statutory lien has no effect on third parties.
If the liability is not paid after the initial notice and demand for payment, the case will be transferred to the Collection Division of the IRS (Collections). Initially, Collections will issue letter CP504 – Notice of Intent to Levy. The CP504 is a warning letter – pay the liability or the IRS will begin taking enforced collection at some point.
Assignment of Revenue Officer
There are two separate groups within Collections – the Automated Collection System (ACS) and Revenue Officers (RO). Generally, individual liabilities are addressed (at least initially) by ACS. Business liabilities are generally addressed by ROs. Whereas Factors’ clients are businesses, most of these taxpayers’ cases will be assigned to 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).
Notice of Federal Tax Lien
For the IRS’s lien to be effective against third parties, creditors must be publicly notified that the IRS has a claim against all the taxpayer’s property, including property acquired after the lien is filed. The NFTL is used by courts to establish priority in certain situations. Depending on the state of residence of the taxpayer and the location of the property, the federal tax lien attaches to all the taxpayer’s property (e.g., equipment) and to all rights to property (e.g., accounts receivable). The federal tax lien attaches to all property belonging to the taxpayer on the date of the assessment. The lien also attaches to after-acquired property – to any property owned by the taxpayer during the life of the lien, e.g., accounts receivable (Glass City Bank v. US, 326 U.S. 265 (1945)).
The federal tax lien remains in effect until the liability is paid in full or it becomes unenforceable. The full amount of the lien remains a matter of public record until it is paid in full, including all additions and / or accruals of penalties and interest. For taxes assessed on or after November 6, 1990, the statute of limitations whereby the lien generally becomes unenforceable by reason of lapse is time ten years after the date of assessment (Code Sec. 6502(a)). Various exceptions may extend the time periods.
Effect of NFTL on Priority
Generally, the basic priority rule of federal common law is “first in time, first in right,” assuming the competing interest is choate at the time the federal tax lien arises. An interest is “choate” when (1) the identity of the lienor, (2) the property subject to the lien, and (3) the amount of the lien are established.
Code section 6323(c) governs priority between a filed federal tax lien and a security interest in property acquired by the debtor-taxpayer after NFTL has been filed.
The agreement could be either to lend money (with commercial financing security as collateral) or to purchase the commercial financing security. To be protected, the lenders or purchasers must have entered into an agreement before the NFTL is filed.
Once the lender and taxpayer enter into the agreement, it would be unreasonable to expect the lender to have to check lien recordation on a daily basis to make sure that no NFTL is filed before funds can be advanced. Code Sec. 6323(c) has granted these creditors priority over the federal tax lien to the extent that the loan or purchase is made within 45 days of the filing of the NFTL or made before the lender or purchaser had actual knowledge of the filing, if earlier. This is known as 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.
Final Notice of Intent to Levy
There is a considerable amount of confusion regarding the difference between a lien and a levy. 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.
A federal tax lien does not divest the taxpayer of his or her property or rights to transfer property. A levy does the divesting. A levy transfers constructive ownership to the government. Per Internal Revenue Manual Section 220.127.116.11.2(1), there is no legal distinction between levy and seizure.
Before an RO can issue a levy, the IRS must first issue a Final Notice and provide the taxpayer with 30 days to appeal the action through a Collection Due Process hearing. If the 30 days expire without a resolution or an appeal by the taxpayer, the RO may proceed with enforced collection and can begin issuing levies on the taxpayer’s bank accounts and / or accounts receivable.
The IRS will generally use a notice of levy (Form 668-A or 668-W) to take a taxpayer’s property held by someone else if it can be turned over by writing a check. Contrary to popular belief, the IRS does not have to record a NFTL before it can pursue enforced collection activity (however, there must be an assessment and statutory lien in place and the Final Notice must have been issued).
Subordination and / or Forbearance
Once the IRS issues the NFTL, especially in conjunction with a Final Notice, it is imperative that taxpayers pursue an Installment Agreement and Factors pursue a subordination of federal tax lien (Subordination). Per section 18.104.22.168 of the Internal Revenue Manual, a Subordination “elevates another creditor’s lien to the Service’s priority position making the Service’s lien junior to that creditor’s lien.” Essentially, the junior lienor and the IRS trade positions. By subordinating the lien, the IRS allows a Factor to take a priority interest ahead of any IRS claims on value of the property.
There is no specific IRS form for a subordination or discharge of a federal tax lien. Regardless, the process is very specific. Per Publication 784, How to Prepare Application for Certificate of Subordination of Federal Tax Lien., the taxpayer is to provide the IRS with the following information: (1) a detailed description of the property, (2) a copy of the tax lien, (3) a description of the encumbrance to which the IRS will be subordinated, (4) a list of encumbrances with priority over the IRS, (5) information on the value of the property, (6) how much the IRS will receive currently, (7) how much the IRS will receive in the future, and (8) other relevant information.
This application for Subordination, as it pertains to Factors, was confused considerably September 7, 2006 revisions to IRM section 22.214.171.124(6). The confusing language indicated “issuance of a subordination certificate that purports to allow for the sale of future accounts receivable without the need for a discharge should not be approved.” Many Technical Services Advisors interpreted (and still interpret) the language to mean that Subordinations for Factors purchasing future receivables cannot be granted.
Fortunately, in November 2008, the Director of Collection Policy issued a memo providing “Interim Guidance for Subordination to Factors” modifying the language in the IRM and clarifying the IRS’s position. The new language allows for Subordinations of receivables existing on the issuance date and for after-acquired receivables for up to one year. The description of the assets included in the Subordination must read, “all [or specific] accounts receivable belonging to [taxpayer name] in existence on mm/dd/yyy and coming into existence prior to mm/dd/yyyy.” Any extension would require a new application.
To obtain the Subordination, the application should demonstrate convincingly that subordination of the Service’s position will facilitate collection of the taxes due. Demonstration that factoring is essential to the client / taxpayer remaining current and compliant with the federal tax deposits and making monthly payments to the IRS is generally sufficient. This is convenient since a formal installment agreement (signed 433-D) “must be secured in conjunction with the subordination.” Generally, issues that would result in termination of an Installment Agreement would also result in termination of the Subordination agreement.
Alternatively, the Factor could request a forbearance agreement. With such an agreement, the Director of the IRS “agrees not to assert the Service’s tax lien priority under IRC section 6323(a) or to levy pursuant to IRC section 6331 against the Taxpayer’s accounts receivable, which accounts are used as security for advances made by the Factor to the Taxpayer prior to the termination of this agreement.”
The normal processing time for a Subordination may be as long as 30 to 60 days. However, when there is danger of losing the loan, the IRS may expedite the certificate at the taxpayer’s or representative’s request.
It can take several months from the filing of the returns to the assignment of an RO. Once an RO is assigned, a NTFL and / or Final Notice can be filed within a few days. It may take the IRS a while to catch on, but when they do they can move quickly, which can be quite disruptive to the Factor. The earlier the liability with the IRS can be identified and addressed, the easier it is on the Factor and its relationship with its client.