It is important to understand how the IRS works in order to protect collateral and preserve funding with clients. There are several terms frequently discussed in our conversations with commercial lenders. Below is a list of the most commonly discussed terms and their definition.
Please note this should not be considered legal advice. Rather, these are general rules and there are exceptions to all explanations presented below. Should you have specific questions about a situation, please feel free to contact us for a consultation.
The underlying idea behind Tax Guard’s reporting service is to identify IRS issues before they become a problem for you and your client. The earlier an issue is identified and referred to Tax Guard for resolution, the easier it is to resolve, the better the outcome, and the more likely we can preserve the funding relationship.
A form that should be filed when a lender extends money to a borrower and the borrower pledges collateral to the lender in exchange for the loan. The form is filed to perfect a lender’s security interest in the borrower’s personal property (e.g., inventory, receivables, etc.) based on the requirements of the Uniform Commercial Code (i.e., giving public notice), thereby establishing a relative priority interest with other creditors of the borrower.
Federal Tax Lien
The document used by the IRS to provide public notice to third parties and establish priority of claim against a taxpayer. The federal tax lien is a blanket lien that attaches to all existing and after-acquired property (e.g., equipment) and to all rights to property (e.g., accounts receivable). A federal tax lien does not divest the taxpayer of his or her property (a levy does the divesting).
Set forth in Internal Revenue Code section 6323(c) and (d), the rule governs priority between a filed notice of federal tax lien (NFTL) and a lender’s secured interest in its clients’ revolving assets, e.g., receivables, inventory, etc. Lenders are granted priority over the IRS to the extent that the loan or purchase occurs within 45 days of the filing of the NFTL or before the lender or purchaser acquires knowledge (actual or constructive) of the filing.
If receivables are purchased or used as collateral more than 45 days from date the NFTL was filed, the lender is in second position behind the IRS and subject to a claim for tortious conversion of assets.
Tortious Conversion of Assets
A common law civil action (tort) that exposes a lender to damages and applies when the lender intentionally interferes with personal property (e.g., inventory, receivables, etc.) belonging to another entity (for our purposes, the IRS).
The legal seizure of property to satisfy a tax debt with the IRS or state taxing authority. Taxing authorities can garnish wages and take money from financial accounts (e.g., bank accounts and receivables).
Final Notice of Intent to Levy
Usually takes the form of IRS letter 1058 or LT11. Generally, the IRS cannot levy or seize assets unless and until this letter is issued.
A levy wherein the IRS seizes assets that “belong” to the lender. The “wrongful” label is not applied because the IRS cannot levy – assuming they have issued the final notice of intent to levy, the IRS can levy at any time. However, if the lender has a secured interest in the receivables while the IRS does not (or the lender’s security interest has priority over the IRS’s), the IRS’s levy is considered “wrongful.”
Installment agreements are formal, written arrangements by which the IRS allows taxpayers to pay liabilities over time. If full payment cannot be achieved within the statute of limitations, and taxpayers have some ability to pay, “partial payment” installment agreements may be granted. Generally, no levies may be served while installment agreements are in effect. Importantly, by itself, the installment agreement has no effect on a federal tax lien, and the IRS’s secured interest, assuming the NFTL is in place, still has priority.
Installment Agreement in Good Standing
Agreements can default and terminate if the taxpayer does not meet certain requirements. For an agreement to remain in effect, there can be no new periods of liability outside the agreement (federal tax deposits must be made in full and on time), there can be no missing returns, and the business must make the installment payments in full and on time.
A subordination elevates another creditor’s lien, e.g., a factor, above the IRS’s priority position, making the IRS’s lien junior to that creditor’s lien. By subordinating its federal tax lien, the IRS allows a factor to take a priority interest ahead of any IRS claims to the property, e.g., receivables.
Per the Internal Revenue Manual, a formal installment agreement “must be secured in conjunction with the subordination.” If the underlying installment agreement terminates, there is no “race to collect” the receivables. If the IRS attempts to levy the receivables, it would be considered a “wrongful” levy. With a subordination in place, the lender has priority to the receivables, not the IRS, which means the lender is not exposed to tortious conversion of assets.