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 46th 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 45th 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.
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.
The wisdom of the saying, “Never put off until tomorrow what you can get done today” is not lost on me. Unfortunately, I am more likely to follow the, “If it weren’t for the last minute, nothing would get done” philosophy. It’s human nature to put off projects or tasks we don’t enjoy. Most of the time, it’s understandable, and even though waiting until the last minute makes the project or task harder and/or more chaotic, it’s still possible to get it done.
Of course, there are always exceptions. And negotiating with the IRS is a huge exception.
A few times a month, I’ll speak with a lender confronted with a common issue. The lender indicates a federal tax lien was filed on their client 45 days ago (or more). The question they ask is, “What can be done to fix the issue and preserve funding at this point?” My follow-up question is whether the lender is willing to fund beyond the 45th day (typically this is not advisable, but there are exceptions on occasion). Of course, the answer is usually “no.” I then spend 30 minutes reviewing why there are no “magic bullets” when negotiating with the IRS, and that resolving the problem will take time – likely more time than we have, at this point. This is obviously not what the lender wants to hear, but unfortunately that doesn’t make it any less true.
This point is essential: If a lender is funding, using the receivables as collateral, and wants to preserve the funding relationship, negotiations with the IRS should begin BEFORE the federal tax lien is filed. If the lender waits until the last minute to address the issue, the client is likely DOA (dead on arrival). There is nothing more frustrating than the DOA conversation, especially since the situation is entirely avoidable if the lender and client work proactively to address the issue. In short, the earlier we can begin negotiations with the IRS, the easier it is to resolve the issue, the better the outcome, and the more likely we are to preserve the funding relationship.
Problem
Once the IRS files a federal tax lien, the funding relationship is immediately threatened. The IRS moves into first position relative to its secured interest in the inventory and/or receivables based on the earlier of the following: the lender’s actual knowledge of the federal tax lien or 45 days from the date the lien is filed. (We made this handy video to further explain the 45-day rule.) Once the lender is funding in second position behind the IRS, there are two risks:
Levy. The IRS can levy bank accounts and accounts receivable (AR). If an AR levy is issued, the receivable will send the money to the IRS, not to the lender. As such, the lender will not recoup its advances.
Conversion. The IRS could pursue the lender for tortious conversion of assets on any receivable funded (and subsequently collected by the lender) beyond the 45th day from the date the lien was filed. As such, the IRS could “claw back” or force disgorgement of the collected receivables.
For any lender, both the levy outcome and the conversion outcome represent an unacceptable outcome. Here’s how these outcomes can be avoided…
Solution
There are two items required to protect the client, protect the lender, and preserve the funding relationship when there is an IRS liability. The first is an installment agreement. With an installment agreement in place, the IRS cannot levy bank accounts or AR. The formal agreement protects the taxpayer/client as well as the lender.
The second is the subordination of federal tax lien, which puts the lender back in first position relative to the client’s receivables. A prerequisite or requirement for a subordination of federal tax lien is an installment agreement in good standing. If there is no installment agreement in place, the IRS will not consider the subordination request.
Tax Guard Resolution can assist your client in obtaining both items.
Timing
The filing of the federal tax lien and the existence of the 45-day rule presents a plethora of timing issues. The lender wants the issue resolved within the 45 days (if not sooner). However, the IRS process does not move that quickly. A common question is, “How long does it take to secure an installment agreement with the IRS?” The short answer, which is not terribly helpful, is, “It depends.” Assuming there is a revenue officer assigned to the case and the client/business is making federal tax deposits in full and on time (a requirement for an agreement), a reasonable expectation for negotiation of the installment agreement is approximately 30 days. Agreements have been negotiated much quicker, e. g., one day, but that is not the norm. If the client/business is not making federal tax deposits in full and on time and/or there will be a liability for the current quarter, it will take longer than 30 days to negotiate the agreement.
Once the installment agreement is in place, lenders should assume that it will take an additional 30 to 45 days to secure the subordination of federal tax lien. Tax Guard works with revenue officers to negotiate installment agreements. However, we must secure the subordination of federal tax lien through a different group: Advisory and Insolvency. Every lien issue that lands on an advisor’s desk is an “emergency” to the taxpayer. Since cases cannot be prioritized based on urgency, the advisor will work each issue on a “first in first out” basis. Essentially, the time required to obtain the subordination of federal tax lien is based on the advisor’s workload and inventory (and this assumes the application for subordination was filed properly and the client qualifies for a subordination in the first place).
At this point, you may have noticed that there is a fundamental flaw in the process. Once the federal tax lien is filed, there is a 45-day timeframe to secure the installment agreement and subordination of federal tax lien. However, if the installment agreement takes 30 days to negotiate and the subordination requires another 45 days, the client (or its representative, or even the lender) is trying to cram approximately 75 days of work into 45 days or less.
As with installment agreements, it is possible to secure a subordination of a federal tax lien in a day or two (we’ve done it on occasion), but it is not the norm and should not be any lender’s expectation. Unfortunately, the length of time needed to secure subordinations is increasing.
Trends in Timing
There is a popular theme in Congress to “stick it” to the IRS and decrease its budget. Given the general sentiment surrounding the IRS, the position is understandable and might seem to make sense … up to the point when you need something from the IRS. Due to budget reductions over the past several years, the IRS has not hired employees to replace those employees who leave, retire, etc., who provide customer service to taxpayers. Today, there are fewer revenue officers and technical advisors than there were several years ago. Unfortunately, the number of IRS liabilities and the need to address lien issues has not decreased. Because of budget cuts and the effects on hiring, almost every Advisory and Insolvency office now has fewer employees, but larger caseloads. This results in longer turnaround times for installment agreements and subordinations of federal tax lien, which increases the importance of beginning negotiations before the IRS files a lien.
Conclusion
Because of the inherent limitations within the IRS, it is imperative to begin negotiations for an installment agreement and outline the terms for the subordination of federal tax lien BEFORE the IRS files its lien. By initiating the resolution process when a liability is first identified (as opposed to when a federal tax lien is filed), we can address any underlying issues that could create problems with the IRS accepting an installment agreement, e.g. missing returns, federal tax deposits, etc. We can explain the impact a federal tax lien will have on the funding relationship to the IRS, and prevent or delay the filing of the federal tax lien. While we may not be able to prevent the IRS from filing a federal tax lien in perpetuity, we can delay the filing of a federal tax lien until the installment agreement is approved and reduced to writing. At that point, we have the full 45 days to secure the subordination of federal tax lien. With sufficient time, we can protect the client, protect the lender, and preserve the funding relationship.
This is the third post in a three-part series on what lenders need to understand about IRS levies to foresee risks and mitigate exposure. Be sure to subscribe to the blog to receive all of Tax Guard’s posts.
In Part 1 of our “Understanding IRS Levies” series we covered what business assets are at risk for IRS levy and in Part 2 we discussed when the IRS can begin seizing those assets. These insights will assist you in clearly understanding the risks that a levy could present to your funding—ie, the business’ A/R could be seized, funds in their bank account could be wiped out, etc.
In Part 3, let’s wrap up with a holistic view of what a risk for levy really says about an organization’s creditworthiness and financial health. In other words, what does all this talk about IRS levies mean to the underwriter who is analyzing a credit file?
Tax Levies and a Business’ Creditworthiness
A business that’s at risk of an IRS levy is not to be evaluated the same as a business who has simply missed a tax deposit or has just been notified of a tax liability. The IRS doesn’t immediately file a levy the moment a tax debt is accrued. Rather, it takes time to get to this stage in the IRS collection process.
If we look back to Part 2 of this levy series, we discussed the process that the IRS goes through prior to issuing a levy to seize assets. There are multiple steps, which include numerous warnings and opportunities for a tax debtor to resolve the issues before levies are sent out. This means that businesses facing IRS levies have ignored, for whatever reasons, numerous attempts by the IRS to resolve the liability. This extended ignorance tells you that the business may have a bigger problem.
Anatomy of a Business with a Tax Debt Problem
Businesses typically fall behind on tax responsibilities because of poor cash management, or in less likely instances, intentional theft. Businesses with cash flow problems are afforded time by the IRS’ lengthy collection process, whereas other creditors bang on the door ASAP. Therefore, a levy is, in many cases, a symptom stemming from a larger issue that should be of concern to underwriters such as cash flow, mismanagement, fraud, etc.
When you take a step back from all of this and think about credit risk and due diligence at the highest level– fundamentally underwriters are doing due diligence to determine the business’ financial health and measure the likelihood that the business has the ability to repay the funding. Information about a business’ standing with the IRS should be used by the underwriter to recognize not just an imminent credit risk that a levy could present to their collateral, but also get a better sense of who is their borrower and what is the health of their business.
Tax Guard’s Solution
Tax Guard is able to show underwriters the exact moment that a business fails to pay its taxes and how far along the non-compliant business is in the IRS collection process. This powerful tool provides the insight necessary to truly understand the overall financial health of the business. The more understanding an underwriter has about the creditworthiness of a business, the more exposure can be removed from the funding decision.
At the end of the day, this all makes for better deals which benefits lenders in reducing bad debt, helps borrowers obtain the proper credit product, and supports the economy as a whole in promoting the overall financial health of businesses.
This is the second post in a three-part series on what lenders need to understand about IRS levies to foresee risks and mitigate exposure. Be sure to stay tuned for the third and final part of the series.
Part 1 of the the “Understanding IRS Levies” series addressed what assets of a company are at risk for levy which is valuable for lenders when viewing the assets of the business in the underwriting stage of the deal. If a prospect has a significant tax issues with numerous financial assets at risk of levy, then your exposure is likely to be increased and should be managed accordingly.
In part 2 of this series we’re going to move forward by taking a deeper look into how the timing of the IRS’ processes can affect lenders and help you measure the risks presented with this scenario.
When Can the IRS Begin Seizing Assets?
In order to answer the question of whether your client is at risk of an immediate or near-term levy, it’s best to understand how the IRS levy notification process and statutory requirements work.
To get a better sense of the scenario, imagine the IRS and your tax debtor client are in a proverbial schoolyard fight where the IRS dares the other to cross a line in the sand. In this case, the IRS actually draws the line multiple times before ever striking back. In fact, they have to before taking any levy action, although a few exceptions do exist:
1. The IRS can levy wrongfully by way of systemic or human error, which can be corrected with proper representation from a tax professional who has an understanding of the underlying rules and policies of IRS collection matters.
2. If your client is doing business with the federal government, or is subject to a jeopardy levy (trying to leave the country or exhibiting criminal behavior putting the collection of the debt in jeopardy), or issued a Disqualified Employment Tax Levy which gives the IRS a right to levy for collection of employment taxes without notice provided a certain set of criteria is met (typically this is for businesses with a history of non-compliance).
To the average person, every threatening letter the IRS sends appears to give the IRS the ability to issue a levy and proceed with seizing their assets. These notifications can be threatening in nature and quite confusing for people trying to make sense of where the final line in the sand actually lies.
Understanding The IRS’s Collection Notification Process
The reality is that notification stream usually has some order and process that allows for due process prior to any levy action by the IRS. IRS collection notices generally follow the path below prior to the act of levying by the IRS:
1. Balance Due – Typically the “nice” letter telling the debtor that they have a balance due and to “pay immediately”. Example IRS Balance Due Letter.
2. Reminder, Balance Due – The next line in the sand. This notice is more threatening stating to the debtor that if they “don’t pay…we have the right to seize (“levy”) your property. Example IRS Reminder, Balance Due Letter.
3. 2nd Notice, Balance Due – Typically this will be the same notice as the “Reminder” but list a different notice number. Example IRS 2nd, Notice Balance Due Letter.
4. Final Notice, Balance Due – This line in the sand tells the debtor they they have a stated date to pay in full or they may “seize…property”. Still no levying by the IRS yet. Example IRS Final Notice, Balance Due Letter.
5. Final Notice of Intent to Levy and Your Right to a Hearing – The final-final line in the sand. Now the IRS may start proceedings to take assets. Typically, this notice will arrive as Letter 11 or Letter 1058. Under normal circumstances, the IRS waits 30 days after the date of this letter before taking action, if they choose to levy. Since the IRS doesn’t provide an example letter, the best replica is the following CP 90 which also advises the debtor of the Collection Due Process rights to a hearing: Example IRS CP 90 Letter
This entire notification process can take months to cycle through. However, in cases that involve high-dollar amounts or certain business accounts, the IRS may sometimes go straight to the Final Notice of Intent to Levy. They can skip the entire early notification process, but must issue the Final Notice in order to issue a levy.
What Does This Timeline for Seizures Mean for Commercial Lenders?
Some of this information can feel like inside baseball statistics, but knowing where your clients are in the IRS collection process helps you understand the level of risk that the client presents to you in real time.
The path that the IRS takes to seize assets is not always clear or easy to interpret, but one thing should be clear – when a prospect or client has an IRS tax liability it’s imperative to dig in beyond just looking for liens to understand their current and historical tax compliance. It is only then, when armed with this holistic view, that commercial lenders can proceed with the certainty required to effectively mitigate exposure and to foster successful funding relationships.
The existence of a tax liability with one of your prospects or clients, doesn’t have to mean that the business is knocking on the door of insolvency or that you shouldn’t fund them. It requires some insight, investigation, and at times creativity to get a deeper understanding of their true standing with the IRS. However, understanding what assets are at risk is only part of the risk mitigation picture.
Stay tuned for part 3 of the series, where we’ll take a look at the current levy trends at the IRS so you can be aware of the current state of affairs at the IRS and manage risk accordingly.
This is the first post in a three-part series on what lenders need to understand about IRS levies to foresee risks and mitigate exposure. Stay tuned for the next two parts of the series.
Here’s a scenario that all commercial lenders have found themselves in at some point or another – A prospective borrower is seeking funding and has an outstanding IRS tax liability. This likely prompts a series of questions for the underwriter to continue their credit analysis:
• How much do they owe the IRS?
• Is there a tax lien on file?
• Have they been levied or are they at risk of immediate or near-term levies?
• Do they have a payment plan in place that’s in good standing?
• Do I still have confidence the prospect can repay the amount considered for funding?
Given that each client’s scenario is unique, these questions are just the beginning. Considering underwriting commercial finance deals is part art and part science, let’s focus on what we know about the “science” of the IRS levy process and understand what assets the IRS can levy.
The Difference Between Tax Liens and Tax Levies
To start, let’s rule out what tax levies are not. They are not tax liens. We expanded upon this common point of confusion with a previous blog post “IRS Liens vs. Levies: It’s Time to Clear up the Confusion”, but to clarify, a lien is a legal claim against property to secure payment of a tax debt, while a levy actually takes the property to satisfy the tax debt. Therefore, levies are synonymous with seizures, and importantly, may occur with or without the filing of a federal tax lien.
What Does the IRS Actually Seize From Small Businesses?
Congress has given the IRS statutory authority to seize both physical and financial assets to satisfy tax debts.
In reality, the IRS actually seizes a very small number of physical assets such as real estate, inventory, equipment, or trucks because it’s an expensive and inefficient way to collect on tax debts. They have to be physically seized and then sold in order for the IRS to realize any funds from this collection tactic. Additionally, for commercial lenders most of these physical assets are likely secured in a manner that places the IRS in a subordinate position.
More realistically and worrisome for lenders are the financial assets of the business that may be seized by the IRS such as accounts receivables, bank accounts, merchant processor payments, or stock (This is not a comprehensive list of levy sources, but some that are most common and relevant for lenders).
Understanding what can be levied is valuable when viewing the assets of the business in the underwriting stage of the deal. If a prospect has a significant tax issues with numerous financial assets at risk of levy, then your exposure is likely to be increased and should be managed accordingly.
However, understanding what assets are at risk is only part of the risk mitigation picture. In part 2 of the series, we’ll focus on the IRS levy process so you know when the assets are at risk and how to proactively manage your credit risks.
April 15 was the tax day deadline for most people. If you are due a refund there is no penalty if you file a late tax return. But if you owe tax, and you failed to file and pay on time, you will typically owe interest and penalties on the tax you pay late. You should file your tax return and pay the tax as soon as possible to stop them.
Tax Guard hopes that the following eight facts about IRS penalties helps bring some clarity around how these penalties are determined and computed:
1. Two penalties may apply.
If you file your federal tax return late and owe tax with the return, two penalties may apply. The first is a failure-to-file penalty for late filing. The second is a failure-to-pay penalty for paying late.
2. Penalty for late filing.
The failure-to-file penalty is normally 5 percent of the unpaid taxes for each month or part of a month that a tax return is late. It will not exceed 25 percent of your unpaid taxes.
3. Minimum late filing penalty.
If you file your return more than 60 days after the due date or extended due date, the minimum penalty for late filing is the smaller of $135 or 100 percent of the unpaid tax.
4. Penalty for late payment.
The failure-to-pay penalty is generally 0.5 percent per month of your unpaid taxes. It applies for each month or part of a month your taxes remain unpaid and starts accruing the day after taxes are due. It can build up to as much as 25 percent of your unpaid taxes.
5. Combined penalty per month.
If the failure-to-file penalty and the failure-to-pay penalty both apply in any month, the maximum amount charged for those two penalties that month is 5 percent.
6. File even if you can’t pay.
In most cases, the failure-to-file penalty is 10 times more than the failure-to-pay penalty. So if you can’t pay in full, you should file your tax return and pay as much as you can.
7. Late payment penalty may not apply.
If you requested an extension of time to file your income tax return by the tax due date and paid at least 90 percent of the taxes you owe, you may not face a failure-to-pay penalty. However, you must pay the remaining balance by the extended due date. You will owe interest on any taxes you pay after the April 15 due date.
8. No penalty if reasonable cause.
You will not have to pay a failure-to-file or failure-to-pay penalty if you can show reasonable cause for not filing or paying on time. There is also penalty relief available for repayment of excess advance payments of the premium tax credit for 2014.
If you have any questions about how IRS tax penalties work or how they can affect your borrowers, please contact us.
This article was originally published in Commercial Factor and focuses on important trends at the IRS. Knowing these trends you are able to be more proactive with the IRS.
A leg is perceived to be a “pillar.” An ear is a “fan.” The elephant’s back is a “cliff” and so on. It is not until one mouse puts all of the pieces together that the mice discover they have actually encountered an elephant. There are a number of significant trends at the IRS. When each is considered separately, it might seem inconsequential. However, when the trends are taken into account as a whole, they could have tremendous consequences for lenders as well as their clients with federal tax liabilities. There are two general patterns. First, delinquencies are increasing, but the IRS is filing fewer federal tax liens. Second, additional and deep budget cuts are negatively impacting customer service (fewer employees with much less training). As such, future interactions with the IRS will likely be more difficult. Because of these trends, it is more important than ever to be vigilant and proactive when dealing with the IRS.
Delinquencies Increasing/ Liens Decreasing. The number of taxpayers who owe money to the IRS – businesses and individuals with delinquencies or liabilities (money owed to the IRS after the return was filed) – is increasing. The figure rose from 10,391,000 in 2010 to 11,721,000 in 2013, a 13 percent increase (IRS Data Books).
One might assume that if delinquencies are increasing, the number of federal tax liens filed should increase as well. Well, you know what they say about assumptions. From 2010 to 2014, there was a 51 percent reduction in the number of liens filed – from 1,096,376 in 2010 to 535,580 in 2014 (2014 Taxpayer Advocate Annual Report to Congress, January 2015).
The majority of the decrease can be attributed to the IRS’s “Fresh Start” program, which was implemented in 2011 and 2012 and modified thresholds (dollar amounts) for lien filings. The National Taxpayer Advocate argued in favor of the program, contending that liens interfere with taxpayers’ ability to obtain loans. The logic is that fewer liens allow for more loans, which increases collection. Generally, there are two entities responsible for Collections with the IRS – the Automated Collection System (ACS) and the field (Revenue Officers). Since 2011, ACS is sending more accounts to the “Queue” awaiting assignment to a Revenue Officer without first making a lien determination. As of September 30, 2014, there were 3,097,401 “collectable” delinquent accounts valued at $57.7 billion sitting in the “Queue” delinquencies. However, the IRS is simultaneously filing fewer federal tax liens and taking longer to do it. As such, it is harder for a lender to uncover a federal tax liability through a public record search when the IRS is waiting longer to file a fewer number of federal tax liens.
Make no mistake – if the liability is large enough to be assigned to a Revenue Officer, the Revenue Officer will likely file the federal tax lien at some point. However, because (a) ACS is filing fewer federal tax liens, (b) the lien determination is increasingly being left up to Revenue Officers, and (c) it is taking longer for Revenue Officers to be assigned to cases, lenders cannot rely on public record searches to identify problems with the IRS.
The utilization of public record searches to identify clients’ federal tax liabilities and manage risk is a flawed methodology. The risk is created when the taxpayer client files a return without payment, not when the federal tax lien is filed. When the IRS files a federal tax lien is unpredictable. By the time the lien is filed, there is little, if any, time to resolve the issue before the lender loses its priority secured position.
Additionally, the IRS does not have to file a federal tax lien prior to levying bank accounts or receivables, which can threaten the existence of lenders’ clients and tie up lenders’ monies. The lender can appeal to the IRS based on “wrongful” levy provisions, but the process is time consuming and arduous. It is much easier to simply avoid liens and levies in the first place.
The solution to this shifting of risk is to (a) routinely monitor the taxpayer client for compliance and (b) obtain information directly from the IRS. Routine monitoring allows lenders to uncover federal tax liabilities in real time at the point of accrual, months before a federal tax lien is filed. The additional time is crucial to identify liabilities before they balloon out of control and can be addressed in a timely manner.
Budget Cuts. The IRS’s 2015 budget is $10.9 billion, which represents a 10 percent reduction from 2010 when the budget was $12.1 billion. With inflation considered, the 2015 budget is actually comparable to the 1998 budget. However, the IRS will process 30 million more business and individual returns than it did 17 years ago. In short, the workload is much greater (not to mention implementation of aspects of the Affordable Care Act, which is a separate discussion), but resources are fewer. Something has to give.
Customer Service. The impacts of the declining IRS budgets over the past few years are scary relative to personnel and training. Per the Government Accountability Office, approximately 75 percent of the IRS budget goes to personnel. As such, budget cuts have led to a commensurate decrease in personnel. In 2014, the IRS had about 10,400 (11 percent) fewer employees than in 2010.
Moreover, for every five people who leave due to attrition, the IRS has only hired one replacement (IRS Oversight Board, Special Report from May 2014). This attrition has disproportionately affected the divisions directly involved in enforcing tax laws or providing taxpayer services. From 2010 to 2013, approximately 39 percent of ACS’s workforce and 21 percent of Revenue Officers were lost due to attrition or reassignment (TIGTA Report, November 4, 2014).
The IRS has had to get “creative” when reducing expenses as it is reluctant to terminate employees other than through attrition. As such, the IRS has cut costs in other areas, the most concerning of which is training. From 2010 to 2013, the IRS reduced its training budget by 87 percent, from about $172 million to about $22 million (IRS Oversight Board, Special Report from May 2014). Anyone who has spoken with a representative from the IRS has likely been frustrated by the experience. Additional cuts in training will only make that situation worse in the near future (assuming they answer the call).
Consequences of Budget Cuts. Lenders’ clients with IRS liabilities are going to be working with an understaffed and undertrained IRS workforce. Decreased levels of customer service – unanswered phone calls, delays in processing requests, incorrect information – will make it especially difficult for taxpayers to resolve their issues with the IRS in a timely fashion.
The vast majority of Revenue Officers and Advisors are good people with difficult jobs, who genuinely want to resolve these issues. However, the inability to hire new Revenue Officers and Advisors will stretch the existing staff further, resulting in significant delays in processing Installment Agreements and subordinations of federal tax lien (Agreements and Subordinations, respectively).
Lenders will be adversely affected as well. Once a federal tax lien is filed, the lender has 45 days (at most, depending on the lender’s threshold for risk) to resolve the issue and preserve its priority lien position through an Agreement and Subordination. Every situation is different and there are exceptions to every rule, but it is already difficult to fit negotiations for an Agreement and Subordination into 45 days. Because of existing staffing issues with Advisory offices across the country, Subordinations alone typically take 30 to 45 days to obtain.
If a lender waits until the federal tax lien is filed to begin negotiations for an Agreement and Subordination, the 45 days may come and go with proposals and/or applications stuck on desks with partial or no review. Without an Agreement and Subordination from the IRS, the lender will have to cease funding and lose a client; the client will likely cease operations.
There is a two-part solution to the delays and customer services issues within the IRS – (1) be proactive and (2) ensure the client is working with a representative who understands how the IRS works and also understands the specific needs of the lender. If a lender regularly monitors compliance with the IRS, a federal tax liability will be uncovered well before a federal tax lien is filed. Once the issue is identified, it can be proactively resolved prior to the filing of a federal tax lien. It is much easier to prevent or delay the filing of a federal tax lien than to try to cram months of work into a few weeks. Moreover, because of the backlog, delays, and the IRS’s lack of understanding of the lenders’ concerns, it is imperative that the lenders’ client work with an experienced representative who can navigate the resolution process while ensuring that the lender maintains a priority secured position.
The IRS is not the 800-pound gorilla in the room; it is the six-ton elephant (my apologies for mixing metaphors). It may take some time for the elephant to get up to speed, but once it does it can crush a lender’s client (maybe even the lender) like a grape. However, if the lender monitors its client’s compliance with the IRS and proactively addresses issues as they arise, the lender can recognize the elephant for what it is and deftly avoid getting hurt.
Jason S. Peckham, Esq., is vice president of Resolutions for Tax Guard, Inc. Tax Guard monitors federal tax compliance, identifies risks before federal tax liens are filed and resolves federal and state tax liabilities. He can be reached at jpeckham@tax-guard.com or 303-953-6325.
If you’re a lender trying to determine whether or not a borrower has an outstanding tax liability to the IRS, you likely search public records to detect if any federal tax liens have been filed. Unfortunately, you could be missing out on a large part of the picture needed to accurately measure your true credit risk. The facts remain, there’s important information you are NOT getting with a public records search for IRS tax liens.
Here’s our Top 5 Things a Public Records Search Won’t Tell Commercial Lenders (and what you can do to get the missing information):
1. IRS Levy Risk
We’ve discussed the pitfalls of a public records search that misses a recorded tax lien, a concern we’ll set aside just long enough to say emphatically that the presence or absence of a tax lien does nothing to alert a lender as to a client’s actual risk of levy. Remember, the IRS can, and frequently does, take levy action without ever filing a lien. What is necessary to gauge levy risk is to determine whether the IRS has issued a Final Notice of Intent to Levy. The issuance of this notice is never a matter of public record, and requires contact directly with the IRS, on a case-by-case basis, to detect. This is something that a public records search can never provide.
2. The Existence (or current balance) of an IRS Tax Liability
We’ve beat the drum on the lien issue before, and we’ll give it another refrain here-a lien can only reflect the information the IRS elected to put on it (rarely a full record of account) at a particular moment in time. Its data is frozen in a time capsule, and is never updated to reflect changes in the balances reported. The balance may be several times what you see on the lien, or the balance may not actually exist any more. To read more on these pitfalls in practice, see the hypothetical scenarios presented below.
3. The Real-Time Status of the Account With the IRS.
All tax debtors are not created equal, and finding a tax lien via public records search doesn’t inform a lender as to the nuances of that borrower’s tax liability status which is vital in order to ascertain lending risk.
Consider, for example, the following scenario- a public records search on Borrowers A, B, and C turns up a tax lien on each business for $250,000. A lending decision based on this $250,000 lien information alone could be short-sighted. Consider that a review of each case with the IRS actually reveals the following variations in credit risk:
- Borrower A accrued a $250,000 balance two years ago. The business has been current with all deposit and filing obligations since that time, and is on an Installment Agreement which is in good standing with a remaining balance due of only $15,000. In addition, the case is no longer assigned to the collections system, and the IRS has never issued a Final Notice of Intent to Levy.
- Borrower B accrued $250,000 last year from one bad quarter. Since then the business has been current with all filings and deposits, and now owes a balance of $300,000 with penalties and interest accruals. The case is been assigned to a Revenue Officer, who is actively attempting to collect the debt from the business.
- Borrower C accrued $250,000 over the course of last year, is not current with filings and deposits, has no Installment Agreement in place, and really owes a balance of $2 million. The case is assigned to an aggressive Revenue Officer, who filed a lien on the other $1,750,000 yesterday, which is why your public records search didn’t catch it. The Revenue Officer also filed a Final Notice of Intent to Levy 45 days ago, so the borrower is exposed to imminent levy action which could attach to the lender’s collateral.
- Due to the business’ ongoing non-compliance they’re not eligible for a subordination of tax lien which, in addition to their risk of a tax levy and less-than attractive credit worthiness, will likely result in no funding. This is a potentially high risk situation, that many lenders would stay from unless the business could significantly turn around its IRS non-compliance.
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 5.11.2.2.2(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.