The tax attorneys at Nardone Law Group in Columbus, Ohio, routinely advise taxpayers who have been contacted by a revenue officer with the Internal Revenue Service. If a taxpayer neglects to make a payment on a federal tax liability, the IRS has substantial authority to file a Notice of Federal Tax Lien against the taxpayer’s assets, which can cause the taxpayer significant financial problems. In our previous article, Discharging Property from a Notice of Federal Tax Lien, we focused on the option of discharging property as one of the solutions available to help taxpayers resolve a Notice of Federal Tax Lien.
In this article, we focus on another option for obtaining relief from a Notice of Federal Tax Lien: Subordination. In some situations, the IRS will agree to subordinate a Federal Tax Lien to the rights of other creditors. Essentially, the IRS allows certain other creditors to move ahead in priority of its Federal Tax Lien interest in the taxpayer’s assets. This may enable a taxpayer to obtain a loan or mortgage that a lender would have otherwise refused to extend because of the Federal Tax Lien. Subordination is designed to facilitate the collection of delinquent tax liabilities by providing more flexible procedures for the taxpayer. It is important to understand, however, that subordination does not remove the Federal Tax Lien from the taxpayer’s property.
A recent case dealt with the issue of Notices of Federal Tax Lien and whether those liens take priority over a bank security interest. The full court opinion can be found here: Susquehanna Bank v. U.S. This case demonstrates the IRS’ ability to issue tax liens and how the courts determine who has priority when there are competing interests in a taxpayer’s assets.
Which Has Priority: The IRS or a Bank?
In Susquehanna Bank v. U.S., the U.S. Court of Appeals for the Fourth Circuit held that a bank security interest created by a deed of trust, which was executed before the IRS filed its Notice of Federal Tax Lien, but was recorded thereafter, took priority over the IRS’ tax lien. The Court of Appeals affirmed the district court’s finding that the deed of trust gave the bank an equitable security interest on the date of execution, thereby taking priority over the lien.
The taxpayer, owner of an auto body shop, failed to pay employment taxes over several quarters, from 2002 to 2004. The IRS issued notice and demand for payment of $62,438.99 in taxes, interest, and penalties, which gave rise to a tax lien on all property owned by the taxpayer. On January 10, 2005, the IRS filed Notice of Federal Tax Lien for the relevant quarters of unpaid taxes.
On January 4, 2005, six days before the IRS filed Notice of Federal Tax Lien, the taxpayer borrowed $1 million from Susquehanna Bank, securing repayment of the loan by executing and delivering to the Bank a deed of trust with respect to two parcels of real property. The deed of trust was not recorded, however, until February 11, 2005, more than a month after the IRS filed the notice. When the taxpayer filed for Chapter 11 bankruptcy protection in April 2011, Susquehanna Bank commenced an adversary proceeding against the IRS, seeking a declaratory judgment, to decide which entity had priority over the secured interest: the Bank or the IRS.
The court ultimately held that, under the common law doctrine of equitable conversion, Susquehanna Bank received a protected equitable security interest in taxpayer’s property when the deed of trust was executed in exchange for the $1 million loan on January 4, regardless of recordation.
NLG Comment: As demonstrated in Susquehanna, disputes can arise regarding which entity has priority over an interest, when a taxpayer has existing tax liabilities with the IRS and other unresolved debts. This case presents a prime example of a dispute that could have been resolved through subordination; however, the IRS clearly believed that it was owed priority over the interest. The court’s ruling, in favor of the Bank, essentially forced the IRS to subordinate its Federal Tax Lien to the rights of the bank.
Contact Nardone Law Group
Nardone Law Group represents individuals and businesses in federal tax issues, including resolving a Notice of Federal Tax Lien. If you have been contacted by an IRS revenue officer, or have been subjected to a Federal Tax Lien, contact one of our experienced tax lawyers today. Nardone Law Group’s tax attorneys and professional staff have vast experience representing clients before the IRS. If you are subject to a Federal Tax Lien, we will thoroughly review your case to determine what options and alternatives are available, including subordination.