The IRS has a legal right to use unexpected means to collect the unpaid debt owed to them. All business have an obligation to pay their taxes to the IRS. Although, some businesses forget or simply chose not to pay their tax debt, in doing this, they expose themselves to financial risk. To protect a company’s finances and assets it is important to understand the difference between an IRS tax levy, tax lien and how it can affect a lenders ability to extend financing to their client.
What is a Tax Levy?
It is an IRS enforced collection. A levy allows seizure of a delinquent taxpayers assets to satisfy a tax debt, such as: bank accounts, accounts receivables, and physical assets. If there is a tax liability owed, and no payment plan in place, the IRS will determine if a levy is the next appropriate step. The IRS, however seizes a small amount of physical assets, for example, a car or boat as it is time and labor intensive, and with little collected for tax debt.
What is a Tax Lien?
A legal claim imposed on property to secure payment of taxes. The IRS will put your balance due on the books (assesses your liability), once this is done they will send you a bill that details how much you owe. This is known as the Notice of Demand for payment, if this is ignored or there is failure to pay, a Demand for Payment notice is sent. Within 10 days of receiving this, you must either pay your tax debt in full, or make arrangements with the IRS to pay it over time. If neither of these are done a lien is filled.
What You Should Know?
According to the U.S. Government Accountability office, only 40% of all unpaid payroll tax liabilities currently in the IRS’ portfolio have a tax lien filled against them. It is imperative as a lender to understand your clients or prospective client’s entire picture with the IRS. The IRS doesn’t perform a lien search before issuing a levy, therefore the IRS will have no idea that the assets they are about to levy are secured by another entity (i.e. the lender) Internal Revenue Code Sec. 6323(c) gives creditors limited priority over the federal tax lien to the extent that if a loan or purchase is made within 45 days of the filing of the NFTL (notice of federal tax lien) or before purchaser had actual knowledge of the filing, this is known as the “45 day rule”.
To get ahead of any potential problems related to the 45-day rule, you should be searching for federal tax liabilities, in addition to federal tax liens, before funding, you should also be monitoring for federal tax liabilities every 30 days while funding. If you discover that your client has an IRS liability, safeguard yourself and your client from lien or levies against the receivables or bank accounts with an installment agreement with the IRS. Per the Internal Revenue Code, they cannot levy assets while there is an installment agreement in place. However, if an agreement goes bad, lenders generally have 75 days to collect out.
Importantly, by itself, the installment agreement has no effect on the lien and the IRS’s secured interest still has priority. Therefore, once there is an agreement in place lenders should work to secure a subordination. The subordination is essential in providing additional protection to lenders by maintaining a priority secured position relative to the receivables. This protects the lender from IRS levy as well as exposure to a suit for tortious conversion of assets. Lastly, monitor your client’s ongoing compliance with the IRS to guarantee the installment agreement does not default and your UCC1 sustains priority position throughout the funding relationship.
The IRS allows taxpayers days, months or even years to settle the debt they owe to the Federal Government. When a business fails or chooses not to satisfy their debt, they may be subject to an IRS levy or lien. Businesses can avoid financial crisis and pay what you owe accordingly by learning the differences between both collection activities.