The Nightmare of Federal Tax Liens

When an IRS Lien Takes Precedence

Even though you’ve done your initial due diligence prior to approving a loan, if the IRS files a federal tax lien on your client it may take precedence. This means that you can have a perfected UCC filing and still lose your lien position to the IRS, putting you at risk of being unable to recover your investment. When can this happen and how can you protect yourself from the risk presented by federal tax liens?

For loans made before the IRS files a federal tax lien, the lender has priority. The difficulties arise if you make loans after the IRS files the federal tax lien on your client (for example, loans made in a revolving line of credit). As soon as the IRS files the tax lien, the clock starts on what is known as the 45-day rule.

What is the 45-day rule?

For loans made before the IRS filed the federal tax lien, the lender has priority. In situations where a federal tax lien is filed after a lender has entered into a security agreement with a borrower, the 45-day rule is used to determine who has priority. The 45-day period for this rule starts when the IRS files the lien. This means that whether you know about the federal tax lien or not, the clock is ticking! To make matters even more challenging, the IRS is not required to notify lenders about federal tax liens. It’s entirely up to you to find out about them and protect your interests.

Here’s how the 45-day rule works. If you don’t know about the federal tax lien you have 45 days from when it was filed. During this time, your loan has priority. After this 45-day period, whether you know about the federal tax lien or not, the IRS will have priority. If you know about the federal tax lien during the 45-day period and make an additional loan to your client, the IRS will have priority. This simplified chart breaks it down:

What can you do to minimize your risk?

You can make it a regular practice to search for federal tax liens. A word of caution – relying on online searches of databases for federal tax lien searches is risky. These databases often lag behind real-time data. If you rely solely on them, you may not find about liens before the end of the 45-day period. To avoid this, consider hiring a service provider to do manual searches at the state and county level. This way you can find tax liens before issuing credit that will be second in priority to the IRS.

How often you perform these searches will depend on your risk assessment. For high-risk situations, you may need to search every 30 days; for lower-risk situations, you may decide that every 60 days or once per quarter is sufficient.

A final question to consider is where these searches will need to be performed. Federal tax liens can be found at the state level in some jurisdictions; other jurisdictions only require the IRS to file them at the county level. Again, you may wish to consider using a service provider who is already familiar with these rules.