Spring 2005 • Issue 17, page 8

Can the Court Insulate a Receiver from Tax Related Responsibility and Does a Fed Tax Lien Always Trump a State Tax Lien?

By Rosen, Charles*

Let’s answer a few tax questions that have come my way concerning receivership tax issues.

Q: A receiver seeks and obtains an order from the court stating that the receiver does not have to prepare corporate income tax returns because of the absence of or inadequacy of corporate books and records. The receiver gives the IRS notice of the motion and the government does not object. Is the order binding on the IRS? Will the IRS do anything about it?

A: In most instances neither a state nor a federal court will have valid jurisdictional authority to grant such an order. This is true even if the IRS has taken an active part in the court proceedings for other tax issues. It is quite common for courts to grant receivers (and bankruptcy trustees) such “comfort” orders, but they likely provide no legal protection for the receiver. As a practical matter, if the receiver has noticed the motion to the IRS and subsequently receives the requested court order, nothing is likely to happen to the receiver. In those few reported cases where a receiver (or bankruptcy trustee, for that matter) failed to file returns or pay tax due, the IRS only pursued those receivers (or trustees) who had shown gross negligence in not doing that which was expected of a reasonable and prudent receiver. In most cases where the government has reacted, the government is normally pursuing the matter knowing recovery will come, if at all, from the receiver or trustee’s bond. But there is no guarantee about what the government will do.

Q: Both the state and the IRS have liens filed against a company for non-payment of taxes. Does the IRS lien take precedence over the state tax lien for distribution purposes?

A: There is no simple answer to this question. First, it is necessary to determine the nature of the property. Is it real property or an interest in real property such as a long-term lease? Or is it in the nature of tangible or intangible personal property? Second, where were the state and IRS liens filed? Proper venue or improper venue? Third, if both taxing agencies have liens filed in the proper venue, who filed first? If the liens were properly filed, the general rule is ‘first in time, first in right’. Thus the first agency to record its lien will win.

However, because of games the State of California was playing MANY years ago in attempts to technically ‘perfect’ its tax liens ahead of the IRS and because of two Ninth Circuit Court decisions and one California Supreme Court decision, the state repeatedly lost on this issue. The IRS and all three California taxing agencies (FTB, EDD and SBE) subsequently entered into a written agreement — curiously an agreement signed by no one — that states that if there is no intervening perfected lien creditor between the recorded state and IRS liens, that the taxing agencies will compare their individual tax period unrecorded assessment lien dates to determine how to apportion the financial pie. Most of the world is unaware of this agreement, and sleeps better at night for it.

Just as important as whether an IRS lien was filed is where the tax lien was filed. Under the Internal Revenue Code and because California has adopted the Federal Lien Registration Act (CCP 2100 et seq.), an IRS lien on real property is required to be filed in the county where the property is located, as one might expect. However, with respect to other than real property, the lien is perfected by filing with the California Secretary of State if the taxpayer was a corporation, partnership or trust; and if the taxpayer is an individual it is to be filed with the county where the taxpayer resided - or was last known to reside - at the time the lien was recorded.

A properly recorded IRS lien is perfected as to all personal property of a taxpayer no matter where the personal property is located. Thus if a receiver is selling the business of an individual and the business and individual are in California, but an IRS lien was filed in Florida at a time when the taxpayer resided in Florida, the IRS lien would prevail over a state tax lien that was filed later in California. Likewise, if the business assets being sold are those of a partnership or corporation, it may be necessary to determine if the taxpayer secured its charter from another state, whether it conducted business from the other state, and search public records in that state to see if IRS liens were filed there. As can be seen, the issue of what is the proper location for lien filing is fact driven..

The best advice is for the receiver to ask the necessary questions and then do the research required to determine where to search for liens. If a question of lien priority arises, the receiver should consult a tax attorney to avoid making a costly mistake.

Q: What are the special rules regarding Federal tax liens?

A: There are special rules for perfecting a lien — tax lien or otherwise — with respect to certain types of property. Thus whether a lien is properly perfected depends on whether it was filed with the proper office. For example: a lien against an aircraft must be filed with the FAA in Oklahoma City; a general or maritime lien against a documented vessel must be filed with the U.S. Coast Guard in the home port of the vessel; and a lien on copyrights and patents must be filed with the Library of Congress and the U.S. Patent Office. Under the Internal Revenue Code the IRS does not by law and policy file liens with these agencies, but it follows only a general scheme for filing liens set out in the code at 26 U.S.C. ‘ 6323(f).

Finally, if an individual dies leaving an estate and owes Federal Estate Tax, the lien is perfected immediately upon death and a notice of tax lien is not required to be filed anywhere in order to be perfected. This is true even though an estate tax return is not required to be filed until nine months after death and even if the amount cannot be determined until the return is filed (or until after an audit is conducted See 26 U.S.C. Section 6324). This is truly a potential trap for anyone buying property from a decedents estate.

*CHARLES F. ROSEN, ESQ. of the Law Offices of A. Lavar Taylor has substantial tax expertise involving receiverships and bankruptcy. Mr. Rosen served as a bankruptcy advisor for the Special Procedures Branch of the Internal Revenue Service for more than twenty years.