Do you have questions about how your perfected security interest will be affected by a federal tax lien? Are you at risk to losing priority in regard to after-acquired collateral in the event a federal tax lien is filed against your debtor? Attorney Bennett Cohen of Illinois law firm Cohen, Salk & Huvard, P.C., gets asked questions like this all the time, and has taken the time to write some answers regarding federal tax liens. You may also want to check out his eBook on Purchase Money Security Interests (PMSI).
Effect of Federal Tax Liens: Does the filing of a notice of federal tax lien against a borrower prime an existing lender’s prior perfected security interest in all of the borrower’s present and future assets?
Answer: No, not as to all of the assets, but a lender is at risk with regard to certain after-acquired collateral, as well as for certain future advances made to the borrower, as described below.
The basic priority rule is that a lender will have priority ahead of the IRS in collateral owned by its borrower on the date of the federal tax lien filing, if the lender’s security interest in such collateral is perfected prior to the date of the federal tax lien filing. Stated another way, by virtue of the tax lien filing, the IRS will gain priority in all of the borrower’s collateral acquired by the borrower after the federal tax lien filing. Important exceptions to this general priority rule are discussed below.
There are two twin 45-day rules that affect a lender’s security interest in after acquired accounts and inventory, as well as priority in the lender’s future advances made to the borrower, and these 45-day rules provide lenders with some limited protection against the IRS.
Under Section 6323(c) of the Federal Tax Lien Act of 1966 (“FTLA”), a lender’s security interest in the borrower’s accounts or inventory is superior to the federal tax lien as to any after-acquired accounts or inventory which come into existence within 45 days after the federal tax lien filing. Thus, lenders are at risk if they make an advance against accounts or inventory on or after the 46th day after the filing of a federal tax lien notice, unless the federal tax lien is paid and released or satisfactorily subordinated to the lender’s security interest.
Under Section 6323(d) of the FLTA, a lender is entitled to priority over the IRS as to future advances made by the lender until the earlier of:
- 45 days after the federal tax lien filing
- The lender’s actual knowledge of such filing. The IRS has the burden of showing that the lender had actual knowledge of the tax lien filing.
It should be noted that the lender’s protected future advances made prior to the earlier of 45 days after the federal tax lien filing or lender’s actual knowledge thereof will only be given priority in:
- collateral in existence on the date of the tax lien filing.
- accounts and inventory acquired by borrower within 45 days after the tax lien filing.
Thus, a lender’s protected future advances will not enable the lender to claim a security interest in other types of collateral acquired by the borrower within the 45-day period after the date of the federal tax lien, such as equipment, general intangibles or farm products. Many lenders only obtain an annual federal tax lien search on its borrowers. It may not be practical for lenders to obtain more frequent federal tax lien searches on all of its borrowers, but a case could be made that the expense of running more frequent federal tax lien searches on a lender’s higher risk borrowers may be less costly than being primed by the IRS on one or more loan transactions.