By: The Attorneys of Tenenbaum Law, P.C.
Tax problems can come up in unexpected ways and be an unwelcome surprise at a closing, or even many years later as a consequence of a real estate purchase. This article originally was intended to focus on the latter issue, specifically how the purchase of a home in New York State or New York City, or moving out of New York State while keeping a place in the state or the city, can lead to unforeseen income tax assessments based on domicile or statutory residency. It appears, however, that publication of new nonresident audit guidelines may be imminent and may have already been issued by New York State by the time this article is in print. Therefore, residency matters will be addressed on a separate occasion, and the present article will look at the IRS and NYS tax liens that can encumber real property, and possible ways to resolve these issues, so that a real estate closing or a refinancing can proceed.
An IRS lien arises when a taxpayer neglects or refuses to pay any tax, after demand, including any penalties and interest on that tax (IRC Sec. 6321). The lien is on all real or personal property and rights to property of the taxpayer. Known as a “silent lien” or “statutory lien,” the lien may be effective even though not filed. Due to limited space this article will not address the numerous potential issues associated with lien priorities in varied situations and against assorted creditors (see e.g. IRM 5.17.2).
Nevertheless, in general an IRS Notice of Federal Tax Lien must be filed in order to establish priority with respect to other filed liens. In New York State, the IRS files the notice of lien with the county clerk for the county in which the real property is situated, and for personal property, in the county of the residence of the taxpayer at the time the notice of lien is filed (see IRC Sec. 6323(f)).
Even a filed lien may not have priority against certain interests, known as “superpriorities.” These may include real property taxes and charges for public utilities. Thus, at a real estate closing, the IRS usually permits property taxes to be paid before federal tax liabilities are satisfied. Superpriorities may also permit transfers of securities, motor vehicles, and personal property bought at retail, among others. IRC Sec. 6323 (b).
An IRS lien remains in effect until the assessment is fully paid, or the lien is no longer legally enforceable, for example, as a result of the statute of limitations.
In New York State, the Department of Taxation and Finance may file warrants on unpaid assessments of tax, interest and penalties. The State’s policy is to file warrants as soon as feasible, so as to protect its interests. Upon request, the State may refrain from filing the warrant if full payment is coming soon.
A NYS warrant is a public record, and creates a lien against real and personal property of the taxpayer from the date it is docketed. The length of time the State has in which to file a warrant following an assessment varies with the type of tax involved. A NYS tax warrant is generally enforceable for ten years against real property, and twenty years against personal property. Any voluntary or involuntary payment by the taxpayer on a warrant (other than through application of a refund) is considered by the State as an acknowledgment of the debt, sufficient to start anew a twenty-year collection period.
If the IRS liabilities are old, the practitioner may wish to confirm that the liens are still in effect. Generally, the IRS can collect against assessed liabilities for ten years from the date of assessment. In rare instances the IRS may reduce its liens to judgment, thereby extending the time for collection. The statute of limitations also can be extended by various actions, such as filing an Offer in Compromise, bankruptcy, or filing a Collection Due Process request.
Sometimes the easiest way to resolve an IRS lien is to pay the balance due and request that the lien be released. The face amount of the lien, however, is not a reliable indicator of the payment needed. Accrued interest and penalties can increase a liability considerably; also, payment may have been made on the liability. The IRS will supply a payoff letter on request.
New York State will also provide a payoff letter if needed. As with the IRS, it is impossible to tell the current balance due by looking at the amount of the warrant.
The ideal situation is not to have a lien filed at all. The policy of the IRS is to file a Notice of Federal Tax Lien within ten days of requesting payment, however, it may be possible to avoid this in certain very limited situations. If necessary, the taxpayer can formally protest in advance of the filing through the Collection Appeal Program, known as a CAP. This administrative remedy requires the taxpayer to try to work it out with an IRS representative and his manager; if this is not successful, he has two business days to appeal, preferably by submitting a Form 9423 “Collection Appeal Request” (available on the www.irs.gov website). The case will be assigned to a Settlement Officer who, pursuant to IRS policy, should resolve the matter within five days. There are no appeal rights from a determination on a CAP.
If the Notice of Federal Tax Lien is filed, the taxpayer must be provided with a copy no more than five business days after the filing. The notice gives the taxpayer statutory rights to appeal through a Request for a Collection Due Process Hearing (“CDP”), using Form 12153. The request must be made within thirty days after the day of the filing of the notice of lien, plus the five business days mentioned (IRC Sec. 6320). Filing a CDP places an automatic hold on collection for the tax period involved. The CDP also provides the taxpayer with an opportunity to negotiate other resolutions, even if the lien stays in place. If the taxpayer disagrees with the Settlement Officer’s determination, the taxpayer can appeal to Tax Court.
A taxpayer who missed the thirty-day window for filing a CDP request may still get a chance to be heard, by filing a request for an equivalent hearing. This also can be submitted on Form 12153, within one year of the filing of the Notice of Federal Tax Lien. An equivalent hearing determination cannot be appealed.
Where the goal is to obtain a mortgage or to refinance, the taxpayer can request that the IRS subordinate its liens to those of the proposed lender. If the taxpayer otherwise qualifies for a CDP hearing or an equivalent hearing, Form 12153 specifically provides an opportunity to request a subordination.
More often, the liens have been filed for some time and have become a difficult issue due to the proposed real estate closing or refinancing; and those avenues for appeals are no longer available. In such cases, the subordination request can be made directly to the appropriate technical services unit at the IRS.
In December, 2008, the IRS Commissioner explicitly stated that due to the difficult economic times, the IRS was seeking to make it easier and faster for a homeowner to obtain the necessary subordinations (Press release IR-2008-141, 12/16/08). Resources were being redirected to permit a quicker turnaround time for responses, with a goal of an answer within thirty days.
There is no form for applying for a certificate of subordination. The request must identify the property clearly, provide detailed information about the liens to be subordinated or provide copies of the Notice of Federal Tax Lien, describe the interest that would take priority over the IRS lien and any other relevant encumbrances on the property, among other information (IRS Pub. 784).
Crucially, the subordination request must show adequate grounds for the IRS to grant the subordination. The Internal Revenue Code provides only two justifications for subordination for most taxes (IRC Sec. 6325(d)). The taxpayer may pay the IRS an amount equivalent to the amount of the lien being subordinated. Alternatively, the taxpayer must show that the IRS will ultimately realize more from the property being subordinated, and it will be easier for the IRS to collect the tax liabilities due, if the subordination is issued. Often the IRS interprets this to require that any net proceeds from a refinancing be paid to the IRS, as a condition of the refinancing. There are guidelines for certain situations, such as the new rules for subordination of accounts receivable (“Interim Guidance for Subordinations to Factors,” 11/20/2008, updating IRM 188.8.131.52).
If the property is being sold to a third party, it may be necessary to obtain a discharge of the liens. This is not the same as a release, as the liens remain in full force and effect against the taxpayer, however, they are discharged as against the real property concerned. As with a subordination request, the taxpayer can apply with a CDP or equivalent hearing request or, if it has been more than a year since the liens were filed, with a letter to the appropriate IRS technical services unit.
The application of the statute regarding a discharge highlights the difficulties inherent in addressing the competing considerations of protecting the interest of the IRS while permitting the transfer of property necessary to the continued smooth operation of our society. There are several statutory grounds on which the IRS may grant a discharge (IRC Sec. 6325(b)). These include that the IRS will grant a discharge if it can be shown that the interest of the IRS is valueless. For example, if the real property is encumbered by a mortgage that has priority over the IRS lien, and the amount of the mortgage is equal to or exceeds the fair market value of the property (not uncommon in these economic times) there would be no value to the IRS interest and a discharge may be granted. Also, if the taxpayer has sufficient equity in other assets subject to the IRS lien, or can substitute other assets, the IRS will consider a discharge.
If the technical services unit denies a request for a certificate of subordination or discharge, the taxpayer has an administrative right to appeal the decision with a Collection Appeals Program request, Form 9423 (IRM 184.108.40.206).
New York State also provides for subordinations or discharges of tax warrants. The State may permit a subordination of the warrant if it can be shown that the State’s position is enhanced by issuing the subordination. For example, if a refinancing would result in a significant payment to the State from the net proceeds of the subordination, the State may consider issuing the subordination. For a discharge, as with the IRS, one consideration is whether the taxpayer has other property of sufficient value to protect the State’s interests.
As all of the above indicates, IRS and NYS tax liabilities do not have to get in the way of a smooth closing, and in fact the closing may be an opportunity to resolve long outstanding tax problems.
All IRC references are to the U. S. Internal Revenue Code of 1986, as amended. All IRM references are to the Internal Revenue Manual, available at www.irs.gov.