ALERT: Tax September 2006 the Internal Revenue Service reaffirmed that there is no defense to a federal tax levy served on a party with an interest in the property superior to the federal tax lien, or a right of setoff against the taxpayer. Banks and anyone else served with a federal tax levy should be aware of a recent tax ruling. In Revenue Ruling 2006-42, 2006-35 IRB 337 (August 24, 2006), the Internal Revenue Service ( IRS ) reaffirmed that there is no defense to a federal tax levy served on a party with either an interest in the property superior to the federal tax lien, or a right of setoff against the taxpayer. Even in these circumstances, the property subject to the levy must be turned over to the IRS, although the levied party may bring an action for wrongful levy, which in general must be filed within nine months after the date of the levy. The only two defenses to the levy are (1) the party that is levied is neither in possession of nor obligated with respect to the taxpayer s property or rights to property, or (2) the taxpayer s property is subject to a prior judicial attachment or execution. If neither of these two exceptions is met, the property must be turned over. Failure to do so subjects the levied party to personal liability and a 50% penalty if failure to comply is not due to reasonable cause. The ruling made this determination because the purpose of the levy is to protect the government s interest in collecting taxes, and does not provide a forum to determine lien priority. That occurs in a suit for wrongful levy. However, the ruling states that a party served with a notice of levy acts prudently when it contacts the IRS in a timely manner to resolve its dispute informally. Accordingly, parties served with a federal tax levy should ascertain whether they need to comply with the levy based on the limited exceptions. If they believe their position is superior to the IRS s, they should contact the IRS to attempt to resolve the dispute, which may result in the IRS s release of the levy, but they should not let the jurisdictional nine-month period to file a wrongful levy action pass while this occurs. The ruling addressed two sets of facts. In the first scenario, the taxpayer has a bank account at Bank A. On January 5, 2004, the IRS filed a notice of federal tax lien against the taxpayer. On April 1, 2004, the bank GREENBERG TRAURIG, LLP ATTORNEYS AT LAW WWW.GTLAW.COM
loaned the taxpayer $50,000 and perfected its security interest in the account under the Uniform Commercial Code. The bank acted without actual notice or knowledge of the existence of the federal tax lien. On June 1, the IRS served a notice of levy on the bank in the amount of $100,0000. At the time, there was $15,000 in the taxpayer s account. After receiving the notice of levy, the bank made a demand for full payment of the loan, and when it received nothing, set off all of the taxpayer s account against the taxpayer s liability for the loan, which was permitted under local law. The bank sent no funds to the IRS. On July 1, the bank contacted the IRS and established that it met the requirements of a superpriority interest under Internal Revenue Code ( Code ) section 6323(b)(10) 1. The ruling notes that there are only two defenses to an action brought by the United States to enforce a levy. In the second scenario, the facts are the same except that the bank did not prove its superpriority interest and on May 1, 2005, the United States filed suit against the bank to enforce the levy. 2 No suit for wrongful levy was filed within nine months, and no administrative request was made, which would extend this nine-month period. The ruling holds that the federal tax levy (like the federal tax lien 3 ) reaches all property and rights to property of the taxpayer. The levy does not determine whether the government s claim is superior to other parties. Rather, levy authority is designed to enable the government promptly to secure its revenues while competing claims are resolved. Rev. Rul. 2006-42, quoting United States v. National Bank of Commerce, 472 U.S. 713, 721 (1985). The ruling notes that there are only two defenses to an action brought by the United States to enforce a levy. The first is where the party upon whom the levy is served is neither in possession of nor obligated with respect to the taxpayer s property or rights to property. Unless the levy is specifically directed to salary or wages (in which it has an ongoing effect), a federal tax levy reaches only property or rights to property of the taxpayer in the possession of the party when the notice of levy is served. If that party later comes into possession of such property, that property is not subject to the levy. The second exception is where the taxpayer s property is subject to prior judicial attachment or execution. Accordingly, the right of setoff does not relieve the bank from the obligation to honor the levy, because the setoff was exercised after the levy was served. At the moment that notice of the levy was served, the bank owed a debt to the taxpayer in the amount of the bank account which the notice of levy seized. The ruling concludes that neither the Page 2
right of setoff nor the bank s priority over the IRS relieve the bank of its obligation to honor the levy. This ruling reiterates the conclusion of statutory and judicial law that there are limited exceptions to the obligation to honor a federal tax levy. However, the ruling went on state that the bank prudently contacted the Service in a timely manner to resolve its dispute informally. In this situation, Bank A was able to provides its section 6323(b)(10) priority claim to the Service. In the exercise of its administrative discretion, the Service may release a levy when a bank proves superpriority interest under section 6323(b)(10). Since it would serve no purpose to require Bank A to surrender T s [taxpayer s] funds to the Service when Bank A and the Service agree that Bank A has a priority interest under section 6323(b)(10), the Service will generally release the levy. If Bank A had not contacted the Service informally, it could have timely filed a wrongful levy suit in federal district court pursuant to [Code] section 7426(a)(1). With respect to the second scenario, the ruling held that the bank had no defense to the levy for the reasons discussed with respect to the first scenario. It failed either to contact the IRS to pursue an informal resolution or to timely file a wrongful levy suit to challenge the levy. Bank A s failure to act in a timely manner has left it in a position where it cannot assert its superpriority claim, as a court does not have jurisdiction to hear an untimely wrongful levy suit. E.g., LaBonte v. United States, 233 F.3d 1049, 1051 (7th Cir. 2000). As explained in that case, the statute permitting an action for wrongful levy is a limited waiver of sovereign immunity and must be scrupulously adhered to. Because the plaintiff in that case waited more than nine months to bring the wrongful levy action and had improperly addressed the administrative request 4, the nine-month limitation did not apply and the court had no jurisdiction. A revenue ruling is the conclusion issued by the IRS as to how the tax law applies to a specific set of facts. It lacks the authority of a regulation, and is intended by the IRS to provide guidance to taxpayers, based on the facts presented in the ruling. 5 Although this ruling involves a bank, it provides guidance to any party served with a levy. This ruling reiterates the conclusion of statutory and judicial law that there are limited exceptions to the obligation to honor a federal tax levy. However, it evidences a receptiveness on the part of the IRS to working out issues with the party upon whom the levy is served that may result in the release of the levy. Finally, it reinforces the rule that a suit for wrongful levy is a suit against the sovereign, and may be brought only upon the explicit terms and conditions of the limited waiver of sovereign immunity. Any Page 3
deviation, however slight and seemingly innocuous, may prove fatal, as illustrated by LaBonte. While taxpayers and others are free to negotiate with the Service with respect to levy issues, they should do so while continuing always to adhere to statutory deadlines and other conditions. As the party in LaBonte learned after an expensive trip to the federal appellate court, addressing the administrative request to the Revenue Office rather than the District Director was ineffective to extend the deadline for filing a wrongful levy action. Once that deadline had passed, the District Court had no jurisdiction to consider the action for wrongful levy. 1 Upon non-payment of tax after demand, a federal tax lien arises on all property and rights to property of the taxpayer. Code 6321. A notice of federal tax lien must be filed in order to perfect the federal tax lien as to a purchaser, a holder of a security interest, a mechanic s lienor, or a judgment lien creditor. Code 6323(a). Code 6323(b) provides protection for certain interests even though a notice of federal tax lien has been filed, including a deposit-secured loan. Code 6323(b)(10). 2 Code 6532(c)(2) provides a limited exception to the nine-month time limit for bringing a wrongful levy action. If an administrative request is made for the return of property, the nine-month period is extended for a period of 12 months from the date of filing the request or for a period of six months from the date of mailing by registered or certified mail by the Secretary to the person making the request of a notice of disallowance of the part of the request to which the action relates, whichever is shorter. 3 Federal tax liens and levies are two different things. The levy is a collection device used to seize property and rights to property of the taxpayer, but does not determine the priority of the taxpayer s creditors. The federal tax lien determines the priority of the IRS and other creditors of the taxpayer, but is not a collection mechanism. 4 At the time of the LaBonte case, the administrative request had to be addressed to the district director (marked for the attention of the Chief, Special Procedures Staff of the Internal Revenue district in which the levy was made. 26 C.F.R. section 301.6343-2(b). This request was addressed to the Revenue Officer, Special Procedures/Advisory who was at the same address and shared the same fax number as the district director. It also contained a request that the district director grant a discharge from the lien. That was all for naught, however, because the Court ruled that because it was not addressed to the district director, it was invalid. Note that, since the reorganization of the IRS pursuant to the Internal Revenue Service Restructuring and Reform Act of 1998, there are no longer district directors. 5 The IRS states that Taxpayers generally may rely on revenue rulings and revenue procedures published in the [Internal Revenue] Bulletin in determining the tax treatment of their own transactions and need not request specific rulings applying the principles of a published ruling or revenue procedure to the facts of their specific cases. * * * Each revenue ruling represents the conclusion of the IRS as to the application of the law to the entire statement of facts involved. Therefore, taxpayers, IRS personnel, and others concerned are cautioned against reaching the same conclusion in other cases unless the facts and circumstances are substantially the same. Rev. Proc. 89-14, sections 7.01(5) and (6), 1989-1 CB 814. Revenue Rulings are not binding on a court. Some courts treat them as no more authoritative than the contention of any other litigant, but others give them deference because they were issued by the agency charged with administration of the tax statutes. Page 4
This Alert was written by David W. Bunning in the New York office. Please contact Mr. Bunning at 212.801.9200 or your Greenberg Traurig liaison if you have any questions regarding the subject matter of this GT Alert. Albany 518.689.1400 Amsterdam + 31 20 301 7300 Atlanta 678.553.2100 Boca Raton 561.955.7600 Boston 617.310.6000 Chicago 312.456.8400 Dallas 972.419.1250 Delaware 302.661.7000 Denver 303.572.6500 Fort Lauderdale 954.765.0500 Houston 713.374.3500 Las Vegas 702.792.3773 Los Angeles 310.586.7700 Miami 305.579.0500 New Jersey 973.360.7900 New York 212.801.9200 Orange County 714.708.6500 Orlando 407.420.1000 Philadelphia 215.988.7800 Phoenix 602.445.8000 Sacramento 916.442.1111 Silicon Valley 650.328.8500 Tallahassee 850.222.6891 Tampa 813.318.5700 Tokyo + 81 3 3264 0671 Tysons Corner 703.749.1300 Washington, D.C. 202.331.3100 West Palm Beach 561.650.7900 Zurich + 41 1 364 26 00 This Greenberg Traurig ALERT is issued for informational purposes only and is not intended to be construed or used as general legal advice. The hiring of a lawyer is an important decision. Before you decide, ask for written information about the lawyer s legal qualifications and experience. Greenberg Traurig is a trade name of Greenberg Traurig, LLP and Greenberg Traurig, P.A. 2006 Greenberg Traurig, LLP. All rights reserved. Page 5