Best Practices: Dealing with Federal Tax Liens

When reviewing search results in connection with extending an SBA loan, lenders may come across a recorded Notice of Federal Tax Lien (NFTL) filed against a borrower or guarantor. Understanding the options for addressing a federal tax lien is important for credit underwriting and SBA compliance. A federal tax lien is created when a taxpayer fails to make a payment in full to the IRS when due. While a federal tax lien exists and attaches to the taxpayer’s property from the time the taxpayer fails to make payment, the federal tax lien obtains priority over other liens filed against a taxpayer, such as UCC-1 financing statements, when the NFTL is filed by the IRS in the public record. Typically, an NFTL must be refiled every ten years to maintain priority, but the underlying tax lien remains outstanding as long as the obligation remains due and owing to the IRS.

Where the IRS will file an NFTL depends on state law.  In most cases it is filed in the state and local records where the taxpayer is located or organized. A federal tax lien attaches to all current and future real and personal property owned by the taxpayer. As a general rule, a tax lien only encumbers property owned directly by the taxpayer. Therefore, a federal tax lien in the name of an individual taxpayer would not encumber business assets of a company owned by the individual taxpayer but would encumber the taxpayer’s ownership interest in the company. However, the IRS may attempt to “pierce the corporate veil” if the owner does not treat the company as a separate and distinct entity, but uses it for their personal benefit, or to fraudulently attempt to avoid liability. In addition, an SBA lender should take into consideration any tax liens filed against an owner of a small business loan applicant, which can negatively impact the credit risk of the small business.

The IRS provides a few options for addressing federal tax liens. The best option is to have the tax liability paid in full. The IRS says it will terminate a NFTL within thirty (30) days after receipt of payment in full of the tax obligation. The challenge with this option is that SBA loan proceeds may not be used to pay off delinquent taxes, except in very limited circumstances (see SOP 5010(6), page 163). Therefore, the SBA lender must consider the impact to the cash flow of the business if the taxpayer is using cash in order to obtain the release of the NFTL.

Alternatively, it may be possible to request a Certificate of Discharge to release the lien on a taxpayer’s specific property without paying off the entire tax liability. This is most often done in connection with the sale of certain property to a third party. If the taxpayer pays down the tax obligation equal to the amount of its net proceeds received from the sale, the IRS may issue a Certificate of Discharge for lien filed against that property.

Another option is to request that the IRS subordinate the lien of the NFTL. This is done through the issuance of a Certificate of Subordination by IRS.  The Certificate of Subordination may be granted under two circumstances: (i) a payment is made to the IRS in exchange for the subordination of the NFTL or (ii) IRS determines that the issuance of the Certificate of Subordination will increase the amount of taxes collected or make collection easier in the future. For an SBA lender, a Certificate of Subordination may be appropriate if the Borrower is current under a payment plan with the IRS, and the SBA lender is refinancing current debt to help the Borrower lower its monthly debt service.  A request for a Certificate of Subordination should be made at least 45 days before closing on new financing in order to ensure that the IRS has enough time to consider the request.

The final option is to request that the IRS withdraw the NFTL. A withdrawal may be awarded for a few reasons, but the most likely reason is if the Borrower is on an automatic payment plan with the IRS and the total outstanding liability is less than $25,000. Remember that a withdrawal does not extinguish the tax liability or lien, it just removes the secured lien priority of the NFTL.

While it’s important for lenders to be aware of the above options for dealing with an NFTL, to avoid any claim of lender liability, lenders should not direct the taxpayer on how to deal with an NFTL. Instead, SBA lenders should strongly encourage the taxpayer to seek out their own advice from a tax professional. With the assistance of a tax advisor, the taxpayer may be able to take advantage of one of the above options to address the NFTL in a manner that would be satisfactory to the SBA lender and allow the taxpayer to obtain SBA financing.

For questions on SBA compliant ways to address federal tax liens, please contact krayer@starfieldsmith.com.