With complex IRS tax issues such as the 45-Day Rule it is always a good idea to consult with a Tax Expert such as the Tax Resolution Institute. What follows should NEVER be considered the final word on the topic nor should it be considered legal advice.
We have a great deal of experience dealing with both the lender’s and the taxpayer’s side of these issues over the years. Feel free to contact us to get the ball rolling towards a solution.
There are a host of issues that have to do with the 45-Day Rule imposed by the IRS including:
- 45 day rule on short sales
- The 45 day rule penalties
- The 45 day rule on trust distributions
The text below is an excerpt from the textbook we put together called “The Ultimate Guide to Tax Resolution” (we have a sister site that offers tax resolution specialist training). It is from Chapter 16 which focuses on the 45-Day Rule:
45-Day Rule (Requirement – 6323 n 43)
The United States Congress instituted the 45-Day Rule in 1966 to correct a problem experienced by commercial lenders who suddenly found themselves losing their loan collateral when being set against a federal tax lien. The most basic principle employed in the adjudication of the priority of liens is “first in time is the first in right.” When the IRS makes an assessment for unpaid payroll taxes against a business, a statutory lien arises in favor of the federal government. The lien attaches to all property or rights to property belonging to the business. This lien is called a “silent” lien because it comes into existence without notice to the world. The lien, however, does not necessarily entitle the IRS to priority against most other secured parties unless the IRS files a notice of a federal tax lien.
Once the IRS has filed an official notice of a federal tax lien against a business, both the business and the creditors of the business are placed in financial jeopardy. If you find your company in such a situation and the 45 days are passing, your future viability is being placed in serious crisis. If such a tax lien has been placed on your business and you are in a revolving loan agreement with an asset based lender such as a bank or a factor based on your assets or accounts receivable, please contact Peter Stephan and the Tax Resolution Institute before your cash flow evaporates and your business is closed down.
The 45-day rule gives the IRS special rights against lenders that secured themselves with their customers’ collateral. The rule, which appears in Section 6323(d) of the Internal Revenue Code, (26 U.S.C.) states as follows:
Even though notice of a lien imposed by section 6321 has been filed, such liens shall not be valid with respect to a security interest which came into existence after the tax lien filing by reason of disbursements made before the 46th day after the date of tax lien filing, or (if earlier) before the person making such disbursements had actual notice or knowledge of tax lien filing, but only if such security interest (1) is in property (A) subject, at the time of tax lien filing, to the lien imposed by section 6321, and (B) covered by the terms of a written agreement entered into before tax lien filing, and (2) is protected under local law against a judgment lien arising, as of the time of tax lien filing, out of an unsecured obligation.
Translated, the 45-day rule states that a lender, whose collateral can be identified only after the federal tax lien filing, receives a priority of first position subject to the following five restrictions:
- The security agreement must predate the tax lien filing.
- The holder of the interest may make disbursements no more than 45 days after the tax lien filing.
- The collateral securing those disbursements must be acquired within those 45 days.
At the time of the disbursement, the holder cannot have “actual knowledge or notice” of the tax lien filing (this term is discussed later).
Despite the basic principle of the 45-Day Rule, a federal tax lien by the IRS has always enjoyed certain advantages when it comes to deciding first position. For instance, courts have long held that to be first in time, the non-federal lien must first be “choate,” that is, the identity of the lien and the property subject to the lien are reasonably determinable.
The first-in-time rule created a hardship for commercial lenders and factors in particular. After all, commercial lenders have loans and collateral that change daily. For this reason, in the Federal Tax Lien Act of 1966, Congress changed the law to give commercial lenders a limited priority in certain contests involving federal tax liens. However, the priority Congress granted to commercial lenders in the form of the 45-Day Rule is far from absolute.
If we take a closer look at the key provisions of the 45-Day Rule, there are a number of requirements that must be met. To prevail against the IRS, the lender must confirm beyond any question and the bar is set quite high in these cases:
The date that the notice of the federal tax lien was filed.
- A written security agreement was entered into before that date.
- The collateral at issue relates to the subject agreement and to loans made under the agreement.
- The bank disbursed the loan no more than 45 days after the tax lien filing.
- The customer has acquired the collateral and can identify the collateral inside the 45-day window.
- The lender did not have actual notice or knowledge of the tax lien filing when it made the disbursements.
Under local law, the security interest would trump a hypothetical unsecured judgment lien arising as of the tax lien filing date.
Let us take a step back from the direct examination of the 45-Day Rule and the Internal revenue Code in regards to Payroll Taxes. To begin with, let us explain why a business would choose to enter into a Factoring relationship. For many companies, there are periods in the business cycle where cash flow becomes hard to manage and you look for alternatives. A workable alternative that many consider is an Accounts Receivable Financing Program or an Asset Based Financing program, commonly referred to as Asset-Based Lending or Factoring.
If your company is in financial difficulty, these types of revolving loans can sometimes accelerate the problem, but they can often help a company out of a bad situation. If you have identified the problem and have a plan in place to fix the problem within a specified period of time, accelerating cash flow can be a direct benefit that ends the crisis. It is essential to realize that such a loan agreement places your company in direct jeopardy if you fail to properly cover your payroll taxes or pay them on time.
Overall, the asset based lending industry has acquired an image that is far from ideal. Business owners assume that asset based loans are not as good as unsecured loans. In truth, asset based lending is used with all size companies and can allow an asset-rich corporation to receive financing when you have not met standard credit requirements. You do not always pay a higher rate of interest.
True asset based or “Equity based” lending is easier to obtain for borrowers who do not conform to typical lending standards. You may have no, little or terrible credit. You may have little income to support the payments, and may need to rely on the loan itself to pay back the lender until the property is either sold, refinanced, or your income resumes.
An important part of the decision to take such a loan is to compare the cost of the program to the benefit that the business will receive. It may help our business in the short-term, but if it costs more than increases profit, it is a bad solution. It is best to have a fixed, up-front cost structure that you can budget into your pricing and to know that no additional fees can be added to your cost.
In reality, with the pressure on and payroll taxes around the corner, how much time does a program like this save you and your company. If you spend large amounts of time tracking everything to manage the program and to comply with regulations, you may find yourself again losing money.
Asset based lenders typically limit the loans to a 50 or 65 loan to value ratio or “LTV”. For example: If the appraisal is valued at $1,000,000.00 a lender might lend between $500,000.00 and $650,000.00. In the event of a default resulting in a foreclosure, the first lien position lender is entitled to repayment first, out of the proceeds of the sale.
You generate accounts receivable by selling goods or services to your customers on credit. If a cash squeeze develops, you may extend credit to your customers and sell your accounts receivable to a factor. A factor is a specialized financial intermediary who purchases accounts receivable at a discount. Factoring is a technique used to manage your accounts receivable and provide financing.
Under the lending (often called “factoring”) agreement, you sell or assign your accounts receivable to the factor in exchange for a cash advance. The factor typically charges interest on the advance plus a commission, not mention several service fees along the way. If you are a lender in the position of the factor and your borrower has failed to pay their payroll taxes, your collateral could be in real jeopardy. When it comes to the Trust Fund Recovery Penalty and the enforcing the strictures of the 45-Day Rule, the IRS Collection Officers are orthodox and inflexible.
According to the IRS Code, IRS Collection Officers only invalidate a tax lien against the security interests of a lender that satisfy traditional choateness doctrine within 45 days after the filing of a tax lien. This 45-Day Rule is not a parity rule as it provides for “sudden death” of a security interest that is not acquired within stated period. This “sudden death” potential is essential for lenders to understand in light of a borrower failing to pay their payroll taxes and a tax lien against the company being filed by the IRS.
To avoid the “sudden death” outcome, a factor’s (or lender’s) security interest in the business owner’s (or taxpayer’s) “accounts receivable” must meet federal standards of choateness within 45 days after the filing of the tax lien to have priority over the tax lien. In other words, the security interest must have been “acquired” by the factor (or lender) within that period. In contrast, a security interest in account receivables cannot be acquired until the accounts receivable comes into existence. As a result, the IRS deems such a security interest incomplete.
Security interest arising within 45 days after a federal tax lien is filed takes priority under three specific conditions:
- If your security interest stems from a written agreement entered into before the federal tax lien was filed and it qualifies as a “commercial transactions financing agreement”.
- If your underlying loans were made pursuant to a written agreement within 45 days of the filing of the tax lien or prior to receiving the notice of the tax lien’s being filed
- The agreement covers “qualified property” which was acquired by the taxpayer within 45 days of the filing of the tax lien, and local law gives the security interest holder priority over a judgment lien by an unsecured creditor as of the time the federal lien was filed.
- The Internal Revenue Service considers security interest obligation, which arises from optional advance made during the 45-day period without actual notice or knowledge of existence of federal tax lien protected. However, it is essential for the lender to understand that such knowledge must be categorically proved which can be challenging to say the least.
- If you are a lender and your borrower has failed to properly cover the payroll taxes of their business and the trust fund recovery penalty has come into play, the collateral your loans are based on could be in real jeopardy.
The 45-Day Requirement (Superseded)
The IRS Code only invalidates tax lien as against security interests of lenders or purchasers that satisfy traditional choateness doctrine within 45 days after filing of tax lien; rule is not parity rule as it provides for “sudden death” of security interest that is not acquired within stated period; lender’s or purchaser’s security interest in taxpayer’s “accounts receivable” must meet federal standard of choateness within 45 days after filing of tax lien to have priority over tax lien; security interest must have been “acquired” by lender or purchaser within that period; security interest in account receivable is not acquired, and is therefore inchoate, until account receivable comes into existence. Texas Oil & Gas Corp v United States (1972, CA5 Tex) 466 F2d 1040, 11 UCCRS 575, cert den 410 US 929, 35 L Ed 2d 591, 93 S Ct 1367.
Security interest arising within 45 days after federal tax lien is filed takes priority if security interest stems from written agreement entered into before federal tax lien was filed and it qualifies as “commercial transactions financing agreement”, underlying loans were made pursuant to written agreement within 45 days of filing of tax lien or prior to receiving notice of tax lien’s being filed, agreement covers “qualified property” which was acquired by taxpayer within 45 days of filing of tax lien, and local law gives security interest holder priority over judgment lien by unsecured creditor as of time federal lien was filed. Donald v Madison Industries, Inc. (1973, CA10) 73-2 USTC 9623.
Absent contrary local law or specific statutory priority rules relating to judgment liens, Internal Revenue Service considers security interest obligation which arises from optional advance made during 45 day period without actual notice or knowledge of existence of federal tax lien protected; rule applies only to security interest under 26 USCS 6323 (c) (2) and (d). Rev Rul 72-290, FLAG 1972-1 p 385.
6321 n 14. Accounts receivable or payable
Taxpayer’s invoice instructions to his customer to make checks payable jointly to the taxpayer and the taxpayer’s creditors did not constitute an assignment of the customer’s account to the creditors; hence, although the tax was not assessed until after instructions were mailed to the customer, the tax lien attached to the entire amount due from the customer. Harbert Constr. Corp. v United Iron Works, Inc. (1967, DC Ala) 67-2 USTC 9668.
Accounts receivable for “future” sales to taxpayer’s customer assigned by the taxpayer to his supplier in payment for logs to be delivered to the taxpayer, was not subject to Treasury’s tax lien. Harter v District Director of Internal Revenue (1968, DC Wash) 68-2 USTC 94.