What Is a Subordination of Federal Tax Lien?
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When the IRS files a Notice of Federal Tax Lien (NFTL), it causes problems for businesses (and individuals). Businesses using their accounts receivable as collateral for loans are especially hurt by NFTLs. Lenders do not like funding behind NFTLs — or any lien, for that matter. When the IRS’s NFTL takes priority over a lender’s secured interest in the receivables, they typically stop funding. However, there is a solution to help retain lender funding – the subordination of federal tax lien.
The 3 Main Purposes of an NFTL
As explained in our blog post, Is a Federal Tax Lien the Same as a Levy, there are three main purposes of an NFTL:
- It provides notice of your business (or personal) tax liability to third parties, including your lender.
- It secures the government’s interest in your business’s assets — real and personal property.
- It establishes priority relative to other secured interests.
Determining the Priority for Repayment of Debt
Before funding a business, a lender files a Uniform Commercial Code-1 (UCC-1) document with the Secretary of State to secure its interest in the business’s collateral. The collateral could be real property as well as personal property, e.g., equipment, accounts receivable, invoices, etc. Generally, the priority of secured interests (liens, judgments, etc.) is established on a “first in time, first in right” basis. The entity filing its secured interest first is in first position, the entity filing second is in second position, and so on.
Priority is important because it establishes who has the right to be repaid first in the repayment of debts. The entity in first position has the right to be repaid before the entity in second position.
Who Has Priority Before the Notice of Federal Tax Lien?
It’s helpful to think of priority as a leaderboard. Before the IRS files an NFTL, the lender is the only one on the board. The IRS has not yet secured its interest or provided notice of the liability to the public. There’s no risk to the lender, so funding continues uninterrupted.
The 45 Day Rule of a Notice of Federal Tax Lien
If a business owes money to the IRS, the IRS will file an NFTL. When the IRS files its NFTL, it does not take priority immediately. Generally, a lender remains in first position for 45 days (or until the lender obtains “actual knowledge” of the NFTL, whichever occurs first). For the first 45 days, the lender is in first position and the IRS is in second position. The lender can continue funding in the short-term, but there is a small window (less than 45 days) to address the lender’s concerns. Although the lender still has priority, tensions run high.
The IRS is an exception to the “first in time, first in right” rule. It has what some refer to as a “super priority” – the IRS can jump ahead of other secured parties. On the 46th day, the leaderboard flips, and the IRS takes first position, pushing the lender down to second position. The IRS’s “super priority” is based on the 45-day rule. Without a solution in place, lenders typically stop funding on day 46.
The Solution: Subordination of Federal Tax Lien
There are limited options for restoring the lender’s priority. A business could repay the amount of the IRS’s NFTL in full. That’s not an option for most businesses because it would create additional cash flow problems. Fortunately, there’s another option – a subordination of federal tax lien. A subordination does not discharge or remove the NFTL. Instead, the IRS subordinates or gives up its priority or first position, allowing the lender to move back into first position. As long as the lender has priority over the IRS, it can continue funding. But it’s not as easy as it sounds.
Prerequisites for a Subordination of Federal Tax Lien
A prerequisite for the subordination is an installment agreement in good standing. The IRS will not consider a request for a subordination if there is no installment agreement in place. To negotiate an installment agreement, a business (1) must have filed all its tax returns and (2) must be making its current federal tax deposits in full and on time.
Process and Timing for a Subordination of Federal Tax Lien
Subordination requests are worked by technical advisors within the IRS’s Collection Advisory Group on a first in, first out basis. Advisors do not enter a request into the queue for review until a complete application is received (IRS Form 14134 and substantial supporting documentation).
A business owner, working on their own or with a local accountant or attorney, has little chance of securing an installment agreement and subordination within 45 days. Unfortunately, time is of the essence. If the matter is not resolved within the 45 days, lenders stop funding. However, a knowledgeable and experienced tax specialist can navigate the process, address the lenders’ concerns, and preserve funding.
When federal tax issues arise, don’t wait for the IRS to file a tax lien or issue levies. Be proactive. It’s best not to try to deal with the IRS on your own. Fill out the form below to speak with a specialist about how we can help.