CHAPTER TWELVE

Tax Preferences and Liens

§ 12.1 Introduction

§ 12.2 Tax Preferences

(a) General Provision

(b) Chapter 7 Liquidation Requirement

(c) Ordinary Course of Business

(d) Withholding Taxes: Property of the Estate?

(e) Statutory Lien

§ 12.3 Tax Liens

(a) Introduction

(b) Federal Tax Liens

(c) State and Local Tax Liens

(d) Priorities Outside Bankruptcy

(e) Priorities in Bankruptcy

(f) Chapter 7

(g) Chapter 11

(h) Survival of Lien

(i) Exempt Property

(i) Impact of Tax Levy

§ 12.1 INTRODUCTION

In a bankruptcy case, federal and state and local tax liens are handled differently under certain circumstances than they would be in an out-of-court case. Also, tax payments made within 90 days prior to bankruptcy may be avoided. The objective of this chapter is to examine the issues associated with tax preferences and liens.

§ 12.2 TAX PREFERENCES

(a) General Provision

The payment of a past due tax to a governmental unit can be considered a preferential payment under certain conditions. Section 547(b) of the Bankruptcy Code provides that any transfer of property of the debtor, while insolvent, in payment of an antecedent debt owed by the debtor to an unsecured creditor may be avoided if made within 90 days before the petition is filed.

There is no specific statutory provision generally authorizing chapter 13 debtors to exercise trustees’ avoidance powers. Thus as a general rule, courts have denied standing to chapter 13 debtors who assert a preferential transfer cause of action under 11 U.S.C. section 547.1 However, in In re Straight,2 the bankruptcy court held that chapter 13 debtors have standing to pursue the avoidance of an allegedly preferential transfer, that a federal tax lien has priority over a bank’s security interest, and that a prepetition payment to the bank was an avoidable preferential transfer. The bankruptcy court, noting that the trustee had refused to pursue the matter and reasoning that a secured creditor should not retain an advantage over other creditors when it had not perfected its lien, held that the debtors may prosecute these claims so long as any recovery is deposited with the trustee.

When determining when a tax claim is incurred for preference purposes, a special rule applies: Section 547(a)(4) states that “a debt for a tax is incurred on the day when such tax is last payable without penalty, including any extension.”

Thus, for purposes of determining the preference of an employment tax, it is the date when the tax claims first became subject to a penalty for the taxpayer’s failure to deposit with a qualified depository institution the taxes it later paid to the IRS. The district court3 rejected the IRS’s position that the return is due on the date that it is due, which for the first quarter of the year would be April 30 and not the date that the deposit was made. It is the date that the debtor is exposed to the penalty and not the date that the penalty is actually assessed or the date on which the quarterly return is due.

(b) Chapter 7 Liquidation Requirement

The avoidance of a preference is based on the assumption that the creditor received more as a result of the transfer than would have been received if the case were under chapter 7. In Tenna Corp.,4 it was determined that the payment of federal income tax deficiencies two months before filing a chapter 11 petition was a preferential payment and that the amount that the government repaid was subject to statutory interest. This decision was reversed by the Sixth Circuit on the ground that the IRS did not receive more than would have been received in a chapter 7 liquidation.5 The district court held that, in determining whether the debtor received more than would have been received in a chapter 7 liquidation, all events occurring after the petition is filed, up to the date of the hearing on the issue, are considered. The Sixth Circuit, in reversing the district court’s decision, held that postpetition debt should not be considered in determining whether the creditor received more than would have been received in a chapter 7 liquidation.

It should be realized that courts have not followed the Tenna decision where the preference action related to a contract that was subsequently assumed.6

The bankruptcy court ruled, in In re Healthcare Services,7 that a preferential transfer occurred when the IRS seized approximately $295,000 from the company’s bank account. The court concluded that, because administrative expenses and employee benefit claims have a greater priority than seventh (2005 Bankruptcy Act changed to eighth) priority tax claims, the IRS received more than it would have received in a chapter 7 liquidation.

(c) Ordinary Course of Business

A transfer is not a preference to the extent that the transfer was in payment of a debt incurred in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was made according to the ordinary course of business or financial affairs of the debtor or made according to ordinary business terms. The 2005 Act modified section 547(c)(2) to provide that a transfer is not a preference if it meets only one of the requirements—made in the ordinary course of business or made according to ordinary business terms. For petitions filed prior to October 8, 1984, it was also necessary that payment be received within 45 days after the debt was incurred to meet the ordinary business exception. The Bankruptcy Amendments and Federal Judgeship Act of 1984 eliminated the 45-day requirement. For tax purposes, the date the debt was incurred is, according to Bankruptcy Code section 547(a)(4), the day when such tax is last payable, including any extensions, without penalty. Thus, the trustee or debtor in possession could recover a tax paid within the last 90 days. In In re Greasy Creek Coal Co.,8 the bankruptcy court held that a trustee may avoid transfers to the government if all the statutory requirements are met and if the transfer is not excepted from the avoidance rules. In this case, the transfer did not qualify as an exception because it was made more than 45 days after taxes were payable without penalty and because the court determined that the transfer was not made in the ordinary course of business. The debtor used money transferred by a third party and intended as a payroll advance to pay withholding taxes, and payment was made in the form of a third-party check.

In Union Bank v. Wolas,9 the Supreme Court held that timely payments and interest under a long-term note are not preferences. Thus, payments made under a long-term agreement with the IRS or other taxing agencies would not be a preference even if made within 90 days prior to the petition date.

In In re Middendorf,10 the bankruptcy court noted that the trustee must prove the transfer (1) was for the benefit of the creditor; (2) was for an antecedent debt owed before the date of the transfer; (3) was made while the debtor was insolvent; (4) was made within 90 days of the bankruptcy filing; and (5) enabled the creditor to receive more than it would have received under a chapter 7 if the transfer had not been made. The court ruled that there was no recovery of preference because all these requirements must be met and the trustee could not prove the second element. The debtors did not elect to split their tax year pursuant to 26 U.S.C. section 1398(d)(2) and, thus, the tax obligation did not arise until after the petition was filed.

(d) Withholding Taxes: Property of the Estate?

The Supreme Court agreed with the Third Circuit, in Harry P. Begier, Jr.,11 and ruled that taxes are held in trust for the government and are not subject to recovery.

During the spring of 1984, American International Airways, Inc. (American) became delinquent in remitting Social Security, withholding, and airline passenger excise taxes. As a result, the IRS required American to file monthly returns and deposit the taxes in trust for the IRS in a separate bank account.

In April 1984, American paid the IRS $695,000 from the trust account and $734,798 from the company’s general operating account. Additional payments from its general operating account were made in June 1984, resulting in a total of $946,434 being paid from the general fund.

The Third Circuit, in a split decision, reversed the decision of the bankruptcy court and the district court, ruling that prepetition payments on account of tax withholding obligations are held in trust for the government and are not preferential transfers. No distinction was made for deposits in a special trust fund. The court ruled that the legislative history of section 547(b) of the Bankruptcy Code suggests that Congress intended that withholding taxes be considered as funds held in trust. The funds are not property of the estate and thus are not subject to the preferential transfer rules.

The Supreme Court held, without dissent, that the payment of trust fund taxes to the IRS from general accounts were not transfers of “property of the debtor” but were instead transfers of property held in trust for the government pursuant to I.R.C. section 7501. As a result, the Court concluded that such payments cannot be avoided as preferences. The Court rejected the argument that a trust was never created because the funds were not segregated under I.R.C. sections 7501 and 7512.

This decision made the Ninth Circuit decision not applicable. The Ninth Circuit held, in In re R&T Roofing Structures,12 that trust funds could be recoverable as preferences under some circumstances.

The bankruptcy court held that a prepetition payment of withholding taxes did not constitute an avoidable preference.13 The corporation used $498,000, part of the proceeds from the sale of collateral, to settle a tax lien of $897,000 with the IRS. The IRS allocated $478,000 to trust fund taxes and $19,000 to non–trust fund taxes. The bankruptcy court concluded that of the $497,000 payment, $478,000 was not a preferential payment under Begier, but that the $19,000 portion representing non–trust fund taxes was a preferential transfer.

In United States v. Pullman Construction Industries, Inc.,14 the district court affirmed a bankruptcy court’s decision that three of a company’s eight prepetition payments to the IRS were recoverable as preferential transfers. The court also held that the date the debt is incurred is the date that the deposit is due, not the date that the return is due. The court noted that under section 547(a)(4) of the Bankruptcy Code, a debt for a tax is incurred on the day when such tax is last payable without penalty. Only non–trust fund payments were considered preferences.

A federal district court15 held that the IRS’s levy on a debtor’s bank account to collect outstanding employment taxes was avoidable as a preferential transfer under Begier. In 1992, Ruggeri Electrical Contracting, Inc., became delinquent in paying employment taxes, owing $150,000 by the third quarter of 1992. In September, Ruggeri entered a $5,000-per-month installment agreement with the IRS, which it kept current until March 1993. In April 1993, the company terminated its business operations, and in May, it paid $60,000 to the IRS.

The IRS issued a levy notice in August; at that time, Ruggeri owed $196,000 of employment taxes. A few weeks later, several of Ruggeri’s creditors filed an involuntary bankruptcy petition against it. Ruggeri’s bank transferred the company’s $54,000 account balance to the bankruptcy trustee, Paul Borock. The bankruptcy court ruled that the $54,000 did not become property of the estate because Ruggeri did not retain any interest in the funds.16 In a subsequent hearing, the court ruled that the levy did result in a preferential transfer because the IRS had failed to demonstrate a sufficient nexus between the section 7501 trust and the funds seized, under Begier.17

The district court stated that, under Begier, it must conduct a two-pronged inquiry to determine whether the levy was a preferential transfer: (1) Did a trust for the IRS exist, and, if so, (2) was the $54,000 part of that trust? As to the first prong, the district court concluded that a trust did exist, explaining that a trust is created when a debtor pays its employees and withholds taxes. With respect to the second prong, however, the court found that the funds Ruggeri withheld from its employees’ wages did not have a reasonable nexus with the $54,000 paid to the IRS.

The district court reasoned that Ruggeri, unlike the debtor in Begier, did not make a voluntary payment of the disputed funds, and the court noted that the IRS had conceded that a levy does not constitute a voluntary payment. The district court also refused to extend Begier to involuntary tax payments.

The Eighth Circuit, reversing a district court decision, held that a pension plan’s receipt of $6 million of benefits payments within 90 days before an employer’s bankruptcy is not an avoidable preference.18 In May 1991, after failing to make pension and welfare plan contributions, Jones Truck Lines, Inc. and the fund negotiated an agreement under which Jones delivered $2.9 million in promissory notes to the fund and agreed to pay its current plan contributions on a weekly, rather than a monthly, basis. From April to July, Jones paid $6 million to the fund; no part of these payments was applied to the promissory notes. In July, Jones filed for relief under chapter 11 and attempted to recover the $6 million as preferential payments. The bankruptcy and district courts held that the payments were preferential, rejecting the fund’s contention that the contributions were not avoidable because Jones received contemporaneous new value under 11 U.S.C. section 547(c)(1). The Eighth Circuit held that new value was received in the form of the services its employees continued to provide within the 90-day prebankruptcy period. The court further concluded that the parties intended a contemporaneous exchange and that the exchange was in fact substantially contemporaneous.

(e) Statutory Lien

Section 547(c)(6) of the Bankruptcy Code provides that the fixing of a statutory lien is not a preference. Thus, the creation or perfecting of a tax lien is not a preference item unless the lien is not properly perfected. Section 545 of the Bankruptcy Code provides that the trustee may avoid the fixing of a statutory lien on property of the debtor to the extent that such lien is not perfected or enforceable at the time of the commencement of the case against a bona fide purchaser that purchases such property at the time of the commencement of the case, whether or not such a purchaser exists. For example, a bankruptcy court held that tax liens arising out of various employer taxes for which the debtors were responsible are statutory liens, and these cannot be avoided under Bankruptcy Code section 545.19 The court held that a prepetition penalty could be avoided to the extent the penalty was not compensation for actual pecuniary loss.

In In re Robert F. Totten,20 the bankruptcy court held that a federal tax lien established before an individual declares bankruptcy may not be avoided by the trustee as a preferential transfer. In May and June 1987, the IRS filed notices of federal tax lien against the taxpayer, Robert Totten. In July 1987, Totten filed for bankruptcy. The trustee then sought to avoid the tax liens as preferential transfers under 11 U.S.C. section 547. The court concluded that a tax lien properly filed before the bankruptcy petition is filed is not included among the statutory liens that may be avoided as preferential transfers. The bankruptcy court21 noted that IRS liens arising by virtue of I.R.C. section 6321 are statutory liens. Such liens may be perfected by filing in the court of common pleas in accordance with the provisions of section 6323(f). Thus the IRS filed notice of its lien in the court of common pleas for Dauphin County, Pennsylvania, on March 25, 1992, one and one-half months prior to the filing of debtors’ petition for relief under chapter 7. Under these circumstances, the lien is not avoidable under section 547(b), because section 547(c)(6) prevents it from being avoided as it is not the type of statutory lien avoidable under section 545.

The bankruptcy court held that a transfer of funds to the IRS under a levy served less than 90 days before a debtor filed his chapter 7 petition was not avoidable as a preference.22 The taxpayer argued that his insolvency at the time of the levy brought the levy within the provision of section 545(1)(D) of the Bankruptcy Code for a statutory lien that first becomes effective when the debtor becomes insolvent and that an IRS lien or levy therefore fell outside the safe harbor available to creditors under 11 U.S.C. section 547(c)(6).

The bankruptcy court held that a federal tax lien or levy does not become effective against a debtor upon his insolvency but rather when either demand for payment of tax is made or the levy is served.

In another case, within 90 days before the debtor filed his chapter 13 petition, the IRS garnished the taxpayer’s bank account.23 The bankruptcy court noted that although there was no evidence that the lien had been perfected by the filing of a notice, the lien was perfected by attachment and seizure of the bank account. The seizure was not avoidable under section 545 or 547(c)(6) of the Bankruptcy Code, and because a tax lien is a statutory, rather than judicial, lien, the garnishment could not be avoided under section 522(f)(1) of the Bankruptcy Code. Section 522(f)(1), according to the bankruptcy court, applies only to judicial liens.

In a legal memorandum, Mitchell S. Hyman, senior technician reviewer, branch 2 (general litigation), concluded that payments of non–trust fund taxes, whether voluntary or involuntary, may be avoided by a chapter 7 trustee and brought back into the bankruptcy estate.24 However, Hyman noted that the voluntary but undesignated payments and involuntary payments that the IRS applies to trust fund taxes also are not property of the debtor but are held in trust for the United States under I.R.C. section 7501 and, therefore, are not avoidable by the trustee.

§ 12.3 TAX LIENS

(a) Introduction

It is not unusual for the debtor in a bankruptcy case to discover that some or all of the debtor’s property is subject to either federal or state and local tax liens, or both. Interests in property in a bankruptcy case are generally governed by state statutes; however, federal laws determine the validity and enforceability of federal tax liens. State and local tax liens are governed by state statutes.

(b) Federal Tax Liens

A federal tax lien is created under I.R.C. section 6321 when a tax assessment has been made, notice has been given of the assessment, stating the amount and demanding its payment, and the amount assessed is not paid within 10 days after notice and demand. Once these events have occurred, a tax lien is imposed against all property and rights to both real and personal property that belong to the debtor on the assessment. These liens are regarded as “secret liens” because public notice of the lien is not required. Only the taxpayer is aware of the assessment and the demand for payment.

However, for the IRS to have priority over the interests of other creditors, especially in a bankruptcy case, the IRS will need to file a notice of lien. I.R.C. section 6322 provides that the lien arises at the time the tax is assessed, unless another date is specifically fixed by law, and continues until the amount assessed is collected or becomes unenforceable. The lien generally becomes unenforceable after 10 years from the assessment. The securing of a personal judgment against a taxpayer for back taxes does not extend or curtail the 10-year collection period beginning on the assessment.25

Section 6502 of the Internal Revenue Code provides that, where the assessment of any tax imposed by this title has been made within the period of limitation properly applicable thereto, such tax may be collected by levy or by a proceeding in court, but only if the levy is made or the proceeding begun within ten years after the assessment of the tax.

In November 1990, the time period was extended from 6 years to 10 years. Thus, for all assessments that were made more than 6 years prior to November 1990, the 6-year period would apply.

The district court held that the federal tax liens were valid where the taxpayers received notice of assessments as required by section 6303 of the Internal Revenue Code, where the government provided IRS Form 4340 that listed the amounts of each assessment, and the IRS Form 23C assessment date for each tax period in question as well as dates of notices sent to the taxpayers.26 The district court noted that courts have accepted IRS Form 4340 as sufficient to establish a prima facie case that notice of assessment and demand for payment was sent to the taxpayer. The bankruptcy court27 held that the IRS lien arose at the time the jeopardy tax assessment was made, as provided in I.R.C. section 6322, and that the lien is valid in bankruptcy because it was recorded before the bankruptcy petition was filed.

In In re Dakota Industries, Inc.,28 it was held that the effective date provision of the federal tax collection statute of limitations has been construed to mean that if a tax would be discharged as computed by the 6-year period as of the November 1990 effective date of the extended statute of limitations, the tax was subject to the 6-year limitation period. In the event that the tax would not be discharged as computed by the 6-year period, the tax was subject to the 10-year limitation period.

In In re Babich,29 the bankruptcy court held that the IRS was precluded from pursuing its claims for the 1978, 1979, and 1980 tax years because it did not complete filing tax liens for the liabilities for those years until 30 days after expiration of the six-year limitation period. Although the IRS filed the notice of tax lien for the 1977 liability within the six-year limitation period, the IRS was not allowed to pursue collection because the first attempt to collect the liability was not made until 1991.

The court in Babich noted that there are four sets of circumstances that will affect the tolling of the statute of limitations:

The court then held that the IRS was barred from collecting debtors’ 1978, 1979, and 1980 tax liabilities because of its failure to act within the attendant statute of limitations.

Following In re Priest,30 the bankruptcy court held, in United States v. Donald E. Morris,31 that the government liens were not valid until all the administrative steps necessary to create the lien were completed.

Under state law, if additional action must be taken by the state, the lien does not become effective until such action is taken. For example, in In re McTyre Grading & Pipe,32 the ad valorem taxes of Cobb County and Powder Springs arose and attached upon the date of valuation; however, those taxes did not become choate until the county’s tax digest was approved by the state revenue commissions as required by Georgia law because the amount of the tax is subject to change until the tax digest is approved. Thus, Cobb County’s lien for ad valorem taxes became choate when the tax digest was approved.

In In re Cecilia Ann Pardue,33 the bankruptcy court held that perfection of a tax lien is required only to preserve priority and validity against third parties. The court noted that perfection does not affect whether the tax lien is valid.

In this chapter 13 case, the IRS filed a timely proof of claim for unpaid income taxes. The proof of claim was filed as secured to the extent of the value of the personal property listed in the schedules filed by the debtor. Pardue objected to the IRS’s secured claim, arguing that because the IRS failed to file its notice of lien in the proper location, a lien was invalid because it was unperfected. As noted, the court denied Pardue’s objection.

The state in which the property of the taxpayer is located dictates where the notice of a tax lien is filed (e.g., state, county, or other governmental office). If the state fails to designate an appropriate central filing location, the notice of tax lien may be filed in the office of the clerk of the U.S. District Court.34 If real estate is involved, the notice of tax lien is filed in the state or county where the real property is located. Where personal property is involved, the notice is filed in the state of residence of the taxpayer. A lien on personal property held by a corporation is filed in the appropriate location in the state where the business is incorporated.

Form 668, Notice of Tax Lien, is used by the IRS. This form explains the type of tax involved, the date of assessment, the unpaid balance, the interest, and the penalty amount. The form does not specifically mention the property to which the lien applies, because the IRS takes the position, based on I.R.C. section 6321, that the lien is applicable to all property (real or personal) of the taxpayer. In 21 West Lancaster Corp. v. Main Line Restaurant,35 the court held that a liquor license was property that was subject to a federal tax lien, even though under state law the license was not assignable, attachable, or subject to claims from state law creditors, because I.R.C. section 6331 provides that a federal lien attaches to property rights that may not be attached under state law.

The first-in-time, first-in-right rule applies in determining whether a federal tax lien has priority over state tax liens, as determined in In re Shea-nanigan’s, Inc.36

Shea-nanigan’s, Inc., filed a chapter 7 bankruptcy petition in November 1988. The corporation’s liquor license was transferred to the bankruptcy trustee as property of the estate. The trustee filed a notice of her intention to sell the license. The bankruptcy court confirmed the sale, reserving for later determination the issue of the priority of liens on the liquor permit and sale proceeds asserted by the IRS and the Ohio Department of Taxation. Both the Department of Taxation and the IRS filed proofs of claim. In October, just prior to the filing of the chapter 7 bankruptcy petition, the IRS filed a notice of tax lien against Shea-nanigan’s. The Department of Taxation argued that a liquor license is not property to which a federal tax lien can attach. The Department of Taxation also argued that a liquor license cannot be transferred under Ohio law until all Ohio sales taxes are paid.

The bankruptcy court ruled that the federal tax lien has priority over the state tax lien. The court, in rejecting both arguments of the Department of Taxation, cited In re Terwilliger’s Catering Plus, Inc.37 The court applied the first-in-time, first-in-right rule and held that the IRS lien had priority.

The bankruptcy court held that under I.R.C. section 6322, the federal tax lien had priority over the Florida tax warrants because the federal tax lien arose when the tax was assessed, which was four days before the first tax warrant was recorded. The court noted that none of the exceptions of section 6323 that would require the United States to first file a notice of federal tax lien in order to have priority over the Florida tax warrants apply because the State of Florida, as a holder of a tax warrant, is not a purchaser, holder of a security interest, mechanic’s lienor, or judgment lien creditor.38

In In re Whyte,39 the bankruptcy court held that the IRS tax lien was junior to the assignment of rents from the real estate executed by Whyte in favor of First Federal Savings Bank of Indiana. The court noted that the tax lien did not attach to rent payments as they accrued because, at the moment a payment became due, it became personal property under Indiana law. The court concluded that, under Indiana law, the IRS would have had to file its notice of federal tax lien with the clerk of the U.S. district court to perfect a tax lien as to Whyte’s personal property, which it had failed to do. The court noted that a tax lien for personal property must be filed with the clerk of the U.S. district court under I.R.C. section 6323(f)(1)(B). The court affirmed an earlier decision in which it had held that the assignment of rentals granted to First Federal a valid security interest in the accrued rentals that was, under Indiana law, superior to a subsequent judicial lien and thus met the requirements of I.R.C. section 6323(h)(1)(A).

The Sixth Circuit affirmed a district court judgment holding that a tax lien has priority over a judgment creditor’s lien.40 The court concluded that the judgment creditor’s notice of lis pendens did not satisfy the state recording statute.

The Sixth Circuit found that under state law, a judgment creditor must file a notice of judgment lien to perfect its claim; even if the judgment is a foreign judgment, state law makes full faith and credit automatic upon proper registration. The court found no reason why the taxpayer could not have filed a notice of judgment lien when it filed the notice of lis pendens because under state law a notice of lis pendens cannot, independently, create a lien against property.

A notice of lis pendens simply gives notice of pending litigation. The Sixth Circuit noted that a notice of judgment lien, however, attaches to all of the judgment debtor’s property but to no one piece of property in particular. Thus, filing a notice of judgment lien cannot cloud title of a property that is currently owned by an individual other than the judgment debtor or perpetrate a fraud upon the court because the judgment will not attach to property in which the judgment debtor has no ownership interest.

In Annette Kilker v. Commissioner,41 the bankruptcy court held that there is no statutory requirement that the IRS deliver a notice to the taxpayer prior to filing the notice of a federal tax lien. The court refused to void the lien.

In In re Varrell,42 the court held that the failure to record a lien in both a husband’s and a wife’s name did not make it invalid. The IRS recorded two notices of tax lien against William Varrell and the Mulberry Inn Restaurant and Lounge in 1990, to collect unpaid Social Security taxes. Varrell and his wife operated the restaurant under the name of Mulberry Inn, and they filed a chapter 13 petition in 1991. The IRS filed an amended secured proof of claim for the unpaid taxes. The Varrells challenged the secured status of the IRS lien.

The Varrells argued that the security was invalid because the notices of federal tax lien were filed solely in William Varrell’s name, and the property was held by the Varrells in tenancy by the entirety. They contended that, under Florida law, property held in tenancy by the entirety can be reached only by a joint creditor of both spouses.

The bankruptcy court ruled that it is irrelevant in whose name the notices were filed, because the lien arose automatically upon the assessment, notice, and demand for payment of the taxes. The court concluded that because the notices reflected two taxpayers (William Varrell and Mulberry Inn) and both William and his wife did business as Mulberry Inn, both of them may be liable for the taxes, depending on whether they were partners or joint ventures in the restaurant. The court also noted that, even if the IRS lien could not attach to the Varrells’ property prepetition (because of the tenancy by the entirety), the claim would be converted to an unsecured priority claim.

An incorrectly identified tax year in a notice of tax lien was a minor defect, insufficient to void the lien or the notice, and an IRS lien may reach property exempt from levy under I.R.C. section 6334(a)(7). The Fifth Circuit stated that the error in tax year was a minor error in an otherwise properly filed notice and that the notice therefore gave constructive notice sufficient to comply with I.R.C. section 6323(f) and section 522(c)(2)(B) of the Bankruptcy Code.43

The premature distribution penalty does not apply to Keogh and individual retirement account (IRA) funds withdrawn to satisfy federal tax liens, according to the bankruptcy court. In Larotonda v. Commissioner,44 the Tax Court held that the involuntary withdrawal from a Keogh account to satisfy a federal tax lien was not subject to the I.R.C. section 72(m)(5) penalty for premature withdrawal. However, the Office of Chief Counsel has announced nonacquiescence to this decision with no appeal. The IRS cited In re Kochell,45 which involved an IRA distribution in bankruptcy where the court held that the statute makes no exceptions from the penalty except in cases of disability. The IRS stated that the individual benefited “to the same extent as if he had withdrawn the money himself in order to pay off creditors.”

The bankruptcy court held, in William Thomas Hanna v. United States,46 that the IRS may not levy postpetition against the proceeds of a noncompetition personal service contract. The court noted that the value of the contract, at the time of the filing, was dependent on the continued personal service—that is, to not compete—of Hanna.

In a case of a secured lien, the Ninth Circuit Bankruptcy Appeals Panel (BAP) held that there is no requirement that the IRS file a proof of claim to protect a secured tax lien.47

For additional discussion of the proof of claims and the importance of filing, see § 10.3(b).

In In re Schreiber,48 the bankruptcy court held that tax liens attach to subsequent equity when there was no equity at the time the petition was filed. Citing Dewsnup v. Timm,49 the bankruptcy court noted that “[a]ny increase over the judicially determined valuation during the bankruptcy rightly accrues to the benefit of the creditor, not to the benefit of the debtor.”

The court then ruled that, because the IRS was oversecured, it is entitled to postpetition interest from the date the petition was filed until the date the secured claim is fully paid.

A bankruptcy court held that an IRS tax lien attached to a debtor’s interest in an Employee Retirement Income Security Act (ERISA)–qualified pension plan, even though Massachusetts state law exempts the pension plan from creditors’ claims.50 Citing United States v. Bess,51 the court stated that state law “is powerless to exempt property from the federal tax lien.” Thus, as security for its claim, the IRS has a valid lien on a taxpayer’s pension plan.

U.S. district court52 has determined that a debtor’s annuity rights are property of his bankruptcy estate, reversing the order of a bankruptcy court that sustained the debtor’s objection to a proof of claim.

After the taxpayer, James McIver Jr., filed a chapter 13 bankruptcy petition, the IRS filed a proof of claim for $119,700, alleging that it held a secured claim for unpaid federal income taxes as to McIver’s car, real estate, and all of his right, title, and interest to property under section 6321. At the time of the bankruptcy filing, McIver had a beneficial interest in six pension annuity contracts administered by Teachers Insurance and Annuity Association/College Retirement Equities Fund (the pensions), from which he was receiving $2,273 in monthly income.

On appeal, the district court determined that McIver’s rights in the pensions were property of the bankruptcy estate and, therefore, the IRS had a secured claim against McIver’s annuity rights to the extent of their value. The district court noted that the parties agreed that the pensions qualified as spendthrift trusts under New York law, which many courts have excluded from the bankruptcy estate under 11 U.S.C. section 541(c)(2). The district court relied on In re Lyons53 and reasoned that a debtor’s beneficial interest in a trust is property of the estate to the extent that, under federal tax lien law, the IRS could reach the interest outside of bankruptcy, even if the interest would be excluded from the bankruptcy estate under section 541(c)(2) with respect to other creditors due to valid spendthrift provisions. The value of the annuity rights were fixed at the present value of the future stream of payments to be received by the debtor under the annuities.54

A bankruptcy court held that a federal tax lien attached to a debtor’s interest in property owned with his nondebtor spouse as tenants by the entireties, and, thus, the IRS can sell the property to satisfy the debtor’s outstanding tax liability.55 The property was included in the debtor’s bankruptcy estate, and under Oregon state law, the tax lien attached to the property and creditors of one spouse can have a lien that attaches to that spouse’s interest in land held by the entireties.

The bankruptcy court concluded, in In re Young,56 that because Young was entitled to the refund at the time he filed his bankruptcy petition, the refund was part of the estate to which the IRS’s tax lien attached. Rodney Young objected to the proofs of claim filed in his bankruptcy case by the IRS. After Young had filed for bankruptcy, the IRS released his 1993 refund of $3,293 and filed a claim in the bankruptcy case for $11,819, of which $6,113 was a secured claim. The bankruptcy court agreed with the IRS that despite having released the refund, it still held a security interest in Young’s property.

I.R.C. section 6334(a)’s limitation on the government’s power to seize property is not a prohibition on the IRS’s ability to secure its interest in property.57 The IRS obtained a secured tax claim in a house that the taxpayers had purchased with workers’ compensation benefits, a claim that was challenged by the taxpayers. The Fifth Circuit affirmed the decisions of the bankruptcy and district courts by holding that the levy exemption for workers’ compensation did not limit the reach of a tax lien under I.R.C. section 6321.

A chapter 7 debtor was not allowed to avoid a prepetition levy that perfected a tax lien.58 The IRS levied on a bank account of the taxpayer two days before he filed a chapter 7 petition, and three weeks later the bank disbursed the balance of the account to the IRS. The taxpayer objected on the basis that the funds represented prepetition wages and that, under state (Colorado) law, 75 percent of his wages were exempt from the bankruptcy estate and the claims of his creditors. He sought turnover of 75 percent of the amount disbursed by the bank.

The court ruled that only the trustee in a chapter 7 proceeding has standing to request turnover but that the taxpayer had standing to bring an action to avoid a preferential transfer to preserve an exemption. On the merits, however, the court concluded that the IRS’s prepetition levy perfected its security interest in any wages on deposit and, because the IRS had a perfected prepetition lien, the funds were not subject to avoidance.

(c) State and Local Tax Liens

The bankruptcy court has ruled that a lien on “homestead property,” which was perfected by the IRS prior to the filing of a petition for relief under chapter 7 by the taxpayer, remains valid even though the tax obligation itself must be discharged under the Bankruptcy Code. A discharge in bankruptcy does not prevent the enforcement of valid liens on nonexempt property as well as exempt property.59

State and local tax liens can also be used to secure the payment of taxes (such as income, sales, and real or personal property taxes) owed to a state or local government. The assessment of these taxes and the filing of liens depend on state law. For example, in some cases, the tax lien may arise automatically, but in others, the tax authority must take some type of action such as issuing a warrant before the tax lien will be effective. State law determines the effective date of the lien and the property to which the lien attaches. Some states may have liens that attach to all property; however, in the case of real property taxes, the lien generally attaches only to the property subject to the tax.

(d) Priorities Outside Bankruptcy

As noted, a tax lien becomes effective without filing the notice; however, the filing of a notice determines the priority of the tax against other claimants, according to I.R.C. section 6323. In the case of a properly filed notice, the “first-in-time, first-in-right” rule applies. Thus, if the tax lien notice is filed prior to filing of the financial statements, the tax lien will have the senior status. A purchase money security interest for both personal and real property acquired after a tax lien was filed has priority over a perfected federal tax lien.

Section 545 of the Bankruptcy Code allows the trustee to avoid the fixing of statutory liens under certain conditions. One of those conditions was that the lien was not perfected or enforceable at the time the bankruptcy case commenced. Section 711 of the 2005 Act amends section 545 to prevent the avoidance of unperfected liens against a bona fide purchaser of items (securities and motor vehicles) specified in section 6323 of the Internal Revenue Code or a similar provision under state or local law.

I.R.C. section 6323(c) allows certain commercial transaction financing agreements a preferred status over tax liens. To qualify, the property must be negotiable instruments, accounts receivable, mortgages on real property, or inventory. The financing agreement must precede the filing of the tax lien, and any property acquired after the lien is filed must be acquired within 45 days after the tax lien is perfected. I.R.C. section 6323(d) also has another 45-day rule. Under this rule, the tax may be subordinated. A filed tax lien is not valid with respect to a security interest that came into existence within 45 days after the filing of the tax lien as the result of a disbursement or an advance made according to the terms of a written agreement entered into prior to the filing of the tax lien.

Unsecured creditors who have not reduced their claim to judgments will have their claims subordinated to tax liens even though notice was not filed. Claims reduced to judgments, mechanics’ liens, and secured creditors’ claims, however, have a priority over unfiled tax liens.

In United States v. 717.42 Acres of Land,60 the Fifth Circuit held that expenses of a liquidator have priority over a tax lien.

Petit Bois, Inc. (PBI) owned land on Petit Bois Island off the Mississippi coast and transferred an undivided three-fourths interest (two-thirds of this interest was later transferred to others) in the mineral estate to its shareholders in 1954. John Stocks purchased all of PBI’s shares in 1979. In 1980, the United States filed a declaration of taking for 717.42 acres of land on the island, which included the acreage on which PBI held its one-fourth mineral interest. As a result of this action, PBI then terminated its activity on the island, and Stocks placed PBI in voluntary liquidation and was designated the corporate liquidator. PBI conveyed all of its rights in the mineral estate to Coastal Land & Marine Company, Ltd., a partnership owned by Stocks. In 1984 and 1985, the IRS made personal tax assessments against Stocks and filed tax liens from 1986 through 1988. Stocks filed for bankruptcy in December 1988.

The United States valued the one-fourth mineral interest at zero dollars, but the district court overseeing the eminent domain proceedings awarded compensation of almost $1.1 million and ordered the government to place $2.8 million (including interest) into the court registry. The court then awarded more than $1.7 million in fees and costs to PBI’s attorneys and ordered any residue to be distributed to Coastal as assignee of PBI’s assets, subject to a final determination by the bankruptcy court presiding over Stock’s petition.

The Fifth Circuit held that, under applicable state law, the liquidator is vested with all rights, powers, and duties of the board of directors and officers and that the liquidator owes a fiduciary duty to the corporate creditors. The court noted that the liquidator is required to pay the debts of the dissolved corporation, including attorneys’ fees and costs. The court concluded that any rights Stocks had in the eminent domain proceedings were subject to the priority claims of the attorneys.

The Fifth Circuit also held that the United States had no right of setoff—the claim for compensation was owed to PBI by the United States, and the tax liabilities were owed by Stocks.

Finally, the Fifth Circuit concluded that the attorneys had super priority under I.R.C. section 6323(b)(8) and that the exceptions of section 6323(b)(8) only apply where there is right of setoff.

(e) Priorities in Bankruptcy

Section 506 of the Bankruptcy Code provides that secured claims are to be paid to the extent of the value of the collateral. If the amount of the claim is greater than the value of the collateral, the difference is considered an unsecured claim. Section 506 treats secured claims, judgments, and statutory liens, including tax liens, the same way. Thus, the rule of first-in-time, first-in-right applies.

The doctrine of first-in-time, first-in-right61 was applied to tax liens by the Sixth Circuit. In In re John Darnell,62 where the federal tax lien was perfected prior to the Kentucky Department of Revenue’s lien, the court held that the federal tax lien was superior to the state of Kentucky’s tax lien and awarded to the United States the remaining property of the debtor.

The district court, in United States v. Johnny Wayne Clayton,63 held that the IRS could not satisfy its lien against Johnny Wayne Clayton from the funds owed to his spouse from the sale of property declared as exempt by his spouse in their joint petition. The court noted that the IRS had an opportunity to file an objection to the wife’s equitable interest in the exempt homestead property but failed to file such an objection. The failure of the IRS to timely file its objection to the amendment to the exemption schedule adding sale proceeds and the IRS’s confusion regarding the spouse’s equitable interest in the exempt property were noted by the court in discussing the case.

An IRS tax lien does have priority over judgment creditors. In In re Richard Granger,64 the court was asked to determine whether a tax lien had priority over a default judgment and a garnishment against the Grangers’ 1/12th interest in Gertrude Granger’s estate. The court, holding that the tax lien has priority, stated that the IRS’s lien attaches to all property of the debtor, which included the interest in Granger’s estate. Under the proposition of first-in-time, first-in-right (United States v. City of New Britain65), the IRS would have priority because it filed before the creditor garnished the estate.

In In re National Financial Alternatives, Inc.,66 the court examined the relationship between a bank’s lien and the lien of the IRS. National Financial Alternatives, Inc. (NFA) produces steel products. In the course of business, NFA receives purchase orders, buys raw material, ships the finished product, and generates accounts receivable and collects them. NFA’s claim against First Midwest Bank/Joliet is partially secured by a perfected security interest both in the inventory, accounts receivable, and purchase orders of NFA and in the proceeds of these items of collateral.

A district court affirmed a bankruptcy court decision prohibiting the IRS from participating in the distribution of estate assets because the IRS failed to file a motion to value collateral under Bankruptcy Rule 3012.67 The bankruptcy court ruled this way even though the tax lien was allowed as a secured claim.

The district court held that the lower court properly precluded the government from participating in the distribution of estate assets, citing In re Linkous68 and In re Harrison.69 The court found the government’s discussion of the scope of a federal tax lien largely irrelevant, because tax liens are treated the same as conventional secured claims under the Bankruptcy Code. The court further noted that there is nothing in bankruptcy law that affords the government more protection than other secured creditors. The IRS’s size and complexity do not excuse it from complying with the Bankruptcy Code; instead, because the IRS is a huge federal governmental agency, its level of sophistication as a secured party should actually be higher than that of the ordinary private secured party.

NFA failed to properly remit its withholding taxes and, on April 16, 1988, the IRS filed a notice of tax lien for the 1987 withholding taxes. NFA filed a bankruptcy petition on June 22, 1988. On the schedules filed with the bankruptcy court, the assets of NFA were less than the indebtedness to First Midwest. Both the bank and the IRS filed motions to keep NFA from using cash collateral. When NFA filed its bankruptcy petition, there was a fairly large balance in the inventory and accounts receivable accounts but almost no cash balance.

The IRS argued that its tax lien had priority over the bank’s security interest in the accounts receivable acquired by NFA more than 45 days after filing of the tax lien. The inventory, contract rights, and accounts receivable acquired by NFA before the expiration of the 45-day period were “qualified property,” according to the IRS, under I.R.C. section 6323(c).

First Midwest argued that its security interest had priority in the accounts receivable acquired after the expiration of the 45-day period to the extent such accounts receivable are proceeds of “qualified property.” The IRS claimed that accounts receivable cannot be considered “proceeds” of any form of collateral because, under a treasury regulation,70 accounts receivable may be acquired only at the time the right to payment is earned.

The bankruptcy court held that accounts receivable may be proceeds of both inventory and contract rights and that the bank has a qualifying security interest in any accounts receivable that were held by NFA on June 22 and that were either acquired before the expiration of the 45-day period or were the proceeds of contract rights or inventory acquired before that date. The court further ruled that the bank has the burden to prove which of the accounts receivable fit into these categories.

The court also noted that if some of NFA’s inventory at June 22 (the time of filing the bankruptcy petition) was purchased with cash received between the expiration of the 45-day period and June 22, it may not be qualified property.71 Under this condition, the IRS is entitled to claim an interest before that of the bank. However, the IRS has the burden of establishing the value of these rights.

The court did not accept the argument of the IRS that accounts receivable may not be proceeds; the Treasury Regulations plainly extend the protection for security interests in qualified property to the proceeds of that property. Those proceeds are normally in the form of cash, negotiable instruments, or accounts receivable.

The court held that NFA is required to obtain consent of both the bank and the IRS before using any cash that it acquires.

In Oliver J. Latour, Jr. v. Commissioner,72 the bankruptcy court held that tax liens do not attach to property acquired after the petition is filed. Oliver and Jane Latour filed federal income tax returns for the years 1980 and 1985 through 1987. The IRS assessed deficiencies against the Latours for those years and filed notices of federal tax liens against the Latours’ property. In September 1991, the Latours filed for bankruptcy under chapter 7 and listed the tax liabilities in their schedules filed with the court. They filed an adversary proceeding to determine the dischargeability of the tax liabilities and the validity of the tax liens. The bankruptcy court held that the tax liabilities were dischargeable because the tax claims were not subject to the exception to discharge set forth in section 523 of the Bankruptcy Code and because the tax returns were filed more than two years before the date of the petition. The court also determined that the tax liens that attached to prepetition property and to any other property of the estate were valid and enforceable. However, the court ruled that the liens did not attach to any property acquired after the petition was filed and, thus, could not be enforced against such property.

In In re Anderson,73 the tax lien is created as of the assessment date and continues until the liability is satisfied or becomes unenforceable due to the passage of time, as indicated in I.R.C. section 6322. This tax lien attaches to a taxpayer’s property immediately upon assessment; however, the lien does not attach to a taxpayer’s property acquired postpetition when the tax debt is discharged in bankruptcy.74 An issue that has received considerable attention in the Ninth Circuit is the priority of a federal tax lien over liens created by state law. The Ninth Circuit examined this issue extensively in In re Kimura.75

During part of 1986 and 1987, Roger Kimura and Donna Kimura, as “responsible persons” of Nikko Garden, Inc., failed to pay over to the U.S. income and Federal Insurance Contributions Act (FICA) taxes due. On May 19, 1987, the IRS assessed a penalty against the Kimuras in the amount of $103,617 for the taxes owed, under I.R.C. section 6672. As a result of the assessed and unpaid federal taxes, a federal tax lien attached to all of the Kimuras’ property pursuant to I.R.C. section 6321, and proper notice of the federal tax lien was filed on June 3, 1987.

In 1988, the Kimuras filed a chapter 7 bankruptcy petition. The bankruptcy trustee attempted to liquidate the Kimuras’ liquor license issued by the Alaska Alcoholic Beverage Control Board (ABC Board). Subsequently, the bankruptcy court approved the sale of the Kimuras’ interest in the liquor license for $82,500. Alaska law provides that a liquor license may not be transferred to another person without the consent of the ABC Board.76 The statute also provides that the ABC Board may not consent to the transfer of a liquor license if the transferor has not paid all debts or taxes arising from the conduct of the business licensed under this title unless the transferor gives, for the payment of the debts or taxes, security that is satisfactory to the creditor or taxing authority.77 Three of the Kimuras’ trade creditors initially objected to the proposed sale but later agreed to the sale, provided the claims of all creditors that under state law may object to the approval of the sale, transfer, and renewal of the license could be asserted against the cash proceeds of the sale. The amended order also provided that all liens and encumbrances on the liquor license would be transferred to the proceeds of the sale.

The trustee filed a notice of final accounting in which he proposed to distribute the funds in the following order:

• Administrative expenses, including a broker’s commission, incurred in the sale of the license
• $15,528.87 to the Municipality of Anchorage for local taxes
• The balance of the proceeds on a pro rata basis to creditors that had liens against the liquor license recognized by the ABC Board

The IRS objected to this proposed distribution, arguing that it was entitled to receive the entire balance after the payment of taxes to the Municipality of Anchorage. The bankruptcy court overruled the objection, and the Ninth Circuit BAP affirmed the bankruptcy court.

The Ninth Circuit held that whether the interest created by the state is “property” or a “right to property” to which the federal tax lien can attach is a matter of federal law.78 The Ninth Circuit noted that, were federal law not determinative of the classifier of the state-created interest, states could defeat the federal tax lien by declaring an interest not to be property, even though the beneficial incidents of property belie its classification.79

The Ninth Circuit noted that the nature of the interest created by Alaska does not require extensive analysis because a liquor license will constitute property, within the meaning of federal law, if the license has beneficial value for its holder and is sufficiently transferable. The court cited Little v. United States,80 which concluded that a declaration that an asset is property under I.R.C. section 6321 involves determining whether it has pecuniary worth and is transferable.81

The Kimura court stated that courts have recognized the value that a liquor license creates for a licensee. Generally, a liquor license has intrinsic worth that is subject to bargain and sale in the marketplace. The court further noted that, subject to certain conditions, Alaska liquor licenses are transferable both from person to person and from location to location.82 The transferor of a license may retain a security interest in the license to secure payment for real and personal property conveyed to the transferee.83 Based on these statutes, the Kimuras’ liquor license was ultimately capable of being surrendered and reduced to a value of $82,500. Thus, the Ninth Circuit concluded that an Alaska liquor license satisfies both requirements—independent value and sufficient transferability—and constitutes property or a right to property within the meaning of I.R.C. section 6321. As a result, a federal tax lien was attached to the Kimuras’ liquor license when notice of the tax lien was filed by the IRS.

However, the trade creditors argued that even if the Kimuras’ liquor license was property to which the federal tax lien attached, all the IRS obtained was the debtors’ right to petition the ABC Board for transfer of the liquor license, and because Alaska law mandates payment to trade creditors before transfer of the license can occur, the IRS was entitled to attach only the residual value of the license after payment to the debtors’ trade creditors. In support of their contentions, the trade creditors cited a string of Ninth Circuit authority, beginning with United States v. California.84

In a footnote, the Ninth Circuit stated:

BAP came to this conclusion when it improperly relied on state law. The Supreme Court in Bess made clear, however, that federal law is to be used to determine the consequences of the attachment of a federal lien to property held by the debtor. 357 U.S. at 55; see also Aquiline v. United States, 363 U.S. 509, 513–14, 4 L. Ed. 2d 1365, 80 S. Ct. 1277, 5 A.F.T.R.2d (P-H) 1698 (1960) (“Once the [federal] tax lien has attached to the taxpayer’s state-created interests, we enter the province of federal law, which we have consistently held determines the priority of competing liens asserted against the taxpayer’s ‘property’ or ‘rights to property’”); United States v. Acri, 348 U.S. 211, 213, 99 L. Ed. 264, 75 S. Ct. 239, 46 A.F.T.R. (P-H) 986 (1955) (“The relative priority of the lien of the United States for unpaid taxes is . . . always a federal question to be determined finally by the federal courts. The state’s characterization of its liens, while good for all state purposes, does not necessarily bind this Court.”).

Citing Queen of the North, 582 P.2d at 149, the panel used Alaska law to conclude that the federal tax lien attached only to the debtors’ right to petition the ABC Board for transfer of the liquor license.

The Ninth Circuit rejected the trade creditors’ argument that the State of Alaska may validly impose on transferability conditions that reserve an interest not in itself, but in favor of a class of trade creditors.85 The Ninth Circuit agreed with the IRS that, in this case, “state law has been used to create in a creditor other than the State, a property interest that would limit the property subject to a federal tax lien.”

The Ninth Circuit concluded that Alaska’s statutory conditions for the transferability of a liquor license invalidly establish in trade creditors a property interest that violates the supremacy of a federal tax lien under federal law.

The Ninth Circuit expanded on the difference between its decision in United States v. California, where it held that California had a right to reserve to itself payment of state taxes as a statutory condition for the transfer of a state-created liquor license,86 and the facts in Kimura. The court concluded:

[T]he state’s statutory scheme was not in violation of the “paramount right of the United States to levy and collect taxes pursuant to Article I, section 8, of the United States Constitution,” even though the scheme’s effect was to subordinate the federal tax lien. Id. at 727. We reasoned that the issue was not the supremacy of the federal tax lien but the nature of the property to which the lien attached.

The Ninth Circuit, in United States v. California, noted:

[The] license existed because the state had issued it and if the licensee acquired something of value, it was because the state had bestowed it upon him. Whatever value the license, as property, may have had to a purchaser depended upon its transferability. If it was transferable, it was because the state had made it so. If the state had seen fit to impose conditions upon issuance or upon transfer of property it has wholly created, that is the state’s prerogative so long as its demands are not arbitrary or discriminatory.87

The Ninth Circuit, in Kimura, then noted that, because California had required that state taxes be paid before transfer of the liquor license, the interest in property to which the federal lien attached was the residual value of the property after the state taxes were paid. Consistent with its holding in United States v. California, the Ninth Circuit concluded that the State of Alaska had the right to reserve to itself payment of delinquent state and local taxes, such as taxes owed to the Municipality of Anchorage, which are entitled to first priority from the proceeds of the sale of the Kimuras’ liquor license.88

The Ninth Circuit noted that two cases89 have given priority to tax claims but that these cases did not involve a federal tax lien or a preference for third-party creditors.90 The Ninth Circuit noted that these cases cannot “be read for the broader proposition that the state can reserve any interest it sees fit, to the detriment of the federal government.”91

The Kimura court noted that, in Artus v. Alaska Department of Labor (In re Anchorage International Inn, Inc.),92 the Ninth Circuit considered whether Alaska’s statutory requirement that trade creditors be paid before transfer of a liquor license was preempted by federal bankruptcy law and held that “no statutory bankruptcy policy forbids [Alaska] from giving one creditor a greater right to payment of his claim from a given asset than that conferred to another.”93 This case, however, did not construe federal law involving competing claims as against a federal tax lien.94

The Ninth Circuit concluded that Alaska may reserve a property interest to itself, to be paid before transfer of a liquor license, but it may not reserve the same property interest in third parties and thereby subordinate the federal tax lien.95

After ruling that the federal tax lien in this case attached to the proceeds from the transfer of the Kimuras’ liquor license, the Ninth Circuit concluded that, under federal law, when a federal tax lien and a state law lien compete, priority is determined by the general rule that “the first in time is the first in right.”96

The Sixth Circuit97 gives a federal tax lien priority over a state law lien. The bankruptcy court held that under Kentucky law, Dishman Independent Oil, Inc.’s attachment lien became effective at the time of the levy rather than at the time of the judgment, giving it priority over the federal tax lien. The district court affirmed the bankruptcy court’s decision. The Sixth Circuit reversed by explaining that the Supreme Court determined in United States v. McDermott98 that a state lien is perfected only when the identity of the lien, or the property subject to the lien, and the amount of the lien are established. The appeals court here concurred with the IRS’s assertion that Dishman’s lien was not perfected until April 27, 1992, when the bankruptcy court determined the amount of the lien and the property subject to it.

Citing United States v. Acri,99 the appeals court held that, for federal tax purposes, Dishman’s interest in the property was inchoate when the government’s tax lien attached, because the amount of Dishman’s lien was contingent on the bankruptcy court’s decision. An interesting aspect of this case is that it appears that the IRS may have become the owner of the property at issue even before filing its tax lien. As a result the Sixth Circuit advised that on remand, the lower court must “also consider whether the actions of the IRS, purporting to file a tax lien on its own property in January 1992, constituted additional inequitable conduct.”

In In re Boerne Hills,100 the Fifth Circuit held that a tax lien that is avoidable under state law has priority if no action is taken to avoid the lien. Chrysler Credit Corp. perfected a lien against Boerne Hills Leasing Corp. by filing a financing statement. Subsequently, the City of Boerne (Texas) and Kendall County filed tax liens, and Boerne Hills filed a bankruptcy petition. The bankruptcy court authorized the debtor to sell its inventory free and clear of any liens and then determined that Chrysler’s lien had priority. Because the proceeds from the sale did not generate sufficient proceeds to cover Chrysler’s claim, the bankruptcy court ordered Boerne Hills to distribute all the sale proceeds to Chrysler. The local taxing authorities objected.

At a hearing, the taxing authorities argued that their liens had priority pursuant to Texas law, and Chrysler claimed that because the tax liens were unenforceable against a bona fide purchaser without notice, at the time of the bankruptcy filing, they were unperfected. The bankruptcy court held that Chrysler had a superior claim, and the district court affirmed, holding that the tax liens were avoidable under section 545(2) of the Bankruptcy Code. Although neither the debtor in possession nor the trustee had initiated an adversary proceeding to avoid the tax liens, the district court concluded that Chrysler had standing to exercise the debtor in possession’s avoidance power.

The Fifth Circuit reversed, holding that the tax liens had priority because they were not avoided. The court noted that, under Texas tax law, a tax lien has priority over all other liens. However, the tax liens were avoidable because they were unenforceable against a bona fide purchaser without notice of the tax liens. The Fifth Circuit concluded that only the trustee or debtor in possession has avoidance powers under the Bankruptcy Code and that a creditor may exercise that power only after moving the bankruptcy court for authority to act on behalf of the trustee or debtor in possession. Because Chrysler did not request such authorization, the Fifth Circuit concluded that the tax liens were not avoided.

In C.S. Associates v. Miller,101 the bankruptcy court held that the city’s prepetition liens had priority over secured claim and suggested that the city attempt to collect its postpetition taxes and rents for water and sewer from the sales proceeds pursuant to either section 503(b)(1)(B)(i) or section 506(c) of the Bankruptcy Code. The city then moved the bankruptcy court, pursuant to section 506(c), to surcharge the sales proceeds and allow the city to collect its postpetition tax claims. The bankruptcy court granted the motion. The secured lender appealed, arguing that the city had not satisfied 11 U.S.C. section 506(c), and the district court affirmed.

The Third Circuit reversed the decision of the lower courts and held that the city did not demonstrate that the taxes on which its claim was based conferred a direct benefit to the secured lender, whose claim was secured by the property. The Third Circuit noted that the city’s postpetition real estate taxes and water and sewer rents could not attain lien status for purposes of the Bankruptcy Code according to section 362(a)(4) of the Bankruptcy Code. Citing Equibank, N.A. v. Wheeling-Pittsburgh Steel Corp., 884 F.2d 80 (3d Cir. 1989), the court noted that for taxes to be paid absent lien status, “they may be payable by the secured creditor as payment for benefit received.” The appeals court held that the city had not conferred a sufficient, tangible benefit on the creditor in return for the real estate taxes or water or sewer rents, and thus would not be preferred over the secured creditor. The Third Circuit explained that “[h]ad the City put forth evidence that the property had received some direct or special government service which benefited the property.” However, it should be noted that section 712(d)(2) of the 2005 Act amended section 506(c) of the Bankruptcy Code to permit a trustee to recover from a secured creditor the payment of all ad valorem property taxes.

In Paul Revere Life Insurance Co. v. Brock,102 the Sixth Circuit reversed the lower court and held that interest has the same priority as a tax lien, noting that pursuant to I.R.C. section 6321, tax liens included all interest due. According to I.R.C. section 6601(a), the interest on underpaid taxes accrues from the date payment is due until the date paid and under section 6665(a), penalties and interest are to be collected in the same manner as taxes. The court stated that “[f]rom these statutes, it follows that whatever priority the government enjoys with regard to tax liens, the government enjoys the same priority with regard to interest in those liens.”

A federal tax lien on the sales proceeds of the debtor corporation’s property had priority over the opposing creditor because the creditor was merely the debtor’s alter ego.103 The Eighth Circuit concluded that the owner of the debtor corporation attempted to shelter the debtor’s assets from its creditors by means of a self-imposed lien and that it would be inequitable to allow the debtor to deplete the estate by paying itself at the expense of its true creditors.

A district court held that the IRS had priority over a judgment creditor to the proceeds of a noncompete agreement, finding that the bankrupt couple who acquired the proceeds resided in Florida where the IRS filed its lien and had only business ties with Illinois.104

The bankruptcy court105 held that a tax lien for unpaid withholding taxes attached to the taxpayer’s rights the settlement monies received as soon as the case was settled, and the settlement monies were paid to her counsel. The settlement funds that were disbursed to creditors after being received and prior to the filing of the bankruptcy petition and recovered by the trustee were subject to the tax lien. However, the court held that the IRS’s lien is subordinate to the trustee’s commissions and the fee of the attorney for the trustee.

(f) Chapter 7

Section 724(a) of the Bankruptcy Code gives to the trustee the right to avoid liens that are for fines, penalties, forfeiture, and the like that arose prior to the filing of the petition and that are not for actual pecuniary losses. Section 544(a) of the Bankruptcy Code allows the trustee to cancel any tax lien that was not filed prior to the bankruptcy petition.

In United States v. LMS Holding Co.,106 property subject to the tax lien was acquired by Retail Marketing Corp. (RMC) under the creditors’ bankruptcy plan of liquidation. The IRS was notified of the bankruptcy and was aware of the formulation and confirmation of the plan that included the terms of the sale to RMC. The IRS did not file a new notice of tax lien naming RMC, and RMC subsequently filed for bankruptcy. The IRS filed its proofs of claim against RMC approximately one year after the deadline.

The bankruptcy court held that because the IRS failed to timely file a new notice of tax lien against RMC, RMC was entitled to avoid the lien. The IRS’s lien was therefore unsecured.

On appeal, the district court affirmed the lower court’s decision relegating the IRS claim to that of an unsecured creditor. The court noted that, although no mandatory precedent could be found on the issue, the facts in the case were analogous to cases involving taxpayer name changes, where courts have held that the IRS has an affirmative duty to refile the notice of tax lien to show the taxpayer’s new name.

The court explained that the transaction in this case was more complex than a name change, and if the IRS is required to file a new notice when a taxpayer merely changes names, the same result should ensue when an entirely different entity is involved. Collateral that is subject to a tax lien may be sold in bankruptcy. Prior to the 2005 Act, section 724(b) of the Bankruptcy Code provided that, in a chapter 7 liquidation, tax claims secured by a lien are paid only after the first six priority items are paid. Because of the change to priorities by the 2005 Act, the first six priorities are now the second through seventh priorities. The 2005 Act made two major changes. Section 724(b) modifies the subordination provision by not subordinating perfected, unavoidable tax liens arising in connection with an ad valorem tax on real or personal property. Also, administrative expense incurred after the petition is filed is restricted to chapter 7 expenses unless the claim is for wages, salaries, or commissions or employee benefits incurred in chapter 11. The 2005 Act adds a subsection (e) to section 724 providing that before a tax lien may be subordinated, the trustee shall (1) exhaust the unencumbered assets of the estate, and (2) in a manner consistent with section 506(c), recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving or disposing of that property.

Subsection (f) provides that notwithstanding the exclusion of ad valorem tax liens, claims for wages, salaries, and commissions that are entitled to a section 507(a)(4) priority and claims for contributions to an employee benefit plan entitled to a 507(a)(5) priority may be paid from property of the estate that secures a tax lien, or the proceeds of such property.

The provision to not subordinate property taxes, to use unencumbered assets, and to subordinate property tax claims to wage holders appears fair. However, the provision to limit the subordination to chapter 7 expenses may limit the recovery of assets for unsecured creditors. A trustee appointed in a chapter 11 case, where there is a tax lien on all assets, has no incentive to go after known or potential recoveries, because any costs that are incurred will not be allowed unless the tax claims are paid in full. Trustees are often better equipped to recover assets than the taxing authorities. Removing the incentive for the chapter 11 trustee may in fact result in less recovery to both the taxing authorities and other creditors.

The following list indicates the order in which proceeds from the sale of property subject to a tax lien are to be distributed:

In N. Slope Borough v. Barstow (In re Bankr. Estate of Markair, Inc.),107 the Ninth Circuit analyzed extensively the priority set forth in section 724(a) and accepted the bankruptcy court’s interpretation of the distribution and rejected the position taken by the district court. The Ninth Circuit concluded that section 724(b) of the Bankruptcy Code subordinates the interests of tax lienholders to that of priority unsecured creditors, but only up to the total amount of the tax lien. Any remaining proceeds are to be distributed first to junior lien claimants, next to the tax lienholders, and, finally, to the debtor’s estate. The court noted that section 724(b)(2) allows the priority claimants under section 507(a) to prime a tax lienholder, but expressly limits the amount distributable to section 507(a) claimants to the “amount of such allowed tax claim that is secured by such tax lien.” The amount going to the debtor’s estate would then be distributed in accordance with the provisions of section 726 of the Bankruptcy Code.

Thus, in chapter 7, claims of unsecured creditors or claims of secured creditors that are not perfected are subordinated to all tax liens. Note that both personal and real tax liens are subordinated to the payment of priority tax claims. Under the Bankruptcy Act, only personal tax liens were subordinated. These provisions apply equally to federal and state and local taxes. The fact that state and local taxes are subordinated by a federal statute does not violate the Tenth Amendment to the U.S. Constitution, because equal treatment is established for both federal and state and local taxes.108

Even unfiled tax liens and unsecured tax claims have priority over other unsecured claims, provided these taxes are classified as priority taxes. Tax claims of individuals that are classified as priority tax claims and are not satisfied are not discharged under the provisions of section 523 of the Bankruptcy Code.

Section 724(d) of the Bankruptcy Code provides that a statutory lien that is determined in the same manner as a tax under I.R.C. section 6323 will be treated under section 724(b) as a tax lien.

(g) Chapter 11

In chapter 11, all tax liens that were properly perfected are treated as secured claims, and their interest must be dealt with in the plan, along with other secured claims. IRS penalties that are fully secured may not be subordinated in chapter 11 as provided for in chapter 7.109 Unfiled tax liens or tax liens filed after the chapter 11 petition is filed can be avoided.

The payment of both secured and unsecured tax claims must be provided for in the plan. A plan will not be confirmed by the court unless the tax claims are not impaired under the plan, the tax authority accepts the plan, or the plan provides for tax payments in accordance with the provisions of section 507 of the Bankruptcy Code (see §§ 11.2(e) and (m)).

If the tax lien is properly perfected and the tax authority does not accept the plan, then the taxing authority may retain the lien securing the claim, receive deferred cash payments equal to the amount of the claim, or receive the indubitable equivalent of the claim.

The U.S. Supreme Court held, in Whiting Pools,110 that the IRS could not keep property seized prior to the filing of a chapter 11 bankruptcy petition. In this case, the IRS seized the operating assets of the debtor just prior to filing of a reorganization petition. The court held that, under Bankruptcy Code section 542(a), the bankruptcy court has the authority to order the IRS to return the property to the trustee of the reorganized estate even though the debtor no longer had a possessory interest in the property. The court further stated that nothing in the legislative history suggests that Congress intended to permit the IRS to interfere with the reorganization effort by depriving the estate of its assets essential to the rehabilitation effort. The IRS interest, like the interest of other creditors, is adequately protected under the Bankruptcy Code.

In In re Penrod,111 the Penrods filed a chapter 11 plan that provided for their secured claim to be paid in full, plus interest, on a monthly basis over a seven-year period. The secured creditor voted to accept the plan, which was subsequently confirmed by the bankruptcy court. There was no provision in the plan that provided for the lien on the collateral (hogs). The hogs became diseased, forcing the Penrods to liquidate the entire herd. The Penrods refused to provide a replacement lien or to remit the proceeds to the lender. The bankruptcy court ruled that since the plan did not provide for the continued liens on the hogs, the claim was unsecured. The bankruptcy court held that unless the lien is expressly preserved by the terms of the plan of reorganization, it is voided by the confirmation of that plan. The Seventh Circuit upheld the bankruptcy court’s decision.112

See In re Kinion,113 where the Fifth Circuit would not allow the ruling in In re Penrod to apply.

(h) Survival of Lien

Most courts have held that the debtor may not obtain an order to compel the IRS to release the liens under I.R.C. section 6325(a)(1) when a valid tax lien exists against the debtors’ property for unpaid taxes that were discharged under sections 523(a)(1), 507(a)(7), and 727 of the Bankruptcy Code.

I.R.C. section 6325(a)(1) provides that a lien shall be released when “[t]he Secretary finds that the liability for the amount assessed . . . has been fully satisfied or has become legally unenforceable.” In In re Robert H. Isom,114 the Ninth Circuit held that the liability for the amount assessed remains legally enforceable even where the underlying tax debt is discharged in the bankruptcy proceeding. A discharge in bankruptcy, however, prevents the IRS from taking any action to collect the debt as a personal liability of the debtor.

In John Braddock v. United States,115 the bankruptcy court held that the properly filed tax liens were excepted from the homestead exemption pursuant to 11 U.S.C. 522(c)(2)(B). The IRS did not file an objection to the claim for an exemption of the homestead. The court, however, found that the IRS was not required to file such an objection for the tax lien to survive.

The Braddocks filed their homestead exemption prior to the filing of the tax lien for unpaid FICA taxes. However, the tax lien was filed prior to the filing of the bankruptcy petition. The bankruptcy court held that the first-in-time argument with respect to tax liens was without merit and that the Braddocks’ reliance on Crow v. Long116 was misplaced.

The bankruptcy court noted that Mrs. Braddock was not listed on the tax notice and she had no interest in the produce business. Thus, the tax lien did not apply to her and she was entitled to her homestead exemption.

Federal tax liens attach to property exempt from an administrative levy under I.R.C. section 6334. Section 6334 exempts from levy, inter alia, the following personal property: wearing apparel, school books, fuel, furniture, tools of a trade, business, or profession, unemployment benefits, undelivered mail, pension payments, workers’ compensation, and judgments for support of minor children.117

The circuit courts were split on whether section 506(d) of the Bankruptcy Code permits a chapter 7 debtor to avoid tax liens related to taxes that are dischargeable. The Supreme Court looked at the issue in Dewsnup v. Timm.118

The Supreme Court held that after a property has been abandoned by the trustee, a chapter 7 debtor cannot use section 506(d) of the Bankruptcy Code to strip down an undersecured creditor’s lien on real property to the value of the collateral.

Bankruptcy Code section 506 provides in relevant part:

(A) An allowed claim of a creditor secured by a lien on property in which the estate has an interest, . . . is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property, . . . and is an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.

* * *

(d) To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless (1) such claim was disallowed only under section 502(b)(5) or 502(e) of this title; or (2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.

Thus, section 506(a) of the Bankruptcy Code bifurcates claims into secured and unsecured claims, depending on the value of the collateral. Section 506(d) then apparently voids the portion that is not an “allowed secured claim.”

In affirming the Tenth Circuit Court of Appeals, the Supreme Court held that section 506(d) does not allow the debtor to “strip down” the creditor’s lien to the judicially determined value of the collateral, because the creditor’s claim is secured by a lien and has been fully allowed pursuant to section 502 and, therefore, cannot be classified as “not an allowed secured claim” for purposes of the lien-voiding provision of section 506(d). The Supreme Court held that section 506(d) and its relationship to other Bankruptcy Code provisions are ambiguous. The Court reasoned that the words “allowed secured claim” in section 506(d) need not be read as an indivisible term of art defined by reference to section 506(a) but should be read term by term to refer to any claim that is, first, allowed and, second, secured generally.

The Court reasoned that Congress must have enacted the Bankruptcy Code with a full understanding of the rule that liens on real property pass through bankruptcy unaffected and, given the statutory ambiguity that the majority found, to attribute to Congress the intention to grant a debtor the broad new remedy against allowed claims to the extent that they become “unsecured” for purposes of section 506(a) without mentioning the new remedy somewhere in the Bankruptcy Code or in the legislative history would be implausible and contrary to basic bankruptcy principles.

In footnote 3, the majority stated: “[W]e express no opinion as to whether the words ‘allowed secured claim’ have different meaning in other provisions of the Bankruptcy Code.”

The case is significant in that the Court went out of its way to construe statutory language to accommodate the policy that secured real property liens survive bankruptcy intact. The Dewsnup attempt to strip liens on property abandoned by the trustee is only one of debtors’ techniques to strip liens. Another technique is for the debtor to obtain a discharge of the debt by liquidating in a chapter 7 but to retain the mortgaged property by curing the defaults in a later filed chapter 13. That is, the debtor uses a chapter 7 to strip away any possible personal liability on a possible deficiency, should the mortgagee prove to be undersecured. Then the debtor uses a chapter 13 to cure and reinstate only the secured portion of the mortgagee’s claim. In Johnson v. Home State Bank,119 the Supreme Court held that the Bankruptcy Code did not preclude such “serial filings,” but the Court did not reach the question of whether such filings are in good faith. If the Dewsnup case shows the Court’s inclination against lien stripping, this bodes well for secured creditors in these other lien-stripping techniques.

In In re Scott Warner,120 the individual debtor attempted to distinguish Dewsnup on the grounds that Dewsnup involved a consensual mortgage lien, while this case involved a nonconsensual tax lien that does not pass through bankruptcy unaffected. The district court, in rejecting the debtor’s arguments, noted that the Supreme Court did not limit the application of its analysis to mortgage or consensual liens only. The district court, citing In re Baund,121 noted that, to the extent a tax lien has attached to property before the filing of a petition, a later discharge in bankruptcy does not affect the right of the government to proceed against the property subject to the lien.

In Richard A. Anderson v. United States,122 a Ninth Circuit bankruptcy appellate panel has held that the pension plan was not part of the property in the bankruptcy estate. The court then concluded that the vested right to receive funds prior to the filing of the bankruptcy constituted property or a right to property to which the IRS lien could attach. Richard Anderson had a vested interest of $85,000 in a pension plan, and the IRS had filed two tax liens prior to the petition but had not levied against Anderson’s interest in the pension plan.

In In re Campbell,123 the court limited the secured claim to $3,725, which was the Campbells’ interest in the properties to which the tax lien attached. The Campbells also owed additional taxes that were not secured. The secured claim was paid in full under the confirmed chapter 13 plan.

The IRS objected to the release of the claim, contending that if the chapter 13 petition were dismissed, the Campbells could encumber their properties in favor of third parties who would have no notice of the government’s lien.

Because the government’s allowed secured claim was paid in full, the bankruptcy court found no merit in the government’s position that the tax lien must remain intact until the unsecured portion of the tax debt is discharged. The court noted that it was “difficult to conceptualize a lien in a vacuum, that is, a lien which does not encumber and attaches to a specific, identifiable property.”

In Nobelman v. American Savings Bank,124 the Supreme Court held that a debtor can value the property securing the lien, pay off an amount equal to the value of the secured claim under the chapter 13 plan, and then retain the property free and clear of the lien. Any appreciation in the value of the property goes to the debtor. In the case of a chapter 7 case, the appreciation would go to the creditor. When a secured tax lien is paid off and the debtor retains the property, but the chapter 13 plan is not completed and the petition is dismissed, the courts are split on whether the tax lien remains attached to the asset when the unsecured part of the tax remains unpaid.

In contrast, the bankruptcy court held, in In re Gibbons,125 that voiding of the tax lien is not allowed until the debtor completes the chapter 13 plan.

In deciding how to handle the issue, some courts have looked at sections 349(b)(1)(C) and 506(d). Section 505(d) provides that, to the extent a lien is not secured by property, it is void. Under section 349(b)(1)(C), a lien that is voided under section 506(d) is reinstated if the case is dismissed. Under chapter 13, when the secured part of the lien is paid, the courts are split as to whether the secured creditor’s lien has been satisfied or avoided. In In re Cooke,126 the bankruptcy court held that the lien was satisfied and thus was not reinstated. However, in In re Scheierl,127 the bankruptcy court held that the lien was avoided and thus was reinstated.

The bankruptcy court held that if the chapter 13 secured part of the claim is paid in full before the chapter 13 petition is converted to chapter 7, no additional payments are required to redeem a vehicle from the creditor.128 However, in In re Jordan,129 the debtor was not entitled to a release of lien when the secured portion of the claim was paid in full before the conversion took place.

In In re Wessel,130 the bankruptcy court held that the government may continue to levy on annuity payments, reasoning that Wessel had a fixed right to receive the payments prior to his filing for bankruptcy. The court noted that, because tax liens attach to all rights to property, the tax liens attached to Wessel’s contractual right to receive the payments.

George Wessel owed about $26 million in federal income taxes when he filed for bankruptcy protection. Wessel owned a group annuity contract under which he was entitled to receive monthly annuity payments of $7,200 for 97 months. If he died before the expiration of that period, the remainder of the 97 payments were to be made to his beneficiary. Following the expiration of that period in January 1993, Wessel was entitled to receive the monthly payment only for the duration of his life. Prior to filing the bankruptcy petition, the IRS had levied on a portion of those monthly payments. Wessel argued that the levy was illegal because the tax liens did not attach to the postpetition annuity payments, noting that the taxes had been discharged.

The court also rejected Wessel’s contention that his staying alive was a condition precedent to receiving the payments. The court noted that a release of the levy on one of the payments had no effect on the IRS’s right to collect pursuant to a subsequent levy because the tax liens on the property were never released.

The district court reversed the bankruptcy court’s decision in In re Demarah v. United States131 and held that exempt property was subject to the tax lien for unpaid tax penalties. The court followed the decision in In re Carlton,132 noting that the statutory purpose of section 724(a) of the Bankruptcy Code is to protect unsecured creditors from the debtor’s wrongdoing. Allowing Demarah to avoid penalties on taxes does not protect unsecured creditors in this case, because the penalties only impact the amount that the debtor would receive; the property exempt from the bankruptcy estate is out of the reach of the creditors.

The court also held that because the payments under the bankruptcy reorganization were not voluntary, the IRS could apply them as it saw fit. The court also noted that whether the payments were made pre- or postconfirmation was irrelevant to the determination of whether they were voluntary.

The bankruptcy court held that tax liens are not valid against a chapter 13 debtor’s residence, because notices of tax liens were not filed until after the debtor elected to exempt his homestead.133 The court noted other cases in which the courts have held that chapter 13 debtors lack standing to bring avoidance actions.134 But, citing In re Perry,135 the court ruled that a chapter 13 debtor may avoid tax liens as to exempt property. Thus, the court concluded, because Rogelio elected to exempt his homestead prior to the filing of the notices of tax liens, the liens are not valid against that property, pursuant to section 522(c)(2)(B) of the Bankruptcy Code.

The bankruptcy court held that a chapter 13 debtor’s thrift savings plan (TSP) account was attached by a federal tax lien and that the lien was not avoidable.136 The taxpayer argued that the tax liens did not attach to her TSP account because 5 U.S.C. section 8437(e)(2) states that TSP accounts may not be alienated and are not subject to execution, levy, attachment, garnishment, or other legal process. The bankruptcy court concluded that 5 U.S.C. section 8437(e)(2) should not be read as an implicit repeal of I.R.C. section 6321, because the two statutes do not conflict irreconcilably. The court reasoned that the TSP statute is susceptible to a reasonable interpretation that does not bar the attachment of the federal tax liens. The court noted that because the tax code does not exempt TSP accounts from tax levies, it is doubtful that Congress intended for the attachment of a federal tax lien to be barred by section 8437(e)(2). The court further noted that the goal of section 8437(e)(2) is to guard against unwise assignments by the employee beneficiary of a TSP account and to safeguard the account from being subject to attack by creditors in general.

(i) Exempt Property

A bankruptcy court held that section 522(c)(2)(B) of the Bankruptcy Code prohibits the avoidance of a properly filed prepetition tax lien on property claimed exempt by the debtor, even if the lien would otherwise have been avoidable under section 522(h).137 The court concluded that although the levy in this case was a transfer that was potentially avoidable by the trustee, it is not avoidable by the debtor under section 522(h). The bankruptcy court cited In re Straight,138 where the Tenth Circuit BAP held that section 522(c)(2)(B) prohibits the avoidance of a prepetition tax lien on property claimed exempt by a debtor, even if the lien would otherwise be avoidable under section 522(h).

The Fifth Circuit has held that a cause of action held by an insurance agent against State Farm Insurance Co. for its failure to ensure that a Keogh plan complied with the law is property of the agent’s bankruptcy estate that is exempt under state (Texas) law.139

In United States v. Parmele,140 the district court reversed the bankruptcy court and held the tax claims should not be reduced because the lien to which the taxes relate is exempt property. The bankruptcy court had ruled that the claims could be reduced by $3,226, which was the value assigned to the exempt property. The amount of the claim was $34,624, and the value of the property, including exempt property, to which the IRS had a valid lien was over $35,000.

The district court held that chapter 7 debtors’ exempt homestead proceeds were not exempt from IRS tax liens and debtors were not entitled to void the tax liens pursuant to section 506 of the Bankruptcy Code.141 The court rejected the taxpayers’ claim that voiding the tax lien was authorized by section 506. As noted by the court, under section 522(c)(2)(B) of the Bankruptcy Code, exempt property remains subject to debts secured by tax liens. Adopting any other policy, according to the court, would render section 522(c)(2)(B) meaningless and would allow the more general statute (section 506) to govern the statutory construction of the more specific statute (section 522).

The court also rejected the debtors’ assertion that “it would be unjust to allow the United States to benefit from their efforts to have various judicial liens senior to the IRS tax liens voided under [section 506].” The court reasoned that “prohibiting the Stauffers from voiding the IRS’[s] tax liens does not allow these liens to ‘leap frog’ what were previously more senior liens,” because the avoided judicial liens “had no equity against which to attach.”

The district court upheld the IRS’s secured claim against a chapter 7 debtor’s exempt personal property and affirmed the bankruptcy court’s ruling that the debtor lacked standing to challenge a tax lien on exempt property.142 The court also rejected the debtor’s alternative argument that the tax lien was invalid because the IRS had not refiled a notice of lien in a different state to which the debtor had relocated the property. The district court noted that regardless of where the tax lien was filed or recorded, the law created the lien upon assessment of the tax liability.

(i) Impact of Tax Levy

In In re Nine to Five Child Care,143 the bankruptcy court ordered the government to turn over to the trustee funds that the United States received in response to a notice of levy issued in an attempt to collect the debtor’s tax debt. The IRS served a notice of levy on the School Board of Palm Beach County (Fla.) in November 1994, seeking payment of amounts that the school board owed to the Nine to Five Child Care Center. Later the same day, Nine to Five filed for chapter 7 bankruptcy protection. The school board issued a check to the IRS for $39,779 in response to the levy nine days after the petition was filed. The bankruptcy court held that the notice of levy did not give the IRS a possessory interest in the funds as it had argued, but rather it protected the IRS against diversion or loss of the funds until priority among creditors could be determined.144

1 Wood v. Mize (In re Wood), 301 B.R. 558, 561-562 (Bankr. W.D. Mo. 2003). See In re Hamilton, 125 F.3d 292, 296 (5th Cir. 1997), and In re Lauer, 98 F.3d 378, 388 (8th Cir. 1996).

2 200 B.R. 923 (Bankr. D. Wyo. 1996), aff’d, 207 B.R. 217 (B.A.P. 10th Cir. (1997).

3 In re Pullman Constr. Indus., 210 B.R. 302 (N.D. Ill. 1997). See In re Harvard Mfg. Corp., 97 B.R. 879 (Bankr. N.D. Ohio 1989); In re E & S Comfort, Inc., 92 B.R. 616 (Bankr. E.D. Pa. 1988); and In re American Int’l Airways, Inc., 83 B.R. 324 (Bankr. E.D. Pa. 1988).

4 86-2 USTC (CCH) ¶ 9675 (D.C. Ohio 1986).

5 801 F.2d 819 (6th Cir. 1986).

6See In re Superior Toy & Manufacturing Co., 78 F.3d 1169 (7th Cir. 1996); Seidle v. GATX Leasing Corporation, 778 F.2d 61159, 660 (11th Cir. 1985); and Alvarado v. Walsh (In re LCO Enterprises), 12 F.3d 938, 940 (9th Cir. 1993).

7 80 B.R. 563 (Bankr. N.D. Ga. 1987).

8 84-2 USTC (CCH) § 9651 (Bankr. S.D. W. Va. 1984).

9 112 S. Ct. 527 (1991).

10 381 B.R. 774 (Bankr. D. Kan. 2008).

11 496 U.S. 53 (1990), aff’g, 878 F.2d 762 (3d Cir. 1989).

12 887 F.2d 981 (9th Cir. 1989).

13 In re Jones & Lamson Waterbury Farrel Corp., 208 B.R. 788 (Bankr. D. Conn. 1997).

14 210 B.R. 302 (N.D. Ill. 1997).

15 In re Ruggeri Elec. Contracting, 214 B.R. 481 (E.D. Mich. 1997).

16 See In re Ruggeri Elec. Contracting, Inc., 185 B.R. 750 (Bankr. E.D. Mich. 1995).

17 See In re Ruggeri Elec. Contracting, Inc., 199 B.R. 903 (Bankr. E.D. Mich. 1996); aff’d, 214 B.R. 481 (E.D. Mich. 1997).

18 In re Jones Truck Lines, Inc., 130 F.3d 323 (8th Cir. 1997).

19 In re Barry, 31 B.R. 683 (Bankr. S.D. Ohio 1983).

20 82 B.R. 402 (Bankr. W.D. Pa. 1988). See also In re Barry, 31 B.R. 683 at 685.

21 In re Wiles, 173 B.R. 92 (Bankr. M.D. Pa, 1994). See also Fandre v. Internal Revenue Service, 167 B.R.7 (Bankr. E.D. Tex. 1994); In re J.B. Winchells, Inc., 106 Bankr. 384, 390–91 (Bankr. E.D. Pa. 1989).

22 In re Gillenwater, 1996 Bankr. LEXIS 428 (Bankr. W.D. Va. 1996).

23 In re Filipovits, 1995 Bankr. LEXIS 1447 (Bankr. D. Md. 1995).

24 ILM 200029002 (Feb. 29, 2000).

25 The Revenue Reconciliation Act of 1990 increased the statute of limitations on collections from 6 to 10 years in I.R.C. §§ 6502(a)(1). The 10-year period applies to all taxes assessed after the enactment of the Act and any taxes assessed before the date of enactment, provided the statute of limitations on collections had not expired.

26 United States v. Berk, 374 B.R. 385 (D. Mass. 2007).

27 In re Gibout, 2000 Bankr. LEXIS 918 (Bankr. E.D. Mich. 2000).

28 131 B.R. 437 (Bankr. D. S.C. 1991).

29 164 B.R. 581 (Bankr. D. Ohio 1993).

30 712 F.2d 1326 (9th Cir. 1983).

31 No. CV-F-87-314; LEXIS, 89 TNT 191-19 (E.D. Cal. 1989).

32 193 B.R. 983 (N.D. Ga. 1996).

33 No. 91-90151 (Bankr. E.D. Cal. Oct. 15, 1992). See Cannon Valley Woodwork, Inc. v. Malton Construction Co., 866 F. Supp. 1248, 1250 (D. Minn. 1994) (“Minnesota’s statute does not require the commissioner to make a formal assessment and demand for unpaid taxes before the state has a lien against the taxpayer’s property”).

34 I.R.C. § 6323(f)(1).

35 790 F.2d 354 (3d Cir. 1986).

36 No. 588-2046 (Bankr. N.D. Ohio Jan. 3, 1991).

37 911 F.2d 1168 (6th Cir. 1990); see In re Long, 519 F.3d. 288 (6th Cir. 2008).

38 In re Clark, 2000 Bankr. LEXIS 740 (Bankr. M.D. Fla. 2000).

39 164 B.R. 976 (Bankr. N.D. Ind. 1993).

40 Redondo Constr. Corp. v. United States, 157 F.3d 1060 (6th Cir. 1998).

41 145 B.R. 300 (Bankr. W.D. Ark. 1992).

42 Adv. No. 92-913 (Bankr. M.D. Fla. 1993).

43 In re Sills, 82 F.3d 111 (5th Cir. 1996).

44 89 T.C. 287 (1987).

45 804 F.2d 84 (7th Cir. 1986).

46 1992 Bankr. LEXIS 1610 (Bankr. W.D. La. 1992).

47 In re Bisch, 159 B.R. 546 (Bankr. 9th Cir. 1993).

48 163 B.R. 327 (Bankr. N.D. Ill. 1994).

49 112 S. Ct. 773 (1992).

50 In re Tourville, 216 B.R. 457 (Bankr. D. Mass. 1997).

51 357 U.S. 51 (1958).

52 In re McIver, 255 B. R. 281 (D. Md. 2000).

53 148 B.R. 88 (Bankr. D.D.C. 1992).

54 See In re Wesche, 193 B.R. 76, 78–79 (Bankr. M.D. Fla. 1996) and cases cited therein.

55 In re Pletz, 225 B.R. 206 (Bankr. D. Or. 1997), aff’d, 234 B.R. 800 (D. Or. 1998).

56 1994 Bankr. LEXIS 2116; 75 AFTR 2d (PH) 728 (Bankr. S.D. Ga. 1994).

57 In re Sills, 82 F.3d 111 (5th Cir. 1996).

58 In re Davis, 1996 Bankr. LEXIS 133 (Bankr. D. Colo. 1996).

59 In re Stephenson, 96 B.R. 388 (Bankr. S.D. Fla. Sept. 20, 1988).

60 955 F.2d 376 (5th Cir. 1992).

61 See Pearlstein v. U.S. Small Business Administration, 719 F.2d 1169 (D.C. Cir. 1983).

62 834 F.2d 1263 (6th Cir. 1987).

63 No. CV 487-026; LEXIS, 87 TNT 193-28 (S.D. Ga. 1987).

64 90 B.R. 298 (Bankr. N.D. Ohio 1988). See In re Burwick, 186 B.R. 501 (Bankr. W.D. Wash. 1995).

65 347 U.S. 81 (1954).

66 96 B.R. 844 (Bankr. N.D. Ill. 1989).

67 In re Envirocon Int’l Corp., 214 B.R. 251 (M.D. Fla. 1997), reaff’d, 992 F. Supp. 978 (M.D. Fla. 1998).

68 141 B.R. 890 (Bankr. W.D. Va. 1992), aff’d, 990 F. 2d 160 (4th Cir. 1993).

69 987 F.2d 677 (10th Cir. 1993).

70 Treas. Reg. 301.6323(c).

71 Id.

72 Adv. No. 91-0350 (Bankr. S.D. Ala. Mar. 27, 1992).

73 250 B.R. 707, 710 (Bankr. D. Mont. 2000).

74 See In re Allison, 232 B.R. 195, 205 (Bankr. Mont. 1998), aff’d, 242 B.R. 705 (D. Mont. 1999) and United States v. Sanabria, 424 F.2d 1121 (7th Cir. 1970).

75 969 F.2d 806 (9th Cir. 1992).

76 Alaska Stat. § 04.11.040.

77 Id., § 360(4).

78 See National Bank of Commerce, 472 U.S. 713, 727 (1985); In re Terwilliger’s Catering, Inc., 911 F.2d 1168, 1171 (6th Cir. 1990), cert. denied, 501 U.S. 1212 (1991) (holding that federal law determines whether state-created interests constitute property to which the federal tax lien can attach); 21 West Lancaster Corp. v. Main Line Restaurant, Inc., 790 F.2d 354, 356 (3rd Cir. 1986) (same); Rodriquez v. Escambron Dev. Corp., 740 F.2d 92, 97 (1st Cir. 1984) (same).

79 Terwilliger’s Catering, 911 F.2d 1168, at 1171–72 (citing Note, Property Subject to the Federal Tax Lien, 77 Harv. L. Rev. 1485, 1487 (1964)); see Bess, 357 U.S. 51, 56–57 (1958); 21 West Lancaster Corp. v. Main Line Restaurant, Inc., supra note 35, at 357–58.

80 704 F.2d 1100, 1105–06.

81 See also In re Terwilliger’s Catering, 911 F.2d 1168, at 1171; 21 West Lancaster Corp. v. Main Line Restaurant, Inc., supra note 35 at 357.

82 Alaska Stat. §§ 04.11.040, 04.11.280, and 04.11.290.

83 Id., § 04.11.270.

84 281 F.2d 726 (9th Cir. 1960).

85 See In re Leslie, 520 F.2d 761, 763 (9th Cir. 1975) (“While a state, as the creator of a liquor license, may validly impose conditions on its transferability for the state’s own benefit, it may not, consistently with paramount federal law, impose conditions which discriminate in favor of particular classes of creditors”).

86 281 F.2d 726 at 728.

87 Id.

88In re Kimura, supra note 75, at 812, referring to Board of Trade v. Johnson, 264 U.S. (1924) and Hyde v. Woods, 94 U.S. 523 (1876) (holding that because stock exchanges created property interest in seats on exchanges, they could reserve unto themselves the right to be paid first any debts owed them from proceeds received upon sale of seats).

89 In re Farmers Markets, Inc., 792 F.2d 1400, 1403 (9th Cir. 1986) (holding California entitled to payment of taxes before transfer of a liquor license); In re Professional Bar, 537 F.2d 339, 340 (9th Cir. 1976) (holding California entitled to payment of taxes ahead of wage claimants).

90 See In re Professional Bar, 537 F.2d 339, at 340 n.2 (“Limitation of the value of state-created property on behalf of the state itself (and not private creditors) does not interfere with or frustrate federal bankruptcy law”).

91 In re Kimura, supra note 75 at 812–13.

92 718 F.2d 1446, 1447 (9th Cir. 1983).

93 Id. at 1451.

94 In re Kimura, supra note 75 at 813.

95 Id.

96 Id., citing United States v. City of New Britain, 347 U.S. 81, 85 (1954).

97 United States v. Dishman Independent Oil Inc., 46 F.3d 523 (6th Cir. 1995).

98 113 S. Ct. 1526 (1993).

99 348 U.S. 211 (1955).

100 15 F.3d 57 (5th Cir. 1994).

101 29 F.3d 903 (3d Cir. 1994).

102 28 F.3d 551 (6th Cir 1994).

103 In re B.J. McAdams, Inc., 66 F.3d 931 (8th Cir. 1995).

104 In re Carousel Int’l Corp., 219 B.R. 807 (CD. Ill. 1997).

105 In re Johnetta Wadkins, 2000 Bankr LEXIS 475 (Bankr. E.D. Ky. 2000).

106 161 B.R. 1020 (N.D. Okla. 1993).

107 308 F.3d 1057 (9th Cir. 2002). See also In re Atlas Commercial Floors, Inc., 125 B.R. 185, 187 (Bankr. E.D. Mich. 1991) (the statute on its face requires that tax-lien claimants be paid under § 724(b)(5) even when priority unsecured claimants have not been paid in full); In re A.G. Van Metre, Jr., Inc., 155 B.R. 118, 123 (Bankr. E.D. Va. 1993) (holding that priority unsecured claimants are entitled to payment “only to the extent of the amount of the tax liens. Then if [such] claims happen to equal or exceed the amount of statutory tax liens, the statutory tax liens are paid behind the claims of junior consensual lienholders”); Hargrave v. Township of Pemberton (In re Tabone), 175 B.R. 855, 860, 862 (Bankr. D.N.J. 1994) (setting forth a distribution in which the tax-lien claimant received payment under § 724(b)(5) even though priority unsecured claims remained unpaid); Marc Stuart Goldberg, P.C. v. City of New York (In re Navis Realty, Inc.), 193 B.R. 998, 1004 (Bankr. E.D.N.Y. 1996) (“It is important to note that the aggregate amount of the payments to the holders of the priority claims under 11 U.S.C. § 724(b)(2) cannot exceed the amount of the tax lien”).

108 In the matter of Hirsch-Franklin Enterprises, 63 B.R. 864 (Bankr. M.D. Ga. 1986); see In re Kamstra, 51 B.R. 826 (Bankr. W.D. Mich. 1985).

109 In re Sheldon Transfer & Storage Co., Inc., 1992 Bankr. Lexis 2409 (Bankr. D. Mass. 1992).

110 United States v. Whiting Pools, Inc., 462 U.S. 198 (1983).

111 169 B.R. 910, 913 (Bankr. N.D. Ind. 1994).

112 In re Penrod, 50 F.3d 459 (7th Cir. 1995). For a detailed analysis of this case, see Beth A. Buchanan Staudenmaier, Note: Survival of Liens, In re Penrod, 50 F.3d 459 (7th Cir. 1995), 21 Dayton L. Rev. 445 (Winter 1996).

113 207 F.3d 751, 756 (5th Cir. Tex. 2000).

114 901 F.2d 744 (9th Cir. 1990).

115 Adv. No. 91/00068 (Bankr. D. Mont. Oct. 20, 1992).

116 107 B.R. 184 (Bankr. E.D. Mo. 1989).

117 896 F.2d 377 (9th Cir. 1990).

118 112 S. Ct. 773 (1992).

119 111 S. Ct 2150 (1991).

120 146 B.R. 253 (N.D. Cal. 1992).

121 289 F. Supp. 604, 607-7 (CD. Cal. 1969), aff’d, 423 F.2d 718 (9th Cir. 1970).

122 149 B.R. 591 (Bankr. 9th Cir. 1992).

123 160 B.R. 198 (Bankr. M.D. Fla. 1993), aff’d, 180 B.R. 686 (M.D. Fla. 1995).

124 113 S. Ct. 2106 (1993).

125 164 B.R. 207 (Bankr. D.N.H. 1993).

126 169 B.R. 662 (Bankr. W.D. Mo. 1994).

127 176 B.R. 498 (Bankr. D. Minn. 1995).

128 In re Stoddard, 167 B.R. 98 (Bankr. S.D. Ohio 1994).

129 164 B.R. 89 (Bankr. E.D. Mo. 1994).

130 161 B.R. 155 (Bankr. D. S.C. 1993).

131 188 B.R. 426 (E.D. Cal. 1993).

132 19 B.R. 73 (D. N. Mex. 1982).

133 In re Rogelio Suarez, 182 B.R. 916 (Bankr. S.D. Fla. 1995).

134 In re Tillery, 124 B.R. 127 (Bankr. M.D. Fla. 1991); In re Bruce, 96 B.R. 717 (Bankr. W.D. Tex. 1989); In re Mast, 79 B.R. 981 (Bankr. W.D. Mich. 1987).

135 90 B.R 565 (Bankr. S.D. Fla. 1988).

136 In re Jones, 206 B.R. 614 (Bankr. D.D.C. 1997).

137 In re Forrest, 220 B.R. 424 (Bankr. W.D. Okla. 1997); aff’d, 1998 Bankr. LEXIS 526 (Bankr. 10th Cir. 1998).

138 207 B.R. 217 (B.A.P. 10th Cir. 1997).

139 In re Swift, 129 F.3d 792 (5th Cir. 1997).

140 171 B.R. 895 (N.D. Okla. 1994).

141 In re Stauffer, 1995 U.S. Dist. LEXIS 8574 (E.D. Cal. 1995).

142 In re Phillips, 197 B.R. 363 (M.D. Fla. 1996).

143 76 AFTR 2d Par 95-5021), Adv. No. 95-0244-BKC-SHF-A (Bankr. S.D. Fla. 1995).

144 See In re Challenge Air Int’l Inc., 952 F.2d 384 (11th Cir. 1992).