IRS Abused Its Discretion In Refusing To Consider Subordinating Its Tax Lien

Alessio Azzari, Inc., (2011) 136 TC No. 9

The Tax Court has concluded that IRS's refusal to consider a corporation's request to subordinate its tax lien, based on the settlement officer's erroneous conclusion that a lender's security interest in the corporation's accounts receivable already had priority over the tax lien, was an abuse of discretion. The Court further held that IRS abused its discretion in denying the corporation's request for an installment agreement based on the corporation's failure to stay current on its tax deposits where such failure was largely due to IRS's refusal to subordinate its lien.

Background. Under Code Sec. 6321, when a taxpayer fails to pay a tax liability after notice and demand, a lien arises that attaches to all the taxpayer's property and rights to property. Under Code Sec. 6331, IRS is authorized to seize and sell the taxpayer's property and rights to property subject to a federal tax lien. Thus, IRS may seize any property or property right (unless it's exempt under Code Sec. 6334(a)) of a delinquent taxpayer (whether held by him or someone else), sell it, and apply the proceeds to pay the unpaid taxes. Seized property may be real, personal, tangible, or intangible, including receivables, bank accounts, evidences of debt, securities, and salaries, wages, commissions or compensation. (Code Sec. 6331(a), Reg. §301.6331-1(a))

Lenders who enter “commercial transactions financing agreements,” in which the lender makes a loan against certain types of commercial financing security such as accounts receivable, are given a 45-day grace period in which to make advances or purchases which are protected against tax liens previously filed within the period under Code Sec. 6323(c). Accounts receivable acquired by a taxpayer more than 45 days after a federal tax lien is filed aren't protected by a financing agreement entered into before the filing of a federal tax lien.

Under Code Sec. 6159, IRS may enter into written agreements with any taxpayer. IRS must enter into an installment agreement requested by an individual whose aggregate tax liability (without interest, penalties, additions to tax, and additional amounts) isn't more than $10,000, and who hasn't failed to file or to pay income tax, or entered into another installment agreement, during any of the preceding five tax years, if IRS determines that the taxpayer is financially unable to pay the liability in full when due (and the taxpayer submits information that IRS may require to make this determination). The agreement must require full payment within three years, and the taxpayer must agree to comply with all Code provisions while it's in effect.

Facts. Allesio Azzari, Inc. (Azzari) is a New Jersey-based corporation in the homebuilding industry. In 2005 and 2006, Azzari experienced financial difficulties and fell behind on its Federal employment tax deposits. Azzari failed to timely file its employer's quarterly tax returns for the last 2 quarters of 2005, but it did timely file such returns for each quarter in 2006. IRS assessed the tax shown on the return for each period but Azzari didn't fully pay its liabilities, which total $1,100,622 for the periods at issue.

During January of 2007, Azzari received financing from a lender secured by an interest in Azzari's accounts receivable. The lender filed a financing statement to record its security interest with the State of New Jersey. The lender's financing helped Azzari remain current with its tax deposits for six consecutive quarters.

Around Nov. 6, 2007, IRS mailed Azzari a notice of intent to levy and subsequently filed a notice of federal tax lien (NFTL) for Azzari's unpaid employment tax liabilities. Around Jan. 2, 2008, Azzari timely submitted a request for a Collection Due Process (CDP) hearing. It also requested that IRS withdraw its lien and consider an installment agreement as a collection alternative, explaining that the tax lien made it more difficult for Azzari to satisfy its tax liabilities. On Jan. 25, 2008, before receiving any reply from IRS, Azzari submitted a written request asking IRS to subordinate its NFTL to a line of credit from the lender and agree to a proposed installment agreement. In this request, Azzari stated that the lender refused to extend any more credit to it unless IRS agreed to subordinate the NFTL to the lender's security interest.

Azzari's counsel and the IRS settlement officer had a face-to-face conference on June 26, 2008. The settlement officer told Azzari that the IRS lien could not be subordinated because it didn't have priority over the lender's earlier-filed security agreement. The officer suggested that the lien might be withdrawn if Azzari paid $300,000 immediately and entered an installment agreement to pay the balance within 10 years, provided that Azzari remained current on its tax deposits.

Azzari again fell behind on its deposits in the third quarter of 2008. The settlement officer contacted Azzari's lawyer and told him that failure to make deposits would render Azzari ineligible for an installment agreement, and also told him that Azzari's proposed installment agreement was likely unrealistic. The lawyer responded that Azzari had taken drastic actions to cut its costs, and again stated that it was “severely hurt” by its inability to borrow against its accounts receivable.

On Sept. 29, 2008, the settlement officer told Azari's lawyer that he would no longer consider an installment agreement, and a notice of determination was mailed to Azzari on October 9. The notice explained that IRS wouldn't withdraw its lien or enter into the proposed installment agreement due to Azzari's compliance record. The notice didn't address the subordination request.

Conclusion. The Tax Court concluded that it was an abuse of discretion for IRS to refuse to consider Azzari's request to subordinate the NFTL based on the erroneous conclusion of law that the lender's security interest already had priority over the NFTL in Azzari's accounts receivable. Contrary to the settlement officer's determination, under Code Sec. 6323(c), the lender's security interest did not have priority over the tax lien in Azzari's accounts receivable acquired more than 45 days after the NFTL was filed, despite the fact that it was first-in-time. Based on this erroneous belief, the settlement officer didn't even consider subordinating the tax lien, even though it was within his discretion to do so under Code Sec. 6325(d).

The Tax Court further determined that IRS abused its discretion by declining to enter into an installment agreement with Azzari. Although the Court has previously upheld IRS's rejection of collection alternatives based on taxpayers' failures to pay their current taxes, which Azzari admittedly did, those cases were distinguishable because IRS had not contributed to such failures. However, in this case, IRS's abuse of discretion contributed to Azzari's failure to make timely tax deposits. Azzari contended that it would have been able to remain current with its employment tax deposits if it had been able to borrow against its accounts receivable, but it was unable to do so because of IRS's refusal to subordinate its lien. Further, despite Azzari's clear indication to IRS that the need for subordination was urgent, IRS didn't respond to Azzari's request for nearly four months. In effect, Azzari wasn't given the opportunity to become current on its obligations.

Since IRS abused its discretion in denying Azzari's request to subordinate the NFTL on the basis of an erroneous conclusion of law, then denied Azzari's request for an installment agreement based on its failure to stay current on its tax obligations (which was arguably attributable in part due IRS's prior error), the case was remanded back to IRS's Appeals office for reconsideration.

References: For property subject to a tax lien, see FTC 2d/FIN ¶V-5902; United States Tax Reporter ¶63,214.02; TaxDesk ¶911,025; TG ¶71974. For installment agreements, see FTC 2d/FIN ¶V-5010; United States Tax Reporter ¶61,594; TaxDesk ¶901,006; TG ¶71904.