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How Does Indexing Federal Tax Lien Impact Its Effectiveness

Posted on Nov. 5, 2015

In a recent post, I discussed the importance of properly mailing the IRS notice of a property tax sale in order to remove the federal tax lien from the property. In TPF Deeds v US, a district court court opinion from last month considers  whether liens were extinguished or attached to interests in real property. The TPF Deeds case also involves the action of the local county office and the impact of its failure to record the federal tax lien in a manner easily searchable by those researching the property records.  The purchasers in this case did not realize they were purchasing property encumbered by a federal tax lien because the title search did not turn up a lien against a prior owner.  These cases do not appear often so I use this opportunity to discuss the indexing and recording of federal tax lien and the important role that the local recording office plays in the process of liens.  If the IRS sends the notice of federal tax lien to the proper office does it bear the burden of insuring that the local office properly records and indexes its lien?

In addition to the lien recordation issue here, I cannot understand the economics of this case and welcome comments or messages that will help me understand why the purchaser or title company chose to litigate the matter.  Although the taxpayer in this case, who like the taxpayer in the prior post really has nothing to do with this case, had many high dollar liens filed against him, the lien underlying this litigation appears to be for $3, 618.99.  I cannot see how, even with interest and penalty accruals that might have doubled the amount of the lien, this amount could justify the effort that went into this litigation by the plaintiffs.

The taxpayer, Ernest Hewlett, failed to pay taxes for many years.  The IRS recorded seven notices of federal tax lien against him in Wasatch County, Utah.  The first lien expired before the period at issue in this case and liens three through seven were filed after the transaction at issue.  That leaves the focus on a notice of lien filed by the IRS and recorded in Wasatch County on August 23, 2005 against Ernest and Colleen Hewlett.  The notice correctly spelled the names of each taxpayer.  The IRS subsequently released the lien with respect to Colleen but not Ernest.

On August 31, 2006, Ernest, Colleen and Michael Hewlett purchased property in Wasatch County.  Ernest was a one third owner of the property.  When they purchased the property, the federal tax lien attached to the interest Ernest owned in the property.  That same day the property was conveyed to Celeste Hewlett.  The opinion does not clearly state the facts underlying the conveyance.  I am guessing that she paid fair market value for the property because the case does not discuss the unfiled federal tax liens that appear to have existed at that time.  If she paid less than fair market value, she would not have attained the status of purchaser protecting her interest in the property because of section 6323(a).  If she obtained the property as something other than a purchaser, e.g., by gift, the transfer to her would not have defeated unfiled federal tax liens.  The failure of the opinion to discuss this possibility leads me to believe that she met the requirements for purchaser set out in section 6323(h)(6) but I cannot state that with certainty.

Still, Colleen obtained the property burdened by the filed federal tax lien against Ernest whether she knew it or not.  In October 2009, Colleen borrowed $150,000 using the property as security.  At this point, the bank lending the money ordered a title search before entering into the agreement.  The title search did not list any liens against the property.  The bank assigned a 69% interest in the mortgage to another company.  Celeste defaulted on her loan.  The bank foreclosed its lien and sold its 31% interest to another party.

Wasatch County has a computer database of the liens recorded in the county.  Someone using that database would not find the lien against Ernest using certain search terms which a title searcher might use but could find the lien using other terns.  The case goes into a detailed discussion of which terms worked and which did not.  The failure of the database to show the lien against Ernest using the terms a title searcher might ordinarily use no doubt caused the failure to pick up this lien when the loan to Celeste occurred.  The parties did not dispute this fact.  The issue concerns which party bears the burden of loss in such a circumstance.  As you can imagine the IRS does not want to lose its lien interest because the online database of the local recorder’s office may not have entered the data in the most efficient way and the current owner of the property does not want to lose value in the property for the same reason either.

Here, it was undisputed that the federal tax lien defeated the interest of the parties if the lien was properly filed.  So, what makes a properly filed lien?  Subsection 6323(a) provides that “the lien imposed by section 6321 [the federal tax lien] shall not be valid as against any purchaser, holder of a security interest, mechanic’s lienor, or judgment lien creditor until notice thereof which meets the requirements of subsection (f) has been filed by the Secretary.”  Subsection (f) contains two main requirements for a valid notice of federal tax lien: (1) the notice must be filed in the right place and (2) it must be filed such that a “reasonable inspection” will reveal it.  The general rule for the place of filing with respect to real property requires that the notice be filed in the county in which the property subject to the lien is located.  That presents no issue here as the notice was filed in Wasatch County which is the location of the property.  While the IRS clearly satisfies this prong here, if you have a lien dispute, look carefully at the location of the filing of the notice.  It does happen that the IRS files the notice in a county other than the county in which the property in dispute is located and sometimes a lien dispute turns on this issue.

The issue here focuses squarely on section 6323(f)(4) which provides that notice of the federal tax lien be “entered and recorded in the index… in such a manner that a reasonable inspection of the index will reveal the existence of the lien.”  Plaintiffs argued that the filing of the notice in this instance did not satisfy the requirements of the statute.  The statute is interesting because the IRS does not control the recording and indexing of the notices it sends to courthouses.  I have written that in the electronic age the IRS should create its own notice of federal tax lien site and not rely on sending notices around the country to various courthouses.  Doing so would save the IRS time it spends on preparation of paper liens and mailing as well as the cost of mailing and recording.  The estimates of savings created by such a system would not balance the federal budget but would be decent.  A national database would make it easier to search for federal tax liens especially when the taxpayers move.  Legitimate concerns about the ability to adequately identify taxpayers yet avoid disclosure of too much person information seem to hold up pursuit of this suggestion.

The IRS countered the plaintiff’s argument about the actions of a reasonable searcher for liens.  Because Ernest not only had a federal tax lien recorded against him but also had an ownership interest in the subject property, a reasonable searcher would not simply have used the search requests plaintiffs thought were reasonable, get zero results and cease all efforts.  Such a researcher would not that Ernest had to come up in a search of the local records and would begin to search in alternate ways.  Using a search that found the lien would also find the notice of federal tax lien at issue here.  In fact, at least one title searcher did find the lien.  The Court agreed that while the lien recording may not have made it as easy as possible to find it, a reasonable search could locate the lien recording and that met the requirement of the statute.

The Court turned away the equitable subrogation argument put forth by plaintiffs and agreed with the IRS to allow foreclosure after application of the Rodgers factors.  I remain confused that the plaintiffs would fight so hard over so little money.

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