Patrick Hannon v. City of Newton, No. 13-1022 (1st Cir. Feb. 28, 2014) provides insight into the interplay between the discharge of a federal tax lien and the scope of the remaining federal tax lien. In this case the First Circuit reversed the lower court and found that the remaining federal tax lien still reached the taxpayer’s interest in the property. The case provides a good opportunity to discuss the broad scope of the federal tax lien and the operation of the discharge provisions.
In the National Bank of Commerce case I discussed recently, the Supreme Court said that the language Congress used in creating the federal tax lien could not have been broader. The fact that the most quoted language about the scope of the federal tax lien comes up in a levy case speaks to the link between these two collection devices available to the IRS. In United States v. Craft, 535 U.S. 274, 122 (2002). The Court demonstrated that scope holding that the federal tax lien allowed the IRS to reach property held as tenancy by the entireties even though no other creditor could do so.
So, the federal tax lien is really a powerful lien but Congress also created ways to remove the lien in whole or in part. One of the confusing things about the Congressional method for removing the lien is the terminology. Removing the lien in whole is described in IRC 6325(a) and goes under the name “release.” Removing the lien in part is described in IRC 6325(b) and goes under the name “discharge.” In many other settings concerning liens in general, the discharge of a lien means removing the lien in whole. It is important to get the Congressional terminology correct in order to follow lien cases.
This post focuses on discharge of the federal tax lien and the scope of that discharge which is bound up in the scope of the federal tax lien.
Mr. Hannon owed the IRS about $4 million. As always I am curious how someone comes to owe that much in federal taxes but the opinion does not satisfy my curiosity on that point. He owned a very nice house or at least a very valuable house at 20 Rogers Street in Newton, Massachusetts. The city took his property through eminent domain and paid $2.3 million to do so. Prior to the taking the IRS must have recorded a notice of federal tax lien in an effort to perfect its security. The federal tax lien stood behind a mortgage on the property. After payment of the mortgage, the value of the lien interest of the federal tax lien was calculated to be $57,214.55.
It is normal when property is sold on which a federal tax lien has attached that the purchaser wants the property free and clear of the lien (of course, the purchaser wants the property free and clear of all other liens as well.) If a notice of federal tax lien had not been filed in the jurisdiction where the property was located, the purchase itself would have defeated and removed the federal tax lien from the property by operation of IRC 6323(a) – assuming that the purchaser met the definition of purchaser in IRC 6323(h)(6). In order to remove the federal tax lien from the property if the notice of federal tax lien was properly recorded before the sale, the taxpayer and/or the purchaser must apply for a discharge of the lien from the specific property and meet the requirements of IRC 6325(b). Generally, if the IRS receives the value of its interest in the specific property being sold, it will issue a certificate of discharge allowing the new owner to take the property free and clear of the federal tax lien. The issuance of the discharge does not remove the federal tax lien from the remainder of a taxpayer’s property but only from this one asset.
Everything about the taking of Mr. Hannon’s property, the payment of the IRS of its lien interest, the issuance of a discharge certificate so that the city acquired the property free and clear of the federal tax lien appears to have gone normally. Mr. Hannon, however, did not believe that the amount paid for the property adequately compensated him for the taking of his property. State law allowed him to bring a post taking lawsuit to seek an additional award since he alleged he was undercompensated. He did so and he won an award of $420,000.
This case is about who gets the additional award. Fighting over this money are the IRS and a lower priority creditor, Rita Manning, who had obtained and recorded a judgment against Mr. Hannon after the recordation of the notice of federal tax lien. Ms. Manning argued that the granting of the discharge with respect to the property at 20 Rogers Street removed the federal tax lien from that property allowing her lien to move up and attach to the further proceeds obtain from that property. The IRS argued that the granting of the discharge was limited to the specific transaction causing title to pass to the City of Newton and did not impact the federal tax lien’s ability to continue to attach to all of Mr. Hannon’s property and rights to property. It argued that the state law granting him to sue the city for additional compensation was a right to property separate from the property itself upon which the discharge had been granted.
The First Circuit agreed with the IRS and reversed the district court by holding that the federal tax lien continued to attach to the post-taking proceeds and was not cut off by the granting of the discharge. I think this is the right result but understand that it presents a close issue and one which the court said was of first impression. The IRS could have written the discharge in such a way that it specifically preserved the lien in any proceeds resulting from a subsequent suit. It probably did not think about the implications of a subsequent suit since the issue appears not to have previously arisen. Maybe it will change the language of its discharge in states with a law like that in Massachusetts or perhaps it will just continue to rely on the power of the federal tax lien.