HOW THE IRS USES TAX LIENS LIKE IT IS WEILDING THE HAMMER OF THE GODS,

AND EXITING BANKUPTCY FREE FROM THE IRS

By Jared M. Le Fevre and John C. Nash

I. GENERAL RULES GOVERNING FEDERAL INCOME TAX LIENS

A. Creation and Duration of Federal Income Tax Liens

Under I.R.C. § 6321, a tax lien automatically arises, by operation of law, after a “person”

assessed a tax liability, neglects or fails to pay the tax, following 1) proper notice and 2) demand

for payment. For purposes of § 6321, “person” refers to and includes individuals, trusts, estates,

partnerships, associations, companies, and corporations.1 The tax lien attaches and is effective

from the date of assessment against the tax debtor.2 As a result, if a taxpayer neglects or refuses

to pay a tax debt, then the date on which the lien is considered to have attached is the date of the

tax assessment.3

An assessment is the statutorily required recording of a taxpayer’s tax liability.4 Under 26

U.S.C. § 6501(a) “the amount of any tax imposed [on a taxpayer] shall be assessed within 3

years after the return was filed (whether or not such return was filed on or after the date

prescribed).” Under 26 U.S.C. § 6203, the assessment is made by recording the tax liability in

the office of the Secretary. To be considered properly recorded, an assessment officer must

prepare a summary record that “provides the identification of the taxpayer, the character of the

1 I.R.M. 5.17.2.2 (3-27-2012). 2 I.R.M. 5.17.2.2 (3-27-2012). 3 I.R.M. 5.17.2.2 (3-27-2012). 4 I.R.M. 35.9.2.1 (08-11-2004).

liability assessed, the taxable period, if applicable, and the amount of the assessment,” along with

supporting documentation.5 The assessed amount is either the tax shown on a return by the

taxpayer, or if determined otherwise, the amount determined and shown on the summary record.6

The date of the assessment is the date the summary record of the tax liability is signed by the

assessment officer.7

Once a tax lien has attached it remains in effect until it is either 1) satisfied or 2) the

liability is no longer enforceable due to lapse of time.8 Generally a lien lasts for ten (10) years

after an assessment has been made by the IRS.9 In certain circumstances the lien may extend

beyond the initial ten (10) year period.10

B. Property Encumbered by a Federal Tax Lien

A federal tax lien attaches “in favor of the United States upon all property and rights to

property, whether real or personal,” 11 belonging to the tax debtor.12 This has been interpreted

very widely and includes things both tangible and intangible. Not only does the lien attach to and

encumber any property or rights to property presently held by a tax debtor, it also attaches to and

encumbers property the tax debtor acquires at any point during the life of the lien.13 As a result a

5 26 CFR § 301.6203-1. 6 26 CFR § 301.6203-1. 7 26 CFR § 301.6203-1. 8 I.R.C. § 6322. 9 I.R.M. 5.17.2.2.2 (3-27-2012). 10 I.R.M. 5.17.2.2.2 (3-27-2012). 11 I.R.C. § 6321. 12 I.R.C. § 6321. 13 I.R.M. 5.17.2.5 (3-27-2012).

federal tax lien also includes a taxpayer’s future interests,14 contingent interests,15 and executory

contracts.16

In determining what is considered property of the tax debtor, state law plays a significant

role in determining what property rights the federal tax lien attaches.17 State law helps determine

when an individual has a property right, in certain situations such as by virtue of a civil union,

domestic partnership, or similar relationship.18 However, federal law determines when the

property right is considered “property” or simply a “right to property” for purposes of attaching

the lien.19 As a result both state and federal law must be consulted in order to determine what

property rights will be encumbered by a federal tax lien.

If the taxpayer decides to sell property which has been encumbered by a federal tax lien

then one of two things happens. If a notice of federal tax lien (“NFTL”) has not been properly

filed, then, subject to certain exceptions for non bona-fide sales and other suspect “sales”,

property purchased by a purchaser, is transferred free and clear of the federal tax lien.20 Rather

than the lien continuing with the sold property, the lien attaches to any property transferred by

the purchaser (such as proceeds) to the taxpayer in exchange for the taxpayer’s property.21 Thus,

any transfer of property is made free and clear of the tax lien, and the property transfers

unencumbered to the purchaser. However, in order for the transfer to be considered a purchase,

14 Rev. Rul. 55-210, 1955-1 C.B. 544. 15 See Fouts v. United States, 107 F.Supp.2d 815, 817 (W.D. Mich. 2000) (under state law an expectant beneficiary of an inter vivos trust has a present interest in property that is attachable); But see Dominion Trust Co. of Tennessee v. United States, 7 F.3d 233 (unpublished table decision) (6th Cir. 1993) (under state law a contingent remainder person did not have an interest in property). 16 See Seaboard Surety Co. v. United States, 306 F.2d 855, 859 (9th Cir.1962) (a lien attached to the taxpayer's rights under an executory contract which the taxpayer had assigned and, when the taxpayer performed under the contract, the government had a lien on the proceeds); See also Randall, Sr. v. H. Nakashima & Co., 542 F.2d 270, 274 (5th Cir. 1976) (contract rights under a partially executed contract constituted a right to property because they had a realizable value). 17 United States v. Craft , 535 U.S. 274 (2002); Drye v. United States, 528 U.S. 49, 58 (1999). 18 I.R.M 5.17.2.5.1 (12-12-2014). 19 See Drye, 528 U.S. at 58-59. 20 I.R.C. § 6323(a). 21 Phelps v. United States, 421 U.S. 330, 334-35 (1975).

the purchaser must provide adequate and full consideration in money, or its equivalent value, and

it must be made pursuant to a sale.22

If the NFTL was properly filed and the tax lien attached to the taxpayer’s property, then

the federal tax lien remains on the property until the lien expires, is released, or the property has

been discharged from the lien. 23 Once a NFTL is properly filed, all property, including property

acquired after the NFTL is filed, is encumbered by the federal tax lien, until paid or removed.24

Thus, a federal tax lien attaches to any and all property25 the tax debtor owns at any time

within the duration of the tax lien.26 Moreover, the lien attaches to personal property regardless

of where it is located,27 and continues on personal property regardless of where or when the

Taxpayer changes their residence, so long as the NFTL was properly filed.28 Finally, because the

lien encumbers the property until the tax liability is paid or removed, any transfers of property

are subject to the tax lien.29 As a result, a purchaser will take the property encumbered by the

lien, and the IRS may still levy the property even from the purchaser.30

C. Perfection and Filing of Federal Tax Liens

Under I.R.C. § 6323(a), “The lien imposed by section 6321 shall not be valid against any

purchaser, holder of security interest, mechanic’s lien, or judgment lien creditor until notice

thereof which meets the requirements of subsection (f) has been filed by the Secretary.” Thus,

22 I.R.C. § 6323(h). 23 In re Eschenbach, 267 B.R. 921, 923 (Bankr. N.D. Tex. 2001). 24 In re Eschenbach, 267 B.R. 921, 923 (Bankr. N.D. Tex. 2001). 25 However, certain property may be exempt from IRS levy. 26 Glass City Bank of Jeanette, Pa. v. United States, 326 U.S. 265, 268–69, 66 S.Ct. 108, 90 L.Ed. 56 (1945). 27 Grand Prairie State Bank v. United States, 206 F.2d 217, 219–20 (5th Cir.1953). 28 26 U.S.C. § 6323(f)(2)(B); United States v. Cohen, 271 F.Supp. 709, 715 (S.D.Fla.1967). 29 United States v. Bess, 357 U.S. 51, 57 (1958). 30 United States v. Bess, 357 U.S. 51, 57 (1958).

the act of filing the NFTL is not required to encumber the taxpayer’s property. However, filing

of the NFTL is required to perfect the lien against third parties. Although I.R.C. § 6323(a)

requires notice to be filed in the proper location, proper recording of the notice by the local

governmental authority (i.e., secretary of state or county clerk and recorder) does not need to

occur in order to perfect the lien on personal property against third parties.31 However, if notice

is not filed, then a holder of a security interest, mechanic’s lien, or judgment lien who perfects its

lien will take priority over the federal tax lien.

I.R.C. § 6323(f) controls the proper procedure for filing a NFTL. Under I.R.C. § 6323(f),

a NFTL must be filed in accordance with the state rules where in the property is situated.32 For

purposes of filing the NFTL, real property is situated at its physical location, and personal

property is situated at the residence of the taxpayer when the notice was filed.33 In Corwin

Consultants, Inc., the court reviewed the legislative history of I.R.C. § 6323(f)(2)(B) and found

that the drafters of the section “deliberately avoided using domicile,…and chose residence

instead because of the difficulty in determining a person’s domicile, based as it is on (among

other things) his state of mind.”34 The use of residence as opposed to domicile was to “increase

the likelihood that creditors, generally, will receive notice as to taxpayers' standing with the

Government.”35

A person may have multiple residences, but only has one domicile.36 Therefore, the

determination of a taxpayer’s residence is a question of fact determined by factors “including:

the taxpayer's physical presence as an inhabitant and not a mere transient; the permanence of that

31 In re Tracey, 394 B.R. 635 (B.A.P. 1st Cir. 2008); I.R.M. 5.17.2.3.1 (12-12-2014). 32 I.R.C. § 6323(f)(1). 33 I.R.C. § 6323(f)(2). 34 Corwin Consultants, Inc. v. Interpublic Group of Companies, Inc., 512 F.2d 605, 608 (2d Cir.1975) (quoting 3 U.S.Code Cong. & Admin.News, 89th Cong., 2d Sess.1966, at p. 3732 (S.Rep.No.1708)). 35 Id. at 610 (quoting 3 U.S.Code Cong. & Admin.News, 89th Cong., 2d Sess.1966, at 3731). 36 Id. at 610.

presence; the reason for his presence; and the existence of other residences.”37 As a result the use

of state law for determining when a taxpayer is considered a resident for tax purposes, although

not controlling, may be useful in determining where the taxpayer’s current residence is located.38

However, generally speaking, the taxpayer’s residence is where he dwells for a significant

amount of time and where creditors would be most likely to look for him.39 It should be noted

that in determining a taxpayer’s residence, the IRS will presume that the taxpayer’s last known

residence is correct, unless the taxpayer provides notice of the change in residence. There are

three ways in which a taxpayer must notify the IRS of the change of residence, 1) in writing to

the IRS, 2) through updating the national change of address database, and 3) through filing a

return or amended return.40 The undersigned has been able to convince the IRS of a residency

change through an explanation and an offer to proof the facts showing the residency.

Under Montana law, a resident is “any person domiciled in the state of Montana and any

other person who maintains a permanent place of abode within the state even though temporarily

absent from the state and who has not established a residence elsewhere.”41 For determining

where an individual’s primary place of residence is located, Montana looks at where the person

“remains when not called elsewhere for labor or other temporary purposes and to which the

person returns in seasons of repose.”42 Montana only allows an individual to have one residence,

if residency is claimed with Montana, then that is the individual’s only residency.43 Moreover,

once an individual has become a Montana resident, they do not lose the residency until they have

37 In re Saunders, 240 B.R. 636, 641 (S.D. Fla. 1999) aff'd sub nom. Saunders v. Tolz, 275 F.3d 51 (11th Cir. 2001). 38 Official comments of M.C.A. § 71-3-204. 39 Id. 40 I.R.M. 5.12.8.6.3 (10-14-2013). 41 MCA § 15-30-2101(28). 42 MCA § 1-1-215(1). 43 Id. at (2).

officially gained a new one.44 Under Montana law an individual only changes their residency by

demonstrating both action and intent to make a new permanent residency.45

In demonstrating residency, the state of Montana generally considers a number of factors,

including: (1) where the individual is registered to vote, (2) location of living quarters, (3)

location of employment, (4) where the individual’s driver's license was issued, (5) where the

individual’s vehicle is registered, (6) whether an income tax return has been filed in the location,

(7) address where mail is received. While no one factor is determinative, the factors are all

viewed and balanced to determine where the individual’s residence is located.

Since real property is deemed to be situated at the Residence of the Taxpayer, at the time

of filing the NFTL, the IRS is not required to file a NFTL in every location where a taxpayer

may carry personal property.46 “To hold otherwise, would be to overlook the practical necessities

of the situation and would require the Collector to file tax liens in every jurisdiction to which the

taxpayers may at any time remove the property.”47 Since the lien attaches to all property once the

NFTL has been properly filed, until filed, and the property is deemed to be located at the

taxpayer’s residence, the IRC removes the need for the IRS to file in every location a taxpayer

may move or obtain property.48 Thus, the lien applies as though the Taxpayer never changed

residency.49

If the state has designated an office where a notice of lien must be filed then, the NFTL

must be filed in that same office; however, if no office has been designated the NFTL must be

filed in the office of the clerk of the United States District Court.50 Finally, some states require

44 Id. at (3). 45 Id. at (7). 46 See 26 U.S.C. §§ 6321 and 6323; Grand Prairie State Bank, 206 F.2d at 219. 47 Grand Prairie State Bank, 206 F.2d at 219. 48 In re Eschenbach, 267 B.R. 921, 924 (Bankr. N.D. Tex. 2001). 49 In re Eschenbach, 267 B.R. 921, 923 (Bankr. N.D. Tex. 2001). 50 I.R.C. § 6323(f)(1)(A) and (B).

notices of lien on real property be filed with a public index in order to be considered valid

against a later bona fide purchaser.51 In those states, if the NFTL is not filed with a public index,

then the NFTL will not be considered filed.52

In Montana,

(2) Notices of liens upon personal property, whether tangible or intangible, for obligations payable to the United States and certificates and notices affecting the liens shall be filed as follows:

(a) if the person against whose interest the lien applies is a corporation or a partnership whose principal executive office is in this state, as these entities are defined in the internal revenue laws of the United States, in the office of the secretary of state; (b) if the person against whose interest the lien applies is a trust that is not covered by subsection (2)(a), in the office of the secretary of state; (c) if the person against whose interest the lien applies is the estate of a decedent, in the office of the secretary of state; (d) in all other cases, in the office of the clerk and recorder of the county where the taxpayer resides at the time of filing of the notice of lien.53

As a result, for an individual taxpayer for personal property, if the NFTL is not filed in the office

of the clerk and recorder of the county where the taxpayer resides in Montana, then the NFTL is

not properly filed.

II. DISCHARGE OF TAX DEBT FOLLOWING BANKRUPTCY

A. Discharge in Chapter 7 Cases

Many of the tax debts and tax related penalties that a debtor may be liable for may be

discharged in a Ch. 7 Bankruptcy. Under 11 U.S.C. § 524(a)(2) a discharge in bankruptcy,

“operates as an injunction against the commencement or continuation of an action, the

51 I.R.C. § 6323(f)(4). 52 I.R.C. § 6323(f)(4). 53 Emphasis added. Under M.C.A. § 71-3-204.

employment of process, or an act, to collect, recover or offset any such debt as a personal

liability of the debtor.” Emphasis added. However, 11 U.S.C. § 523 states:

A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b)…does not discharge an individual debtor from any debt –

(1) for a tax … – (A) of the kind and for the periods specified in section … 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed; (B) with respect to which a return, or equivalent report or notice, if required –

(i) was not filed or given; or (ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition; or

(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.

Thus, in a Ch.7 Bankruptcy, under 11 U.S.C. § 523(a)(1)(B) and (C) certain taxes are not

discharged in bankruptcy. Specifically, any tax debt arising from a tax year in which the debtor

1) did not file a tax return, 2) made a fraudulent return, 3) willfully attempted to evade of defeat

the tax, or 4) where the debtor filed the tax return late and in the 2 years prior to filing for

bankruptcy, will not be discharged.

Additionally, § 523(a)(1)(A) excludes certain taxes that fall within the time parameters

established in 11 U.S.C. § 507(a)(8) from being discharged. 11 U.S.C. § 507(a)(8) places the

following time restraints on taxes:

Income Taxes54 1. With a tax return due within the 3 year period prior to the date of filing for Bankruptcy, plus any extensions granted, OR

2. Assessed within the 240 day period prior to the date of filing for Bankruptcy. a. Not including time an offer-in-

compromise was pending, plus 30 days. b. Not including time a stay of proceedings

against collections was in effect, plus 90 days.

54 11 U.S.C. § 507(a)(8)(A).

Employment Taxes55 1. Earned by debtor before filing for Bankruptcy, AND

2. With a tax return due within the 3 year period prior to the date of filing for Bankruptcy

Excise Tax56 1. On a transaction occurring where a tax return is due within the 3 year period prior to the date of filing for Bankruptcy, OR

2. On a transaction where no tax return is required, that occurred within the 3 year period prior to the date of filing for Bankruptcy

Property Tax57 1. Incurred before Bankruptcy, AND 2. Last payable, without receiving a penalty on

the payment, within the 1 year period prior to filing for Bankruptcy

Tax Required to be Collected or Withheld for which the Debtor is Liable (i.e.Trust Fund Taxes)58

1. No time limit, making them non- dischargeable

Thus, in Ch. 7, a Taxpayer’s personal liability for income taxes will be discharged in

Bankruptcy, where the tax return is 1) filed on time, 2) more than three years prior to filing for

bankruptcy, plus extensions and 3) where the assessment was made more than 240 days prior to

filing for bankruptcy. Similarly if the tax return is 1) filed late, 2) the due date for the return was

more than three years prior to filing for bankruptcy, 3) the return was filed more than two years

prior to bankruptcy, and 3) the tax was assessed more than 240 days prior to filing, then the

Taxpayer’s personal liability for the income taxes will be discharged in bankruptcy.

In addition to a debtor’s taxes, the tax penalties associated with a debtor’s taxes may also

be discharged. Under 11 U.S.C. § 523(a)(7) tax penalties are not dischargeable:

(7) to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty—

55 11 U.S.C. § 507(a)(8)(D). 56 11 U.S.C. § 507(a)(8)(E). 57 11 U.S.C. § 507(a)(8)(B). 58 11 U.S.C. § 507(a)(8)(C).

(A) relating to a tax of a kind not specified in paragraph (1) of this subsection; or (B) imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition;59

As a result, subsection (B) discharges any tax penalty imposed more than three years prior to

filing for bankruptcy, regardless of whether the underlying tax liability was discharged in

bankruptcy.60 Similarly, subsection (A) discharges the tax penalty if it is tied to a tax that was

properly discharged. This is because subsection (A) refers to taxes which are not specified in 11

U.S.C. § 523(a)(1). § 523(a)(1) focuses on taxes that are not discharged. Thus, a penalty on a

tax that has been discharged, because it does not meet the requirements for not being discharged,

is also discharged.61

B. Discharge in Chapter 11 Cases

Discharge of tax debts and penalties in Ch. 11 Bankruptcy works much like Ch. 7

Bankruptcy. As with Ch.7, a discharge under Ch.11 “does not discharge a debtor who is an

individual from any debt excepted from discharge under section 523.”62 As a result the same

restrictions and time parameters, to discharge tax debts and penalties, imposed on a Ch.7

bankruptcy are also imposed on an individual filing under Ch. 11.

In addition to the restrictions and time parameters imposed on Ch.7 debtors, an individual

debtor filing under Ch.11 must ensure that all payments agreed to in a Ch.11 plan are

completed.63 Unlike a business, which files under Ch.11, confirmation of the plan does not

59 11 U.S.C. § 523(a)(7). 60 In Re Roberts, 906 F.2d 1440 (10th Cir. 1990). 61 McKay v. United States, 957 F.2d 689, 693 (9th Cir. 1992). 62 11 U.S.C. § 1141(d)(2). 63 11 U.S.C. § 1141(d)(5).

discharge the debt, rather the individual debtor must also complete all of the payments agreed to

under the Ch.11 plan. However, in some circumstances the debtor may be able to obtain a

hardship discharge, even if all the payments are not made.64 Moreover, discharge will be denied

if:

(A) the plan provides for the liquidation of all or substantially all of the property of the estate, (B) the debtor does not engage in business after consummation of the plan, and (C) the debtor would be denied a discharge under section 727(a) of this title if the case were a case under chapter 7 of this title. 65

As a result, an individual debtor planning to file Ch.11 in order to discharge their tax liability,

must be aware that they must meet the additional requirements for discharge in Ch.11. If they do

not, no discharge will be granted, and the debtor will be personally liable for all their tax debts

and penalties following bankruptcy.

C. Discharge in Chapter 12 Cases

Taxes may also be discharged in Ch.12 Bankruptcy, so long as they are included in the

Ch.12 plan.66 However, they are subject to the same restrictions and time parameters imposed on

tax discharges in Ch. 7 Bankruptcy.67 Taxes and tax penalties may still be discharged even in a

hardship discharge in Ch.12, but they are discharged under the same parameters as in Ch.7.68

D. Discharge in Chapter 13 Cases

64 11 U.S.C. § 1141(d)(5). 65 11 U.S.C. § 1141(d)(3). 66 11 U.S.C. § 1228(a). 67 11 U.S.C. § 1228(a)(2) (subjecting discharge to conditions created by 11U.S.C. § 523(a)). 68 11 U.S.C. § 523(a).

As with all other chapters in bankruptcy, taxes and tax penalties may be discharged in

Ch.13 Bankruptcy. However, Ch.13 discharges and removes more tax debts and penalties than

Ch.7, 11, or 12. Under 11 U.S.C. § 1328(a)(2), “after completion by the debtor of all payments

under the plan…the court shall grant the debtor a discharge of all debts provided for by the

plan…except any debt— … of the kind specified in section 507(a)(8)(C) or in paragraph (1)(B),

(1)(C)… of section 523(a).”

In a non-hardship Ch.13 Bankruptcy, the only non-discharged taxes are 1) Trust Fund

Taxes;69 2) taxes with no filed return, or the return was filed late and within the 2 years prior to

the filing of bankruptcy;70 or 3) taxes where the debtor made a fraudulent return or willfully

attempted to evade or defeat the tax.71 The time parameters associated with discharge of taxes in

Ch.7 Bankruptcy do not apply in a regular Ch.13 Bankruptcy. This is because under 11 U.S.C.

§§1322(a)(2) the bankruptcy plan “shall provide for the full payment, in deferred cash payments,

of all claims entitled to priority under section 507 of this title, unless the holder of a particular

claim agrees to a different treatment of such claim,” in order to be confirmed. As a result the tax

priorities under 11 U.S.C. § 507(a)(8), which are normally non-dischargeable under 11 U.S.C.

§§523(a)(1), are required to be paid in full in Ch.13. Similarly, all penalties on tax debts are

discharged in a Ch.13 Bankruptcy, since 11 U.S.C. § 523(a)(7) is not included in the list of

excepted debt under §§1328(a)(2). However, when discharge in a Ch.13 occurs as a result of a

hardship discharge under 11 U.S.C. § 1328(b), then both tax debts and associated penalties are

discharged under the same restraints and time parameters as in a Ch.7 Bankruptcy.72

69 11 U.S.C. § 507(a)(8)(C). 70 11 U.S.C. § 523(a)(1)(B). 71 11 U.S.C. § 523(a)(1)(C). 72 11 U.S.C. § 523(a) (directly incorporates tax debts and penalties that would otherwise be discharged under 11 U.S.C. § 1328(b) as a hardship discharge.).

III. ATTACHMENT OF FEDERAL TAX LIENS FOLLOWING DISCHARGE

Following discharge in bankruptcy, the IRS may, in essence, re-attach a tax lien to certain

pre-petition property. Prepetition property is property that was held by the debtor prior to

commencing bankruptcy. 73 Often property is not included in the bankruptcy estate, because the

property was (1) exempted from the bankruptcy estate under 11 U.S.C. § 522, (2) abandoned by

the trustee under 11 U.S.C. § 554, or (3) excluded from the bankruptcy estate.74 In those

situations where pre-petition property was not included in the bankruptcy estate and a discharge

was granted, the tax liability may remain with the prepetition property, even though the debtor is

no longer personally liable for the debt. However, the liability may not attach to the debtor’s

property acquired post-petition. It only attaches to the exempted pre-petition property.75

A. Excluded Property

Under 11 U.S.C. § 541(a) and (a)(1), the bankruptcy estate includes all property of the

debtor, wherever located. However, property specifically listed in § 541(b) and (c)(2) is excluded

from the bankruptcy estate. Property excluded from the bankruptcy estate never becomes part of

the bankruptcy estate.76 As a result, excluded property cannot be used to secure a debt in

bankruptcy.77 However, this does not mean that a creditor does not have an underlying right to

payment.78 Rather, the lien continues to exist outside of bankruptcy.79 Therefore, “if a section

73 Wadleigh v. C.I.R., 134 T.C. 280, 284 (2010). 74 Wadleigh v. C.I.R., 134 T.C. 280, 284 (2010). 75 See Allison, 232 B.R. at 205–06; United States v. Sanabria, 424 F.2d 1121 (7th Cir.1970). 76 Wadleigh v. C.I.R., 134 T.C. 280, 292 (2010). 77 U.S. I.R.S. v. Snyder, 343 F.3d 1171, 1179 (9th Cir. 2003). 78 U.S. I.R.S. v. Snyder, 343 F.3d 1171, 1179 (9th Cir. 2003). 79 U.S. I.R.S. v. Snyder, 343 F.3d 1171, 1179 (9th Cir. 2003).

6321 lien on excluded property has not expired or becomes unenforceable under section 6322, it

survives the bankruptcy.”80

Thus, even though a discharge in bankruptcy removes personal liability from the debtor

to pay off the debt on excluded property, excluded property remains encumbered by the

surviving lien. As a result, the holder of the lien may collect the unpaid liability in rem, by

levying upon the property.81

B. Exempt Property

Under 11 U.S.C. § 522 a debtor is allowed to exempt from the Bankruptcy Estate “a

personal residence, a car, certain property used in a trade or business, retirement funds, and

certain other assets, to ensure that the debtor has at least some property with which to make a

fresh start.”82 Unlike excluded property, exempt property starts as part of the debtor's bankruptcy

estate,83 but is then taken out of the bankruptcy estate, making it unavailable to be used for

paying creditors’ claims.84

Property exempted from the bankruptcy estate is not available to satisfy prepetition debts

during or after the bankruptcy.85 An exception is made for debts secured by liens that are not

avoided in the bankruptcy and tax liens where an NFTL has been properly filed.86 Specifically, if

“a tax lien, notice of which is properly filed” has attached to the exempt property, the property

will be liable to debts that arose prior to the commencement of the bankruptcy case following

80 Wadleigh v. C.I.R., 134 T.C. 280, 296 (2010). 81 Wadleigh v. C.I.R., 134 T.C. 280, 297 (2010). 82 Wadleigh v. C.I.R., 134 T.C. 280, 292 (2010). 83 See Taylor v. Freeland & Kronz, 503 U.S. 638, 642, 112 S.Ct. 1644, 118 L.Ed.2d 280 (1992). 84 Pasquina v. Cunningham, 513 F.3d 318, 323 (1st Cir.2008). 85 Wadleigh v. C.I.R., 134 T.C. 280, 292 (2010); 11 U.S.C. § 522(c). 86 Wadleigh v. C.I.R., 134 T.C. 280, 292 (2010); 11 U.S.C. § 522(c).

discharge of the debtor’s personal liability.87 However, if the NFTL has not been properly filed

and recorded in accordance with I.R.C. § 6323(f), then the lien is removed in bankruptcy and the

property may not be used to satisfy prepetition debts during bankruptcy or following discharge.

i. Designating Property as Exempt

Under 11 U.S.C. § 522(b), a debtor may exempt property either in accordance with

§§522(d), or according to applicable state law, if the relevant state has opted out of the federal

scheme.88 “Since property of the estate includes ‘all legal or equitable interests of the debtor in

property as of the commencement of the case,’ 11 U.S.C. § 541(a)(1), a debtor can exempt

property that [was] owned as of the petition date.”89 The exempt property is removed from the

bankruptcy estate unless a party in interest objects to the designation.90 Once a debtor claims an

exemption, it is presumptively valid, and the objecting party shoulders the burden of proving that

the exemption is not properly claimed.91

Under Federal Rule of Bankruptcy Procedure 4403(b), an interested party has 30 days

from the conclusion of the meeting of creditors, or 30 days from the filing of any amendment or

supplemental schedules, whichever is later, to file an objection concerning what property is

exempted from the bankruptcy estate. The 30 day period may be extended for cause; however,

the “Supreme Court has directed that this 30–day limit for objections to exemptions must be

strictly applied.”92 The Supreme Court reasoned:

87 11 U.S.C. § 522(c)(2)(B). 88 In re Eleiwa, No. BAP CC-12-1559-CLDKI, 2013 WL 2443086, at *2 (B.A.P. 9th Cir. June 5, 2013). 89 In re Eleiwa, No. BAP CC-12-1559-CLDKI, 2013 WL 2443086, at *3 (B.A.P. 9th Cir. June 5, 2013). 90 11 U.S.C. § 522(l). 91 In re Eleiwa, No. BAP CC-12-1559-CLDKI, 2013 WL 2443086, at *2 (B.A.P. 9th Cir. June 5, 2013). 92 In re Gould, 389 B.R. 105, 115 (Bankr. N.D. Cal. 2008) rev'd, 401 B.R. 415 (B.A.P. 9th Cir. 2009) aff'd, 603 F.3d 1100 (9th Cir. 2010) and rev'd, 603 F.3d 1100 (9th Cir. 2010).

Deadlines may lead to unwelcome results, but they prompt parties to act and they produce finality. In this case, despite what [debtor's counsel] repeatedly told him, [the trustee] did not object to the claimed exemption. If [the trustee] did not know the value of the potential proceeds of the lawsuit, he could have sought a hearing on the issue, see Rule 4003(c), or he could have asked the Bankruptcy Court for an extension of time to object, see Rule 4003(b). Having done neither, [the trustee] cannot now seek to deprive [the debtor] of the exemption.93

As a result, in the 9th circuit, if the IRS fails to object to excluded property being classified as

exempt, then their ability to collect against the property will be impaired when no NFTL was

properly filed.94 However, when 11 U.S.C. 522(c)(2)(B) applies, because the NFTL has been

properly filed, then the 30 day limit is not important, and the IRS does not need to raise an

objection to the exemption. This is because the liens on the property are specifically given an

exception under the bankruptcy code. As a result, the liens will continue even after discharge in

bankruptcy.95

ii. Effect of Non-Discharge of Tax Liability on Exempt Property, When No NFTL Filed

11 U.S.C. § 522(c) sets out the general rule that exempting property in bankruptcy

safeguards the property from being liable for pre-petition debts post-bankruptcy.96 It states:

(c) Unless the case is dismissed, property exempted under this section is not liable during or after the case for any debt of the debtor that arose ... before the commencement of the case, except—

(1) a debt of a kind specified in section 523(a)(1) [certain taxes] or 523(a)(5) [domestic support obligations] of this title; (2) a debt secured by a lien that is—

(A) (i) not avoided under subsection (f) or (g) of this section or under section 544, 545, 547, 548, 549, or 724(a) of this title; and (ii) not void under section 506(d) of this title; or

93 Taylor v. Freeland & Kronz, 503 U.S. 638, 644, 112 S. Ct. 1644, 1648, 118 L. Ed. 2d 280 (1992). 94 I.R.M. 5.9.2.10.1.1(3) (08-11-2014). 95 In re Duncan, 406 B.R. 904, 909-10 (Bankr. D. Mont. 2009). 96 In re Vaughan, 311 B.R. 573, 578-79 (B.A.P. 10th Cir. 2004) aff'd, 241 F. App'x 478 (10th Cir. 2007); In re Scalera, 521 B.R. 513, 517-18 (Bankr. W.D. Pa. 2014).

(B) a tax lien, notice of which is properly filed; (3) a debt of a kind specified in section 523(a)(4) or 523(a)(6) ... owed by an institution-affiliated party of an insured depository institution to a Federal depository institutions regulatory agency acting in its capacity as conservator, receiver, or liquidating agent for such institution; or (4) a debt in connection with fraud in the obtaining or providing of any scholarship, grant, loan, tuition, discount, award, or other financial assistance for purposes of financing an education at an institution of higher education (as that term is defined in section 101 of the Higher Education Act of 1965 (20 U.S.C. 1001)).97

The “protected status afforded to exempt property applies even if a debt is nondischargeable,”98

because the protection applies to all bankruptcy cases, “Unless the case is dismissed.”99

However, it should be noted that only the protected status only applies to property “exempted

under this section.”100 If the property was not exempted from liability under § 522, then it is still

liable for pre-petition debts post-bankruptcy, regardless of whether it was exempted under any

other section of the Bankruptcy Code.101

Thus, “so long as the debt does not fall within one of the enumerated statutory exceptions

set out in § 522(c)'s subsections (1)–(4),”102 the exempted property will be protected. However,

exempt property falling within the exceptions loses its protection from creditors post-bankruptcy.

“Thus, § 522(c) performs both a protective function, by preserving the exemption if

nondischargeable claims other than those specifically excepted by § 522(c) are sought to be

enforced against exempt property, and a limiting function, by denying the exemption protections

for certain kinds of nondischargeable claims and unavoided liens.”103

Under § 522(c)(1), the general restrictions and time parameters associated with the

discharge of taxes under § 523(a)(1), is incorporated as an exception to the protections of

97 11 U.S.C. § 522(c). Emphasis added. 98 In re Miller, 501 B.R. 266, 276 (Bankr. E.D. Pa. 2013). 99 11 U.S.C. § 522(c). 100 11 U.S.C. § 522(c). 101 In re Bell, 476 B.R. 168, 178 (Bankr. E.D. Pa. 2012). 102 In re Scalera, 521 B.R. 513, 517-18 (Bankr. W.D. Pa. 2014). 103 In re Farr, 278 B.R. 171, 177 (B.A.P. 9th Cir. 2002).

exempted property. If the exempt property is connected to a tax debt that would not have been

dischargeable in bankruptcy, under 523(a)(1), then it will still be liable for the tax debt following

bankruptcy regardless of whether the IRS properly filed a NFTL.

Here, the bankruptcy court consulted legislative history and interpreted § 522(c)(1) correctly when it stated: “The clear intent of Congress in section 522(c) was to preserve property exempted in bankruptcy for satisfaction of tax and support obligations and, if the debtor has no such debts, for the debtor's fresh start.”104

However, if the IRS did not properly file a NFTL, and discharge of the tax debt was not granted

for a reason other than §523(a)(1), i.e. the debtor did not make all the payments required by a

plan, then the exempt property will not be liable for pre-petition debt post-bankruptcy. Thus,

when the exempt property is protected post-bankruptcy, the IRS may only go after the debtor

personally through wage garnishments or levy against property acquired post-bankruptcy, to

satisfy any remaining non-discharged tax debt.

IV. SAMPLE CASE

FACTS

1. Taxpayer owes taxes for TY 2008 and TY 2009.

2. Taxpayer filed TY 2008 federal return on May 25, 2009.

3. In January of 2010, Taxpayer moved from Idaho to Montana.

4. On January 6, 2010, Taxpayer did X,Y,Z to establish residency in Montana.

104 In re Farr, 278 B.R. 171, 177 (B.A.P. 9th Cir. 2002).

5. On April 15, 2010 the IRS noted that Taxpayer had filed for an extension for his 2009

Federal tax return. Taxpayer was given extension of October 14, 2010 to file for TY

2009.

6. The Taxpayer used new Montana address on the filed extension.

7. On April 23, 2010 the IRS filed a Notice of Federal Tax Lien (NFTL) in Idaho county

land records to perfect liens on Taxpayer’s real and personal property for TY 2008. The

IRS never files a NFTL for tax year 2009.

8. By April 23, 2010, Taxpayer had been residing in Idaho for roughly 100 days.

9. On November 15, 2010, Taxpayer late filed tax year 2009 federal tax return.

10. No NFTL was filed for tax year 2009.

11. October 25, 2013, Taxpayer filed for Chapter 7 Bankruptcy.

12. As part of the Bankruptcy, Taxpayer listed his SEP IRA as exempt property.

13. Neither the IRS nor any other party challenged the listing as exempt.

14. Taxpayer’s tax debt was discharged in bankruptcy.

15. In October 2014, IRS began procedures to collect tax debt through levying on Taxpayer’s

pre-petition SEP IRA account. IRS also filed a new NFTL in Yellowstone County,

Montana.

16. When contacted by counsel for taxpayer, the IRS agrees that the SEP IRA is exempt

property.

ANALYSIS

A. Was the NFTL Properly Filed?

The whole case hinges on whether or not the NFTL was properly filed. Specifically, the

case hinges on whether Idaho was the proper place for filing the NFTL. Since the Taxpayer

moved from Idaho to Montana shortly before the IRS filed the NFTL, the issue of determining

where the Taxpayer’s residence was located at the time of filing became the main focus of the

case. If Idaho is determined to be the Taxpayer’s residence, then the NFTL was properly filed,

and the IRS wins and can levy against the Taxpayer’s SEP IRA. Since the NFTL remains in

place even through Bankruptcy, any exempt property could be levied against to fulfill pre-

petition tax debts. However, if Montana is determined to be the Taxpayer’s residence at the time

of filing, then the NFTL was not properly filed and the Taxpayer must demonstrate that the

property was exempt property.

In determining where the Taxpayer’s residence was located, the main facts in favor of

designating the Taxpayer’s residence as Montana is that he live in Montana for roughly 100 days

prior to the NFTL being filed in Idaho. Taxpayer’s job was located in Montana and taxpayer did

not retain any residence, property or close family in Idaho.

B. Was the Property Exempt?

Assuming the Taxpayer’s residence was Montana when the NFTL was filed, the next

critical question becomes whether the Taxpayer’s SEP IRA was exempt property in the

Bankruptcy. There is some debate within the courts about whether an SEP IRA is exemptible or

excludible property for purposes of removing the property from the Bankruptcy Estate. The

question is not as critical in the 9th Circuit, since in the 9th circuit, “claiming excluded property as

exempt may impair the [IRS]'s ability to collect dischargeable taxes from the excluded property

when there was no valid NFTL filed prior to the petition date.”105 During Bankruptcy, the

Taxpayer designated his SEP IRA as exempt property. The IRS did not object to the

classification. Moreover, the IRS has further indicated in its letters that the property was

exempted in bankruptcy. As a result, it is very likely that the property will be considered exempt

for purposes of this case.

C. Was the Tax Debt Dischargeable in Bankruptcy?

The final question becomes whether the tax debt for TY 2008 and 2009 was

dischargeable in Bankruptcy. This questions revolves on whether the taxes fall into the

categories for taxes exempt from discharge under § 523(a)(1). If the taxes fall into the exempted

category under § 523(a)(1) then the exempt property connected to those tax debts will not be

protected under §522(c), and the IRS will be able to levy against the SEP IRA of the taxpayer.

However, if they do not fall into the exempt category under § 523(a)(1), then the exempt

property is protected from liability for the pre-petition debts post-bankruptcy.

Taxpayer filed for Chapter 7 Bankruptcy on October 25, 2013. Taxpayer filed late federal

tax returns for both TY 2008 and TY 2009. TY 2008 was filed on May 25, 2009. Taxpayer

received an extension to October 14, 2010 to file for TY 2009. Taxpayer filed TY 2009 on

November 15, 2010. Since both years were filed late, the main question in determining whether

the tax debt was dischargeable is if they meet the time restrictions laid out in § 523(a)(1). Since

both were filed late, both must meet the 2-year test for filing late under 523(a)(1)(B)(ii). Both

meet the test, since TY 2008 was filed in 2009 more than 4 years prior to filing for bankruptcy,

105 I.R.M. 5.9.2.10.1.1(2) (08-11-2014).

and TY 2009 was filed on November 15, 2010 just less than 3 years prior to filing for

bankruptcy.

Additionally, both must meet the 3-year test for when the return was due under §

507(a)(8)(A)(i) incorporated into § 523(a)(1). Both also me the 3-year test since TY 2008 was

due April 15, 2009 and TY 2009 was due October 15, 2010 after the applicable extensions were

added. Finally, both tax debts must the 240-day test under § 507(a)(8)(A)(ii) incorporated into §

523(a)(1). In this example, the assessment occurred outside the 240-day period prior to

bankruptcy.

Since all three tests were met, the tax debts were properly discharged in Bankruptcy. As a

result, the exempt property (SEP IRA) should not be held liable for the post-petition debts post-

bankruptcy.

CONCLUSION

Federal tax liens can be a powerful weapon wielded by the IRS for the collection of

delinquent income tax debt. However, the bankruptcy code can provide potent discharge relief

for certain delinquent taxes. The careful practitioner will need to be aware of the effects of IRS

tax liens, which properties may be encumbered by the tax liens, the timing rules for discharge of

tax debt, and how to challenge the IRS when it wrongfully asserts a tax lien.

Authors: Jared M. Le Fevre and John Nash.

Jared M. Le Fevre is a partner in the Billings, Montana office of Crowley Fleck PLLP and a

member of the firm’s Tax and Creditor’s Rights practice groups. Jared represents taxpayers in all

manner of federal, state, and local tax disputes and advises clients on tax transactions. Jared

advises clients concerning offers in compromise, installment payment plans and voluntary tax

disclosures to the IRS and state tax authorities. He also represents creditors in secured

transactions, bankruptcy, foreclosure, and debt collection proceedings. He is a past Chair of the

State Bar of Montana Bankruptcy Section.

Jared graduated from the University of Utah School of Law (2001) and received his LLM in

Taxation from the University of Alabama School of Law, Magna Cum Laude (2010). Jared is

licensed to practice law in Montana, Idaho, North Dakota, Wyoming and Utah.

John C. Nash is a third year law student at the University of Utah S.J. Quinney College of Law,

focusing on Tax, Bankruptcy, and Real Estate, and will graduate in 2016. John has worked with

the Chief Counsel for the IRS, as well as with the Utah Attorney General’s Office in the

department of Tax and Financial Services.