Report of the American Bar Association Tax Section Task Force on the Tax Recommendations of the National Bankruptcy Review Commission

AVOIDING TAX LIENS

(COMMISSION TRACK NUMBER 334)

Present Law

The federal tax lien arises automatically if, after demand, a person "neglects or refuses to pay the tax." I.R.C. Section 6321. For a lien to arise, the tax must be assessed; the I.R.S. must make notice and demand on the taxpayer; and the taxpayer must fail to pay. I.R.C. Section 6321 and 6322. The lien is deemed to arise on the assessment date. I.R.C. Section 6322. The federal tax lien attaches to all the taxpayer's property. See, United States v. Barbier, 896 F.2d 377 (9th Cir. 1990) (federal tax lien attaches to property exempt from levy). The government's lien is derivative, and the government's rights cannot exceed the taxpayer's. See, United States v. Solheim, 953 F.2d 379 (8th Cir. 1992) ("government steps into taxpayer's shoes").

The automatic lien places the government in front of a taxpayer's general unsecured creditors. For the lien to be valid against any "purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor," a notice of the lien must be filed. I.R.C. Section 6323(a). To create this additional power, the notice must be filed in the proper location and properly identify the taxpayer.

Even after the notice of tax lien is filed, some transactions can be undertaken without regard to the lien. See, I.R.C. Section 6323(b)-(d). For example, a purchaser without knowledge of the lien can acquire stocks, securities, motor vehicles, inventory, certain goods purchased at retail, and certain household goods valued at less than $250 per item free and clear of the tax lien. A purchaser is one who takes for adequate and full consideration in money or money's worth. I.R.C. Section 6323(h)(6). Securities include money. I.R.C. Section 6323(h)(4). In general, this provision allows for the smooth flow of personal property in commerce without regard to federal tax liens.

The Bankruptcy Code grants some rights and powers to a bankruptcy trustee, including those of a judgment lien creditor and a bona fide purchaser of real property. Bankruptcy Code Section 544. In addition, as to statutory liens, the trustee is deemed to be a bona fide purchaser of property, both personal and real. Bankruptcy Code Section 545(2). These powers enable the trustee to claim property for the bankruptcy estate. For example, it is the trustee's power as a judgment lien creditor that enables the trustee to claim an interest superior to the government's in the taxpayer's property where a notice of lien has not been filed. See, I.R.C. Section 6323(a).

In summary, the Tax Code allows persons who purchase certain personal property for adequate and full consideration in money or money's worth to take that property free and clear of a properly noticed federal tax lien. In avoiding statutory liens, the Bankruptcy Code grants a bankruptcy trustee the power of a bona fide purchaser. Bankruptcy Code Section 545(a)(2).

Is the Bankruptcy Code's bona fide purchaser identical to the Tax Code's person who takes for adequate and full consideration in money or money's worth? If so, the bankruptcy trustee can avoid tax liens based on I.R.C. Section 6323(b). Case law says the two are not identical, and therefore, a trustee cannot avoid tax liens under Section 6323(b). United States v. Hunter (In re Walter), 45 F.3d 1023 (6th Cir. 1995) (bona fide purchaser takes for value without notice of defects; value is lower standard than adequate and full consideration in money or money's worth; because bona fide purchaser is not necessarily a purchaser under Section 6323, trustee cannot take advantage of Section 6323); and United States v. Battley (In re Berg), 188 B.R. 615 (9th Cir. B.A.P. 1995) (same).

Commission Track Number 334 revisits a controversial issue from 1978. In the Senate version of the proposed Code, a subsection (b) was included in Section 545, which limited the trustee's power to avoid tax liens. See, S. Rep. No. 95-989, 95th Cong., 2d Sess. 85-86 (1978), U.S. Code Cong. & Admin. News 5787, 5871-5872 (1978). The final version of the Code deleted this proposed subsection (b), apparently granting tax lien avoidance powers to the trustee. Unsecured creditors appeared to hold the prevailing position after 1978. Under Walter, the federal government now holds the prevailing position.

An ancillary holding should be noted. To fully take advantage of Section 6323(b), in some instances, the purchaser must be in possession of the property, e.g., a motor vehicle. After a bankruptcy is filed, is a bankruptcy trustee in possession of the property for purposes of Section 6323(b)? Case law indicates not. United States v. Hunter (In re Walter), 45 F.3d 1023 (6th Cir. 1995) (Bankruptcy Code does not grant hypothetical possession to hypothetical bona fide purchaser); but see, In the Matter of Hughes, 9 B.R. 251, 256 (Bankr. W.D. La. 1981) ("It would be ridiculous to require a debtor to come to the bankruptcy court bringing all of his property and give actual physical possession to the trustee at the time he files his petition.")

Proposals Before the Commission

Commission Track Number 334. Commissioner Shepard proposes that section 545(2) be amended to prevent the trustee from avoiding federal tax liens, thereby codifying the result in Walter. Santa Fe Discussion Issues, p.18, item II.F.9.

The Justice Department proposes that section 545(2) be amended to prevent the trustee from avoiding federal tax liens, thereby codifying the result in Walter. Justice Proposal, p. 97-8.

See also Unnumbered Government Working Group Proposal.

Task Force Position

The Task Force does not object to codifying Walter. However, is codification necessary? The Task Force proposes that some exemptions to the federal tax lien be available for bankruptcy debtors.

Reasons for Position

Analyzing the consequences of revitalizing the trustee's powers under section 545(2) is difficult. Although revitalizing section 545(2) would be good for unsecured creditors and bad for the federal fisc, the overall revenue impact would probably be small. This assumes that (i) most federal tax claims are granted priority or are nondischargeable and (ii) the funds recovered by the trustee under section 545(2) would not be consumed by administrative expenses and nontax priority claims.

Note, similar to Commission Track Number 100 (repeal of section 724(b)), the party adverse to the government in Commission Track Number 334 is the bankruptcy trustee. With this caveat, the Task Force does not object to the proposals in Commission Track Number 334. However, given Walter is the prevailing position, is codification necessary?

If Walter remains the law, a small exemption against the tax lien, similar to the exemptions against levy, I.R.C. Section 6334, for the household items in I.R.C. Section 6323(b)(4) should be granted. Many debtors in Chapter 13 walk a precarious line between success and failure. Forcing a debtor to buy off the I.R.S.'s tax lien in clothing, furniture, and other basic household goods seems draconian. Similarly, a Special Procedures Officer would no longer be in the uncomfortable position of talking to a Chapter 7 debtor postdischarge about buying off the I.R.S.'s lien in de minimis personal property.

Issues tangential to Commission Track Number 334, but not raised in the Commission's matrix, include the following:

1. Should United States v. McDermott, 507 U.S. 447 (1993), be overruled so that the federal tax lien does not give the government first position in all after-acquired property?

2. Should a provision be added to the Bankruptcy Code so that, if a trustee abandons property with a secret federal tax lien attached (fn. 135) after an unpaid tax debt is discharged, the I.R.S. cannot execute on the secret lien after the automatic stay is dissolved?

3. Should Bankruptcy Code Section 522(h) be amended to make clear that it applies to all parties including the government?

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fn. 135: In other words, notice of federal tax lien was never filed..

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