IRS Rules On Validity Of Superpriority Lien Argument As Defense Against Levy On Bank Account.

Rev. Rul. 2006-42

ISSUE

After receiving a levy, does either a bank's setoff of a taxpayer's deposit account or a bank's claim of a security interest that has priority over the federal tax lien under section 6323(b)(10) of the Internal Revenue Code relieve the bank of its obligation to honor the levy?

FACTS

Situation 1. T, a construction company, has a business deposit account with Bank A in State Z. Under the laws of State Z, Bank A owes a debt to T for the funds deposited into the account. On January 5, 2004, the Service filed a Notice of Federal Tax Lien (NFTL), providing public notice of T's unpaid Federal tax liability and of the statutory lien arising under section 6321. On April 1, 2004, Bank A loaned $50,000 to T. As part of the transaction, T gave Bank A a promissory note payable on demand. Prior to making the loan to T, Bank A did not have actual notice or knowledge of the existence of the federal tax lien.

As security for the loan, on April 1, 2004, Bank A perfected a security interest in T's deposit account under the laws of State Z, which adopt revised Article 9 of the Uniform Commercial Code (U.C.C.). Revised Article 9 allows a bank to create a security interest in a deposit account as the original collateral for a business loan. U.C.C. 9-109(a)(1) (1999).

On June 1, 2004, after providing T with notice and an opportunity for hearing, the Service issued a notice of levy in the amount of $100,000 to Bank A; at that time, T's deposit account in Bank A totaled $15,000. After receiving the notice of levy, on June 1, 2004, Bank A made demand for full payment of the loan ($50,000) and, after not receiving payment, set off all of T's account against T's liability for the loan. Under the laws of State Z, when two parties have mutual indebtedness, either of them may cancel or extinguish one debt with the other. Bank A did not send any funds to the Service in response to the notice of levy. On July 1, 2004, Bank A contacted the Service and provided proof that it met all of the requirements for claiming a superpriority interest under section 6323(b)(10) and requested that the levy be released.

Situation 2. The facts are the same as in Situation 1, except that Bank A did not prove its superpriority interest under section 6323(b)(10) to the Service and, on May 1, 2005, the government filed suit against Bank A pursuant to section 6332(d) to enforce the levy.

LAW AND ANALYSIS

Section 6321 provides that if any person liable to pay any tax neglects or refuses to pay after demand, the amount shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.

Section 6323(a) provides that the lien imposed by section 6321 generally shall not be valid against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor until the Service files its NFTL. Section 6323(b) affords protection for certain interests even if a NFTL has been filed. Section 6323(b)(10) provides that the federal tax lien shall not be valid with respect to a savings deposit, share, or other account, with an institution described in section 581 or 591 of the Internal Revenue Code, to the extent of any loan made by such institution without actual notice or knowledge of the existence of such lien, as against such institution, if such loan is secured by such account. Sections 581 and 591 describe the following institutions: banks, trust companies, mutual savings banks, cooperative banks, domestic building and loan associations, and similar saving and loans associations.

Subject to the notice and opportunity for hearing provisions of section 6330, section 6331(a) provides that if any person liable to pay any tax neglects or refuses to pay within 10 days after notice and demand, the Service may levy upon all property and rights to property belonging to such person or on which there is a federal tax lien. The levy does not determine whether the government's claim is superior to the claims of other parties. Rather, levy authority is designed to enable the government "promptly to secure its revenues" while competing claims are resolved. United States v. National Bank of Commerce, 472 U.S. 713, 721 (1985).

Section 6332(a) provides that any levied-upon person in possession of, or obligated with respect to, the taxpayer's property or rights to property must surrender such property or rights to property, or discharge such obligation, except such part of the property or rights to property subject to an attachment or execution under any judicial process.

Section 6332(d) provides that any person who fails or refuses to surrender property or rights to property subject to levy upon demand shall be liable to the United States in a sum equal to the value of property or rights not surrendered and, absent reasonable cause, provides for a penalty equal to 50 percent of that sum.

Section 7426(a)(1) provides that any person (other than the person against whom is assessed the tax out of which such levy arose) who claims an interest in or lien on the levied upon property may file a wrongful levy suit against the government. An administrative request for return of property under section 6343(b) is not a prerequisite to filing suit for wrongful levy under section 7426.

Section 6532(c)(1) states the general rule that no wrongful levy suit shall be begun after the expiration of 9 months from the date of the levy. Section 6532(c)(2) sets forth a limited exception to this general rule and provides that if an administrative request is made for the return of property described in section 6343(b), the 9-month period prescribed in section 6532(c)(1) shall be extended for a period of 12 months from the date of filing of such request or for a period of 6 months from the date of mailing by registered or certified mail by the Secretary to the person making such request of a notice of disallowance of the part of the request to which the action relates, whichever is shorter.

There are only two defenses to an action brought by the United States to enforce a levy pursuant to section 6332(d). The first is that the levied-upon party is neither in possession of nor obligated with respect to the taxpayer's property or rights to property. The second is that the taxpayer's property is subject to a prior judicial attachment or execution. National Bank of Commerce, 472 U.S. at 721-22. Lien priority is not one of the two defenses to a levy recognized by National Bank of Commerce. E.g., Virgin Islands Bureau of Internal Revenue v. Chase Manhattan Bank, 312 F.3d 131, 139 (3rd Cir. 2002); United States v. Citizens and Southern National Bank, 538 F.2d 1101, 1106 (5th Cir. 1976); United States v. Sterling National Bank & Trust Co., 494 F.2d 919, 921 (2d Cir. 1974); United States v. AmSouth Bank, 947 F. Supp. 459, 461 (M.D. Fl. 1996).

After receiving a levy, a bank's setoff of a taxpayer's account does not excuse the bank from honoring the levy; a bank's liability for honoring a levy is determined as of the time that it receives the notice of levy. E.g., State Bank of Fraser v. United States, 861 F.2d 954, 961 (6th Cir. 1988).

Situation 1. Bank A's setoff does not relieve the bank of its obligation to honor the levy. When the IRS served the levy on June 1, 2004, Bank A owed a debt of $15,000 to T, which the notice of levy seized. State Bank of Fraser, 861 F.2d at 961. At that point in time, Bank A was liable to the IRS for the amount of the debt. IRC § 6332(d)(1). The subsequent setoff does not eliminate Bank A's liability to the Service. Additionally, Bank A's priority interest under section 6323(b)(10) does not relieve the bank of its obligation to honor the levy.

Bank A, however, prudently contacted the Service in a timely manner to resolve its dispute informally. In this situation, Bank A was able to prove its section 6323(b)(10) priority claim to the Service. In the exercise of its administrative discretion, the Service may release a levy when a bank proves its superpriority interest under section 6323(b)(10). Since it would serve no purpose to require Bank A to surrender T's funds to the Service when Bank A and the Service agree that Bank A has a priority interest under section 6323(b)(10), the Service will generally release the levy. If Bank A had not contacted the Service informally, it could have timely filed a wrongful levy suit in federal district court pursuant to section 7426(a)(1).

Situation 2. Bank A has no defense to the notice of levy for the reasons discussed in Situation 1. Here, Bank A did not contact the Service to pursue informal resolution of its section 6323(b)(10) priority claim, nor did Bank A timely file a wrongful levy suit pursuant to section 7426(a)(1) to challenge the levy. Bank A's failure to act in a timely manner has left it in a position where it cannot assert its superpriority claim, as a court does not have jurisdiction to hear an untimely wrongful levy suit. E.g., LaBonte v. United States, 233 F.3d 1049, 1051 (7th Cir. 2000).

HOLDING

A bank's setoff of a taxpayer's deposit account after receiving a levy or a bank's claim of a priority security interest under section 6323(b)(10) of the Internal Revenue Code does not relieve the bank of its obligation to honor the levy. In Situation 1, however, the Service exercised it administrative discretion and released the levy after Bank A timely established that it had a superpriority interest under section 6323(b)(10). In contrast, in Situation 2, Bank A failed to take any action to protect its security interest, and it is barred from asserting superpriority as a defense against the government's suit to enforce the levy.

DRAFTING INFORMATION

The principal author of this revenue ruling is Walter Ryan of the Office of Associate Chief Counsel (Procedure & Administration). For further information regarding this revenue ruling, contact Walter Ryan at (202) 622-3610 (not a toll-free call).