So, you’ve done your initial due diligence and approved a client for a revolving line of credit secured by assets such as inventory or accounts receivables. You file a UCC and begin extending loans, and everything seems to be going smoothly, until you get wind of the infamous “f” word…federal tax lien, filed on your client!
If you’re hearing about this as a result of routine, recurring due diligence, chances are you’re in an excellent position to mitigate your risk. If you’re not searching for federal tax liens routinely, your lien position and ability to recoup your investment may already be lost.
Why should you be concerned about federal tax liens? The short answer is because they may take priority over loans made in revolving lines of credit, and you ultimately may not be able to recover your investment. Let’s begin to examine why and how.
First, consider that you are issuing revolving lines of credits to your clients over a period of time—and, these clients are typically high-risk borrowers. They’ve checked out in the initial due diligence phase, but what about events that may happen during the life of the loan? Specifically, how confident are you that a client is paying its federal taxes on time?
Should the IRS file a federal tax lien against your client (we’re assuming you already have a perfected UCC filing on the record), you have only 45 days from the date of this IRS filing to take appropriate action to protect yourself, including halting any new extensions of credit. The onus is on you to find out that the tax lien was filed. My guess is your client is not going to tell you, and the IRS is notoriously remiss in notifying lenders (as appointees of the 8821 form) that a lien was filed.
But let me give the IRS the benefit of the doubt (hey, it’s almost tax season… I don’t want any bad blood between us); let’s assume they do provide notice. Have you received it in time?
If you have extended any credit to your client beyond the 45th day after the federal tax lien was filed, it is second in priority to the IRS. Should the matter go to collections, the IRS will be entitled to claim its share of the pie first, and you’ll be left hoping for any crumbs left over.
The 45-day rule is a little more complicated than this, and bears further examination. We’ll cover it in more detail in a later post.
Then we’ll explore best practices for developing a due diligence strategy that will maximize your protection against risk from federal tax liens and other threats. Because of the uncertainty of receiving notice of federal tax liens from your clients or from the IRS, it is always best to develop a strategy to proactively search for federal tax liens, so you’re not left guessing whether they might exist.