Priority of Liens - State vs. Federal

A federal trial court in Ohio has held that federal tax liens enjoy priority from the date of assessment over subsequently recorded state tax liens--regardless of when the state tax liens were assessed, and regardless of when notices of the federal tax liens were recorded.







The case is Reed v. Civiello, 297 F.Supp.2d 1008 (U.S.D.C. N.D.Ohio 2003). Here's what happened.







During the 1990s, Carmen and Nancy Civiello failed to pay many of their debts, resulting in loss of their home through foreclosure and recording of sundry tax liens against them by the IRS, the Ohio Department of Taxation ("Taxation"), and the Ohio Bureau of Worker's Compensation.







After foreclosure of the home yielded excess proceeds of $81,312, the IRS and Taxation asked a federal trial court to determine relative priorities of their tax liens. Since the parties agreed on distribution of $2,854, the amount in controversy was $78,458.







As explained by the court's opinion, the parties were in agreement that priority of a federal tax lien as against liens created under state law is governed by the common law rule of "the first in time is the first in right." It therefore was critical to determine when the respective liens came into existence, or became "choate." Under federal law, the federal tax lien becomes choate when it is assessed. (26 U.S.C. sections 6321 and 6322.) However, federal law also provides that a federal tax lien "shall not be valid as against any purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor" until notice of the lien (in a form prescribed by the Secretary of the Treasury) is recorded in the land record system designated by state laws. (26 U.S.C. section 6323[a] and [f].)







In this case, substantial tax liens were assessed both by the IRS and Taxation from February 1992 through May 1993. The first notices of lien were recorded by Taxation in the summer of 1993. The IRS did not record notices of lien until the spring of 1995.







Based on these facts, the IRS argued its liens enjoyed priority pursuant to 26 U.S.C. sections 6321 and 6322. Taxation countered that its liens should be prior because it is a "judgment lien creditor" within the meaning of 26 U.S.C. section 6323(a), whose notices of lien were first recorded. Mainly, Taxation argued that the procedure by which it assesses tax liens is akin to a judicial proceeding, and the result is akin to a judgment lien.







But the trial court disagreed with Taxation's interpretation of section 6323(a), citing the "seminal" decision of the U.S. Supreme Court in United States v. Gilbert Associates, Inc., 345 U.S. 361 (1953). In Gilbert, a town in New Hampshire sought to invoke section 6323(a) to protect priority of its property tax lien as against a federal tax lien. The New Hampshire Supreme Court agreed with the town, but the U.S. Supreme Court reversed, saying







"A cardinal principle of Congress in



its tax scheme is uniformity, as far



as may be. Therefore, a 'judgment



creditor' should have the same



application in all the states. In



this instance, we think Congress



used the words 'judgment creditor'



...in the usual, conventional sense



of a judgment of a court of record,



since all states have such courts.



We do not think Congress had in mind



the action of taxing authorities who



may be acting judicially as in New



Hampshire and some other states,



where the end result is something



'in the nature of a judgment,' while



in other states the taxing authorities



act quasi-judicially and are considered



administrative bodies."







The court also cited a 1976 IRS regulation codifying Gilbert (26 C.F.R. section 301.6323[h]-1[g]) and several lower court decisions that rather consistently follow the Gilbert reasoning.







The court concluded the federal tax liens became choate when they were assessed, the state tax liens became choate when notices thereof were recorded, so the IRS was first in time and entitled to priority for distribution of the $78,458.







Comment: This reads like a correct result, but one wonders (and the court does not explain) how Ohio statutes treat the issue of when a state tax lien becomes "choate." If state statutes may be interpreted to say the state tax lien exists when it is assessed, then at least some of the state tax liens in this case should have been given priority.







Another critical point in this decision was the conclusion (to which the parties stipulated) that the common law rule of 'first in time, first in right' should govern the outcome. What about the more familiar 'race-notice' rule, which is provided by statute in most states? I wonder if state taxing authorities might do better, at least in some states, having sections 6321 and 6322 interpreted in light of race-notice rules. (Yes, I understand section 6323[a] and [f] embodies the race-notice rule, and it may be said that by enacting the section Congress intended to limit it to benefit creditors not to include state taxing authorities and holders of other administrative liens. Maybe so...I just think the court's handling of the issue was too perfunctory.)



By-Bert Rush