Cases involving lien priority fights between the IRS and local taxing authorities became quite rare after the Tax Lien Act of 1966. That act has stood the test of time and brought federal lien law into the “modern” age. With almost no changes to the statute since its enactment, it still operates with great efficiency.
The case of United States v. Tilley, No. 1:19-cv-00626 (M.D.N.C. 2022) purports to resolve a case or controversy between the IRS and a group of counties with local real estate taxes but is really just the court memorializing an assertion of lien priority by the counties and an acknowledgement by the IRS of their priority. It wasn’t always this way. Prior to 1966 and the enactment of 26 U.S.C. § 6323(b)(6), lien priority questions between the IRS and local taxing authorities too often ended up with a circular priority problem. That provided one of the big reasons for passage of the Tax Lien Act. The love fest exhibited in this case shows how the Tax Lien Act fixed the problem.
Mr. Tilley got in a heap of trouble. For readers old enough to have watched the TV series the Andy Griffith Show, I picture Mr. Tilley providing material for one of the episodes of that show, based in rural North Carolina in the central part of the state, as one of the occasional scallywags that Sheriff Taylor had to navigate. While Sheriff Taylor did not deal with too many “elaborate scheme[s] of sham trusts, fake corporations, and other nominee entities,” perhaps the character on the episode Bailey’s Bad Boy grew up to bigger problems.
Mr. Tilley defrauded the IRS through his schemes and ultimately pled guilty to a crime under IRC 7212(a) which is not one of the tax crimes you see prosecuted very often. To be convicted of this crime you need to forcibly interfere with tax administration. He interfered enough to draw a restitution order as part of his sentence of $7,676,757.00. Not bad for a country boy. At the time the IRS brought suit to foreclose on 35 properties he was holding through nominees, he still owed over $6 million.
Most of the people and entities involved in the holding of these properties did not respond to the suit that the IRS brought to foreclose, but a passel of counties and townships in central North Carolina raised their hands and said, “We want ours.” Not surprisingly in a scheme of this type, lots of real estate taxes remained unpaid and that’s where the lien priority issue between the IRS and the counties comes into play.
The general rule of lien priority is first in time, first in right and that rule is reflected in IRC 6323(a) as well as in the Supreme Court’s decision in United States v. City of New Britain, 347 U.S. 81 (1954). This is where the circular priority problem comes into play. In real property the first lien is usually the mortgage. If the IRS then files a lien it comes behind the mortgage. If the owner doesn’t pay his real estate taxes after the IRS has filed its lien, the real estate taxes come after the federal tax lien in a first in time situation but come ahead of the mortgage under local law. That’s why mortgage companies often require borrowers to escrow their local real estate taxes so that no local tax lien comes ahead of them. The mortgage beats the IRS because it was first in time, the IRS beats the local taxes because it was filed first, and the local taxes beat the mortgage because of local law, but the local law cannot trump the federal law, thus creating the circle and the problem.
To fix the problem, Congress passed 6323(b)(6). While 6323(a) sets up the first in time rule of law, 6323(b) provides 10 exceptions which allow a party to defeat the filed federal tax lien even if they come later in time. Number 6 in that list is local property taxes. Here, the liens of the counties and the townships clearly fit within the statutory language and the IRS acknowledged that fact in its concession. The court states:
Although only one taxing authority, the City of Durham, has moved for summary judgment, this court finds judgment may be entered in favor of all taxing authorities similar to the relief requested by the City of Durham. The Government concedes that its interests are not superior to local property tax authorities. … Pursuant to 26 U.S.C. § 6323(b)(6) and 18 U.S.C. § 3613(c), property tax liens held by local property tax authorities have priority over the liens the Government seeks to enforce here. (See Doc. 175.) The City of Lenoir, (Doc. 176), County of Chatham, (Doc. 178), City of Durham, (Doc. 179), County of Harnett, (Doc. 180), County of Wake, (Doc. 181), County of Ashe, (Doc. 182), County of Orange, (Doc. 183), County of Granville, (Doc. 184), County of Durham, (Doc. 185), and County of Alamance, (Doc. 186), all agree with the Government’s position and consent to entry of an order resolving this case as to all property tax authorities which have filed answers.
This doesn’t stop the IRS from foreclosing on the property. It just means that the proceeds from the sale will go first to satisfy the local taxes, then to satisfy any mortgage or other creditor, if they exist, listed in IRC 6323(a) who filed before the IRS perfected its lien interest and then, after those parties are satisfied, the IRS will take the rest up to the amount of the outstanding liability. It was not clear from the opinion whether the sale of all of the properties Mr. Tilley held through his nominees would satisfy his large liability to the IRS. If not, there could be more cases involving Mr. Tilley in the future. What would Andy Griffith say?