Public Law 89-719: The Federal Tax Lien Act

When the federal government has a legal claim to a person’s property due to unpaid taxes, it is known as a federal tax lien. This lien gives the government priority to seize and sell the property to satisfy the tax debt, placing its claim ahead of many other creditors. The rules governing the priority of these liens were significantly updated by the Federal Tax Lien Act of 1966, codified as Public Law 89-719. This law modernized the system to balance the government’s tax collection needs with the stability required for commercial transactions.

The Act clarified the long-standing principle of “first in time, first in right,” which dictates the priority of competing claims to a property. It also established specific protections for certain types of creditors, giving their claims priority over a federal tax lien in particular situations. Understanding these rules is important for anyone involved in property transactions, including buyers, lenders, and other lienholders.

The Legal Landscape Before 1966

Before the Federal Tax Lien Act of 1966, the system for federal tax liens created significant uncertainty in business dealings. Under previous law, a federal tax lien could arise and exist in secret. The lien was effective from the moment the tax was assessed, meaning the government could have a priority claim on a taxpayer’s property without providing any public notice.

This created problems for other creditors. A bank could issue a mortgage or a business could extend credit, believing their claim was secured, only to later discover that a pre-existing but unrecorded federal tax lien took precedence. This uncertainty made lenders and other commercial actors hesitant to engage in transactions, hindering economic activity. The legal framework needed reform to provide clarity and protect innocent third parties who had no way of knowing a tax lien existed.

How a Federal Tax Lien is Established

A federal tax lien is created automatically by law when three conditions are met. First, the Internal Revenue Service (IRS) must assess the tax liability, officially recording the amount owed by the taxpayer. Second, the IRS must send the taxpayer a Notice and Demand for Payment, a bill that details the assessed tax and requests payment. If the taxpayer fails to pay the full amount after this demand, the lien comes into existence.

For the lien to be effective against most third parties, the IRS must file a Notice of Federal Tax Lien (NFTL) in the public record. The NFTL serves as a public announcement that the government has a claim against the taxpayer’s property. This notice is typically filed with a county recorder’s office or a secretary of state, depending on the type of property and state law. The filing of the NFTL is the event that establishes the federal government’s priority against many other creditors.

Priority Rules and the “First in Time, First in Right” Principle

The Federal Tax Lien Act solidified the “first in time, first in right” rule for determining lien priority. This means that a non-federal lien or interest that is recorded and perfected before the IRS files the NFTL will generally have priority over the tax lien. Creditors who perfect their interests after the NFTL is filed will have a junior claim, meaning the government gets paid first from the property’s sale.

However, the most significant change introduced by the Act was the creation of “superpriorities.” These are specific exceptions that grant certain creditors priority over a federal tax lien even if their interest arises after the NFTL has been filed. This protection was designed to facilitate common commercial transactions that would otherwise be impeded by the existence of a tax lien.

Understanding Superpriorities

Superpriorities protect creditors in situations where requiring them to search for an NFTL before every transaction would be impractical. Under Internal Revenue Code Section 6323, these interests have priority over a previously filed federal tax lien. Some of the most common superpriority categories include:

• Purchasers of securities, who can buy stocks or bonds without worrying about a seller’s pre-existing tax lien.
• Purchasers of motor vehicles, provided the purchaser did not have actual knowledge of the NFTL at the time of purchase and takes possession of the vehicle.
• Retail purchasers of tangible personal property, for items bought in the ordinary course of a seller’s business.
• Purchasers in a casual sale for less than an amount adjusted for inflation, as long as the buyer does not know about the lien.
• Holders of a possessory lien on personal property for its repair or improvement, such as a mechanic who works on a car.
• Liens for real property taxes and special assessments, which often have priority over all other liens, including federal tax liens.
• Mechanic’s liens for the repair or improvement of a personal residence, up to a certain value.
• Attorneys’ liens that arise from securing a judgment or settlement for a client.

Release and Discharge of a Federal Tax Lien

There are several ways for a taxpayer or third party to have a federal tax lien removed from a property. The most common method is a Certificate of Release, which the IRS issues within 30 days after the tax debt is fully paid or becomes legally unenforceable, such as through the expiration of the statute of limitations on collection. A release removes the lien from all of the taxpayer’s property.

A Certificate of Discharge removes the lien from a specific piece of property while the underlying tax debt and lien on other assets remain. This is often used to allow the sale of a property, with the proceeds being used to pay down the tax debt. Similarly, a Certificate of Subordination allows another creditor to move ahead of the IRS in priority, which can help a taxpayer secure a loan to refinance a property. Finally, the IRS may withdraw an NFTL if it was filed improperly, which removes the public notice as if it were never filed.

The Enduring Legacy of the Act

The Federal Tax Lien Act of 1966 remains the foundational law governing the priority of federal tax liens in the United States. Its provisions brought much-needed clarity and fairness to the process, protecting the interests of third-party creditors while preserving the government’s ability to collect taxes. By establishing clear rules for the NFTL and creating superpriority exceptions, the Act ensures that commerce can proceed with a greater degree of certainty. The principles it established continue to be applied today, forming a critical part of the legal framework for secured transactions.