8.2 The Federal Insolvency Statute

• Library: Enforcement of Liens and Judgments in Virginia (Virginia CLE) (2019 Ed.)

8.2 THE FEDERAL INSOLVENCY STATUTE

8.201 In General. Before one addresses the specific Internal Revenue Code (I.R.C.) provisions for collecting delinquent taxes, it is useful to understand the federal insolvency statute. ⁵ This statute has antecedents in early American law and in principles of English common law. The ancient principle of the sovereign's priority has been expressed in the phrase "the King's debtor dying, the King comes first." If a debtor is insolvent and owes several creditors, one of whom is the sovereign, the sovereign is given first access to any available proceeds, and the other creditors must wait until the debtor's liability to the sovereign has been satisfied.

The statute reads as follows:

(a)	(1)	A claim of the United States Government shall be paid first when—
(A)	A person indebted to the Government is insolvent and

	(i)	the debtor, without enough property to pay all debts, makes a voluntary assignment of property;
(ii)	property of the debtor, if absent, is attached; or

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(iii) an act of bankruptcy is committed; or

(B)		The estate of a deceased debtor, in the custody of the executor or administrator, is not enough to pay all debts of the debtor.
(2)	This subsection does not apply to a case under Title 11.

Despite the sweeping language of the statute and the strong common law precedent for satisfying the debts of the sovereign first, the application of the insolvency statute has not been as broad as its provisions might suggest. Some of the exceptions to its application are discussed in paragraph 8.202. One obvious exception appearing in the statute itself is that it does not apply if the debtor is in bankruptcy. Bankruptcy cases are governed by the priority provisions in Title 11 of the United States Code.

The insolvency statute does not create a lien in favor of the United States. It operates to restrict action at the point of distribution rather than restricting the sale of the proceeds. Restriction at distribution enforces the government's priority by imposing personal liability on the person who makes an inappropriate distribution in the face of the insolvency statute.

The insolvency statute applies not only to tax debts but to all debts owed to the federal government. A practitioner who administers funds in a situation to which the insolvency statute applies should ascertain whether the debtor owes federal debts of any kind.

8.202 Exception for Federal Tax Liens and Certain Other Federal Liabilities. While the insolvency statute is generally applicable to federal debts, courts have held that in certain situations federal debts are excepted from its provisions because Congress has chosen a more specific mechanism for treating those debts. The principal exception is federal tax debts for which the IRS has a tax lien. This exception is based on the Supreme Court's 1998 decision, United States v. Estate of Romani. ⁶ Prior to Romani, the IRS had argued, and several courts agreed, that the insolvency statute applied broadly to federal tax debts.

In Romani the issue was whether a judgment creditor whose recorded judgment preceded the filing of the federal...