Chapter 5 - § 5.2 • FEDERAL TAX LIENS

• Jurisdiction: Colorado

§ 5.2 • FEDERAL TAX LIENS

§ 5.2.1—Generally

Prior to 1966, the rights of the Internal Revenue Service (IRS)¹ under federal tax liens upon property subject to a foreclosure were governed solely by state law. United States v. Brosnan, 363 U.S. 237 (1960). This was true even if state law allowed the federal tax lien to be divested without notice to the IRS. In 1966, Congress adopted § 7425 of the Internal Revenue Code (I.R.C.; Title 26, United States Code), which governs the process necessary to divest federal tax liens in foreclosures to protect the interest of the federal government in collection and enforcement of its tax liens. See Pub. L. No. 89-719, Title I, § 109, 80 Stat. 1141 (1966). Section 7425(a) references 28 U.S.C. § 2410 for divesture of federal tax liens and redemption rights of the IRS in a judicial foreclosure. Section 7425(b), (c), and (d) provide the process and redemption rights applicable in the case of a non-judicial foreclosure that impacts a federal tax lien.

The provisions of I.R.C. § 7425 preempt any provision of state law that interferes with the IRS's rights under § 7425, but the state law process will divest federal tax liens except to the extent of that preemption. Title Insurance Co. of Minnesota v. United States, 963 F.2d 297 (10th Cir. 1992). Therefore, it is important for the practitioner to recognize the limitations of Colorado law when a federal tax lien is involved and to assure that the required process to divest the federal tax lien is followed.

The requirements for divestiture of a federal tax lien under I.R.C. § 7425 are applied strictly and can lead to harsh results; as the court stated in Mendoza v. Cisneros, 2015 U.S. Dist. LEXIS 134026 (D. Colo. Oct. 1, 2015):

The harshness of this result to Plaintiff is an example, in the Court's view, of overreaching conduct on the part of the IRS which rightly causes cynicism and contempt by the people against their government. In any other regulatory context, the Court would have ruled that the IRS had actual notice of the notice of sale, and its ruling on this issue would have been in Plaintiff's favor. However, the regulations apparently embrace this unjust result, allowing the IRS to disregard a notice of sale sent in good faith and as to which it most obviously had actual notice, so it can lie in wait to seize on a technicality in the convoluted tax laws later on.

Id. at *15. The above quote demonstrates the care that is required if a federal tax lien is involved in a foreclosure. If an improper process results in survival of a federal tax lien after foreclosure, mercy should not be expected and corrections will be difficult; the foreclosing lender may face claims from those prejudiced by the failure. See generally Pehoviak v. Deutsche Bank Nat'l Trust Co., 5 N.E.3d 945 (Mass. App. 2014); and Hoang v. Diamond, 2015 WL 6105460, 2015 Md. App. LEXIS 741 (Md. Sp. Ct. App. Aug. 7, 2015).

A federal tax lien against all property of a taxpayer arises upon assessment of the tax. I.R.C. § 6321. A federal tax lien remains on the taxpayer's property until it is satisfied or becomes unenforceable because of lapse of time. I.R.C. § 6322. However, under I.R.C. § 6323(a) and (f), tax liens are not enforceable against a holder of a "security interest" affecting the taxpayer's real property until notice of the tax lien is recorded in the office designated by state law for the recording of liens against property where the property is located. A "security interest" is defined in I.R.C. § 6323(h)(1) and is broad enough to include a Colorado mortgage or trust deed. The priority of the federal tax lien exists from the date of recording of the notice of the federal tax lien. The priority of a security interest runs from when (1) it is protected under local law against a subsequent judgment lien arising from an unsecured obligation, and (2) the holder has parted with money or money's worth, I.R.C. § 6323(h)(1) (this second requirement may not apply under I.R.C. § 6323(c)(1) in some circumstances). Therefore, a preliminary step in planning any foreclosure should be to ascertain the existence of any federal tax liens encumbering the property to be foreclosed upon and consider the priority of any tax liens relative to the trust deed or mortgage to be foreclosed and the advances made by the lender.

If personal property is being foreclosed as part of a lien upon real estate, additional searches may be required to determine if a federal tax lien encumbers the personal property. Handling a foreclosure of personal property as part of the foreclosure of a real property lien is beyond the scope of this chapter.

§ 5.2.2—Divesting the Federal Tax Lien by Judicial Foreclosure

This section governs the impact of a federal tax lien in a judicial foreclosure; it is not intended to cover all aspects of a judicial foreclosure (see Chapter 3), but rather to provide guidance when a judicial foreclosure is contemplated and a federal tax lien is an encumbrance on the property and is junior to the lien being foreclosed. In order to extinguish a federal tax lien in a judicial foreclosure, the United States must be joined as a party. If the foreclosing party fails to properly join the United States, the property will remain subject to the lien of the United States after the sale.

I.R.C. § 7425(a)(1) provides that, if a notice of federal tax lien has been recorded prior to commencement of the foreclosure action and the United States is not joined in the action, the foreclosure judgment and the accompanying sale are made subject to the federal tax lien. I.R.C. § 7425(a)(2) provides that, if a notice of federal tax lien is recorded after commencement of the foreclosure action, it will be divested, or not, in accordance with Colorado law.

If the title work you obtain in preparation for a judicial foreclosure shows a federal tax lien of record, then the United States should be joined as a party to the foreclosure action, or administrative relief could be sought (as discussed later in this chapter). 28 U.S.C. § 2410 provides that the United States may be named as a party to an action to foreclose upon a mortgage or other lien. Ordinarily, sovereign immunity is a complete bar to suits against the United States, except where the government consents to be sued. Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 141 (1971); United States v. Sherwood, 312 U.S. 584, 586 (1941); United States v. McNeil, 661 F. Supp. 28, 30 (E.D. Ky. 1987). Section 2410 acts as a waiver of sovereign immunity in foreclosure actions, provided that the conditions of the statute are met. McNeil, 661 F. Supp. at 30.

Section 2410 does not itself create jurisdiction over the United States in a foreclosure action. See Hudson County Bd. of Chosen Freeholders v. Morales, 581 F.2d 379, 382-83 (3d Cir. 1978); Pac. Mut. Life Ins. Co. v. Amer. Nat'l. Bank & Trust Co. of Chicago, 642 F. Supp. 163, 166 (N.D. Ill. 1986). Therefore, jurisdiction over the United States must be otherwise established. Pac. Mut. Life Ins. Co., 642 F. Supp. at 166. If the foreclosure action is brought in state court, jurisdiction must be established pursuant to Colorado law. 28 U.S.C. § 2410(a) ("the United States may be named a party in any civil action . . . in any State court having jurisdiction of the subject matter . . . to foreclose a mortgage or other lien upon . . . real or personal property on which the United States has or claims a mortgage or other lien"); see also Smith v. United States, 254 F.2d 865, 868-69 (6th Cir. 1958). Colorado district courts are courts of general jurisdiction, and they have original jurisdiction in all civil cases. Colo. Const. § 9(1). Therefore, a state court foreclosure in Colorado should be filed in the Colorado district court.

If the foreclosure action is brought in federal court, subject matter jurisdiction must be established under federal law. See Pac. Mut. Life Ins. Co, 642 F. Supp. at 165. Commonly, federal jurisdiction over a foreclosure action will be based on diversity of citizenship. See 28 U.S.C. § 1332(a). In order to establish diversity, all plaintiffs must be citizens of different states from all defendants, and the amount in controversy must be more than $75,000. 28 U.S.C. § 1332(a)(1); Caterpillar Inc. v. Lewis, 519 U.S. 61, 68 (1996). Ordinarily, if jurisdiction is based on diversity only, the addition of a non-diverse party to the suit will destroy diversity, unless an independent basis exists for jurisdiction over the claim against the non-diverse party. Pac. Mut. Life Ins. Co., 642 F. Supp. at 165. Because the United States is not a citizen of any state, it cannot be brought into an action by diversity alone. See id. ("Because the United States or one of its agencies is not a 'citizen' of any state under § 1332, it cannot be sued in federal court solely on the basis of diversity jurisdiction."). However, because the validity and priority of federal tax liens are determined under federal tax law, federal courts have federal question jurisdiction over the United States in a foreclosure action involving federal tax liens. Id. (citing 28 U.S.C. § 1340); see also I.R.C. § 6323. Because the federal district court has jurisdiction over questions arising under federal law, it has an independent basis for jurisdiction over the United States and a foreclosure action involving a federal tax lien. Pac. Mut. Life Ins. Co., 642 F. Supp. at 166-67.

Having established jurisdiction, the next issue is proper venue. State court venue generally lies in the district court for the Colorado county in which the property is situated. C.R.C.P. 120(f). In the case of a consumer obligation, venue is proper in the county where the consumer signed the obligation, or in the county where the property is located. Id. In the case of an obligation that is not a consumer obligation, venue is proper in any county. Id. If the case is brought in or removed to federal court, venue is proper in the judicial...