The federal tax lien is a very potent collection device: if someone owes money to the IRS, the lien attaches to everything they have any interest in, even property held by the entireties (with some limited exceptions).
But there are times when the federal tax lien is subordinate to another obligation, and a conversation I had this morning with another lawyer indicated that they may now be as well-known as they should be. This lawyer was concerned about a contingent fee matter where his client had a federal tax lien.
This is an issue that might lead an attorney to reject a viable case. After all it is one thing to take the risk that a case won’t be successful, and quite another to take the risk that you will get no fee even if the case is a winner. No lawyer would take a case where she cannot get paid even if she wins. But there is good news: Congress agrees that lawyers should generally get paid in contingent fee cases.
To walk you through the details, Section 6321 of the Internal Revenue Code gives the IRS a lien on all of a taxpayer’s interests in property once the taxpayer fails to pay taxes, interest or penalties after a demand from the IRS. Section 6323 then deals with the priority of that lien. First of all, anyone doing business with a taxpayer before a notice of federal tax lien is filed is generally protected. I.R.C. § 6323(a). And then, even after the government files a notice of federal tax lien, a variety of other types of interests are protected under Section 6323(b) of the Code. While many of these “superpriority” interest provisions are inapplicable if the individual has notice of the federal tax lien, attorneys are not subject to that limit. Even if you know the client is subject to a federal tax lien, you are entitled to get paid before the IRS.
The relevant provision is Section 6323(b)(8), which gives a priority over a federal tax lien to an “an attorney who, under local law, holds a lien upon or a contract enforceable against such judgment or amount, to the extent of his reasonable compensation for obtaining such judgment or procuring such settlement.” I.R.C. § 6323(b)(8).
There is a catch: this rule doesn’t apply if the case involves a claim against the federal government if it offsets the taxpayer’s liability to the government against the amount due under the settlement or judgment. That’s because the rationale for this particular superpriority is that the lawyer’s work increases the asset pool available to pay the government. The rationale doesn’t fit a situation where the claim is against the federal government because the government does not get any benefit from the prosecution of the claim.
So if you have a client who is subject to a federal tax lien, you can evaluate the case as a normal contingency case despite the federal tax lien, so long as it isn’t against the federal government.
Jim Malone is a tax attorney in Philadelphia; he focuses his practice on federal, state and local tax controversies. © 2014, MALONE LLC.