Can a business borrow with a federal tax lien on file?

What a federal tax lien is

The federal tax lien is created by statute, not by any document the business signs. It arises when three things have happened: the IRS has assessed a tax, it has sent notice and demand for payment, and the tax has not been paid. From that moment the lien attaches to all of the taxpayer's property and rights to property, including receivables, inventory, equipment, bank accounts and anything acquired later, for as long as the debt is collectible.

At first the lien is silent. It binds the business, but it does not beat a lender, purchaser or other secured creditor until the IRS files a Notice of Federal Tax Lien in the public records. The filing is what a lender's lien search finds, and it is what changes the priority contest. A business that owes the IRS but has no notice on file is in a different position from one that does; the refinancing guide to tax liens walks through the difference between an unfiled balance, an installment agreement and a filed lien.

Where the notice is filed matters to lenders. For a corporation or partnership, the IRS files where the state designates for the location of the company's principal executive office, usually the secretary of state. That is not always where a lender searches UCC filings, which is the state where the company is organized. A company organized in one state and run from another can have a tax lien that an ordinary UCC search misses, so careful lenders search both, and the county records for any real estate.

How the lien ranks against a lender

The basic rule is first in time: a lender whose security interest was perfected before the notice was filed generally ranks ahead of the IRS on the collateral that existed then. After the notice is filed, a new loan ranks behind the IRS. The hard cases are the ones in between, and they matter most for revolving lines secured by receivables and inventory that turn over constantly.

The 45-day rule explains something borrowers experience directly. When a notice of federal tax lien is filed against a company with an asset-based line, the lender's priority on new receivables and inventory runs out about six weeks later. Most loan agreements make the filing an event of default anyway, and a lender that keeps advancing past the window is lending against collateral the IRS now outranks it on. So availability is often frozen or reserved against, sometimes within days of the filing. For a business that runs on its line, that is usually the moment the tax problem becomes a liquidity crisis. See when a bank freezes a line.

A tax lien filed against a business on a revolving line does not stay a tax problem for long. It becomes an availability problem.

Three ways lenders close around a lien

1. Payoff at closing. The simplest and most common. The tax balance is a line in the sources and uses, paid by the closing agent from loan proceeds, and the IRS issues a certificate of release once the liability is satisfied, which by law it must do within 30 days. The lender needs a current payoff figure from the IRS, including penalties and interest to the payoff date, in the same way it needs a payoff letter from any other creditor being retired.

2. A certificate of subordination. When the loan cannot or should not pay the whole balance, the business can ask the IRS to subordinate its lien to the new loan, using Form 14134. The IRS agrees when subordination is in the government's interest: typically when part of the loan proceeds go to the IRS, or when the loan will ultimately increase what the IRS collects, for example by refinancing expensive debt or keeping the business operating. The application describes the loan, the collateral, the use of proceeds and what the IRS will receive. It is a real process with its own review, so it belongs on the timeline from the start.

3. An installment agreement, with the lien accounted for. A business that owes a manageable balance and is paying it on a current installment agreement is a different credit from one that is not paying. Some lenders will lend unsecured or on a junior basis behind the lien, or size the loan around it, where the agreement is current and new taxes are being paid on time. For smaller balances paid by direct debit, the IRS may also withdraw the filed notice, which removes it from the public record; the application is Form 12277. A withdrawal is different from a release: the tax may still be owed, but the notice no longer affects other creditors' priority.

The IRS can also discharge a specific asset from the lien, using Form 14135, which matters when the business is selling a building or piece of equipment and the buyer's lender needs it clean. That is more often a tool in an asset sale than in a new borrowing.

What else lenders look at

• What kind of tax it is. Unpaid payroll taxes are the most serious, because the withheld portion is held in trust for the government and the IRS can assess the owners and officers personally for it. Lenders generally require them paid at closing. See unpaid payroll taxes in a refinance.
• Whether current taxes are being paid. A lien over an old balance, with every deposit since made on time, reads as a problem being fixed. New arrears on top of old ones read as a business still borrowing from the government.
• Why it happened. A lost customer, a bookkeeper who did not make deposits, a year of losses: each has a different implication for whether it will recur.
• The owners' personal taxes. A federal tax lien against an owner attaches to the owner's personal assets, including shares in the business. That matters to lenders taking personal guarantees or a pledge of the owners' stock.
• SBA loans. SBA lenders check that applicants are not delinquent on federal debt. A tax debt on a current installment agreement is generally not treated as delinquent, but the lien still has to be paid, subordinated or otherwise dealt with before the lender can take its collateral position.

State tax liens work in similar ways, but each state's rules on priority and subordination differ, and state revenue departments have their own forms. Lenders treat them the same way in principle: paid, subordinated, or accounted for.

Putting the lien in the lender package

The worst way for a lender to learn about a tax lien is on its own lien search, after it has issued a term sheet. Surprises in diligence make lenders ask what else they have not been told. The best way is in the first document they read, with the plan attached. A package that handles a lien well includes:

• A copy of the filed notice and IRS account transcripts showing the assessed balance by tax period
• The installment agreement, if there is one, and proof of the payments made under it
• Proof that current deposits and filings are up to date
• A short explanation of how the arrears arose and what changed
• The proposed route, payoff, subordination or installment agreement, and the payoff or subordination figures in the sources and uses
• The debt schedule listing the IRS alongside every other creditor, with its lien position

Transparent writes the lien and its resolution into the underwriting memo and the financing model, so each lender sees the tax balance, the plan and the effect on cash flow at the outset rather than discovering them. Some lenders in a book of 1,800+ will not lend with a tax lien in the picture at all; others handle them routinely when the plan is clear. Knowing which is which before the package goes out is most of the work.