I. INTRODUCTION
There are occasions when a financial institution’s right to set-off will run head-on into an Internal Revenue Service (IRS) tax levy. In the normal case, the IRS uses the levy procedure to assist in its efforts to collect taxes from a taxpayer who fails to pay an assessed tax. Once a notice of levy is validly issued, an institution’s response must be both timely and appropriate. Typically, service of the notice of tax levy may trigger acceleration of the customer/taxpayer’s indebtedness with the institution, followed by the institution’s immediate desire to exercise its set-of rights.
II. NOTICE OF LEVY
If a taxpayer fails to pay assessed taxes within 10 days after notice and demand for payment is made, the IRS is authorized to collect the tax by way of a levy on all property owned by that taxpayer. Notice of a tax levy must be legally served upon the party who is holding property of the taxpayer. Notice given by way of a telephone call is not appropriate procedure. A financial institution is deemed to have received a notice of levy on a taxpayer/customer when:
1. the IRS personally hands a copy of the notice to an authorized officer of the institution;
2. on the date of mail delivery;
3. on the date noted on a certified mail delivery receipt; or
4. the date on which a notation of receipt is indicated by a bank officer.
Once properly served, the tax levy notice grants the IRS constructive possession of the customer/taxpayer’s property and the institution must surrender the property to the IRS unless it is already subject to a court ordered attachment or execution. The tax levy only extends to property in an institution’s possession at the time the levy is made and does not cover subsequent deposits. The notice of levy is effective for all financial institution offices (main office and branches) and property owned by the customer and held by the institution at any of its offices.
III. FINANCIAL INSTITUTION RESPONSE TO NOTICE OF LEVY
An institution must surrender all customer/taxpayer property in its possession at the time the levy is made. The surrender occurs 21 calendar days after receipt of the levy and includes interest accrued on the account to the extent necessary to satisfy the levy. An institution should note following points regarding interest paid on levy payments:
1. if the account is non-interest bearing, no interest need be paid;
2. never send the IRS more than the levy amount;
3. if the amount in the account when the levy is received is sufficient to satisfy the levy, no interest need be remitted;
4. if the amount in the account is less than the levy amount, interest should be calculated for the 21-day holding period and the first day of the account balance and the interest should be remitted on the 22nd day; and
5. if the account balance is less than the levy amount, but the total of the amount and the 21 days of interest are greater than the levy amount, the institution should send only the account balance and enough of the interest to equal the levy amount.
The 21-day period give the customer/taxpayer an opportunity to challenge the levy.
If the levy is satisfied in whole or in part, an institution is instructed to send a copy of the levy to the customer within 2 working days. If there are no customer funds at your institution, a customer notice is not required.
IV. PROPERTY SUBJECT TO LEVY AND EXEMPT FROM LEVY
Generally, all property in a financial institution’s possession at the time the levy is made is subject to IRS levy. Once a customer’s property is surrendered to the IRS, the institution is discharged from any further obligation to the IRS and is shielded from liability to its customer. If an institution improperly surrenders property prior to the expiration of the 21-day hold period, then the institution is not shielded from liability to its customer. In order to recover property mistakenly surrendered, the institution may sue under a procedure established in Internal Revenue Code § 7426 or seek administrative relief pursuant to Internal Revenue Code § 6343.
The following describes various types of “accounts” or property that are subject to IRS levy:
1. financial institution accounts, including money in an institution represented by a registered Certificate of Deposit in the hands of a customer;
2. proceeds of securities deposited by the customer and sold by the institution at the customer’s request; and
3. uncollected funds if, by custom or agreement, the customer has a legal right to draw against such funds.
Note: Checks in process of clearance do not affect the amount subject to levy since the levy extends the funds in the institution’s possession at the time the levy is served.
The following describes various types of “accounts” or property that are exempt from IRS levy:
1. money represented by a negotiable Certificate of Deposit is not subject to levy by mere notice in that a levy on such funds must be made upon presentation and surrender of the negotiable CD to the maker;
2. individual Retirement Accounts (except in rare circumstances); and
3. property in a safe-deposit box that is leased by the customer, however the IRS may take possession of the safe-deposit box by serving an institution with both a notice of levy and notice of seizure (if requested by the IRS to open the safe-deposit box, an institution may refuse in the absence of customer consent or a court order).
Note: If refused entry, the IRS may seal the safe-deposit box, disallowing access by the customer or any joint holder of the box. A financial institution is protected from liability for refusing entry to a customer after receiving notice of seizure and having the box sealed.
V. TREATMENT OF CERTIFICATES OF DEPOSIT
Assume that on the first day after notice of levy is received from the IRS, the customer has no right to interest, however the CD matures during the 21-day holding period. On the day the funds are remitted, a financial institution is required to include the full amount. The IRS is entitled to any CD amount and interest accrued during the holding period. Assume that the levy is for $1,000.00 and the CD is valued at $1,000.00, but is subject to a $50.00 penalty for early withdrawal. On the day the funds are remitted, an institution must send in $950.00, which is the amount that the customer would have been entitled to obtain at the time the payment for the levy is sent to the IRS.
VI. TREATMENT OF JOINT ACCOUNTS
A joint account is subject to an IRS levy even when only one party has an unpaid tax obligation. A financial institution has no duty to determine relative ownership rights of co-depositor assets prior to turning funds over to the IRS.
When an institution is served with a notice of levy relating to a joint account, the institution must temporarily freeze account assets and notify the IRS of all co-depositors. An institution must provide the IRS with the following information on the back of the levy notice:
1. exact title of the account;
2. social security of employee identification number;
3. addresses of all persons listed on such account;
4. account balance.
If the IRS does not request an institution to remit the amount in the account within 21 days from the date of levy, the levy is deemed released.
If the joint account is subject to levy, the IRS will notify all co-depositors of its action and give all co-depositors a reasonable time period to respond, setting forth the ownership interest claimed and the legal basis for such claim. If no response is made by the co-depositors, an institution must surrender the funds to the IRS and the co-depositors’ remedy, if ownership of the account is subsequently claimed, is to sue for recovery under Internal Revenue Code § 7426. Any claim of ownership by a co-depositor is determined by the IRS in accordance with state law regarding account ownership and an institution must only surrender the appropriate portion of the account.
VII. EXPIRATION OF 21-DAY HOLDING PERIOD
When the 21-holding period expires, a financial institution remits the funds on the first business day following the 21stcalendar day after the receipt of the levy, plus applicable interest, to theIRS, unless a written release of levy is issued. The written release of notice of levy is from the IRS district director, who has the discretionary power to request an extension of the waiting period. Interest accrual ceases upon remittance and is reportable on the same IRS Form 1099-INT provided for other interest payments. NO separate Form 1099 is required.
Examples:
Levy = $10,000.00; balance in non-interest bearing account = $5,000.00; bank send $5,000.00 to IRS
Levy = $10,000.00; balance in interest bearing account = $5,000.00; bank send $5,000.00 plus 21 days interest, as contracted, to IRS
Levy = $5,000.00; balance in interest bearing account = $10,000.00; only $5,000.00 frozen for 21-day period; bank send $5,000.00, without interest, added to IRS
Levy = $10,000.00; balance in interest bearing account = $9,999.99; as soon as interest is earned within 21-day period, $10,000.00 is frozen and remitted to IRS at expiration of 21 days
Levy = $10,000.00; balance in interest bearing account = $5,000.00; account subject to 31% backup withholding; bank remits levied amount, plus 69% of accrued interest, to IRS
Note: A customer may waive the 21-day holding period by notifying the financial institution. Caution should be exercised where more than one depositor is listed on the account, for all owners must also agree to waive the holding period.
Questions are often fielded in regard to the ability of a financial institution to charge a processing fee for a levy and then remit the balance to the IRS. The answer is that a processing fee is not allowed, so long as there are insufficient funds to cover the entire levy amount. The IRS has priority and an institution may not set-off by “paying itself first.”
VIII. SET-OFF V. FEDERAL TAX LIEN
When a financial institution asserts or claims a superior interest in customer property that has been levied upon by the IRS, the institution may attempt to protect its interest in one of the following ways:
1. set off the amount owed to the institution and turn the account balance over to the IRS; or
2. surrender property to the IRS that is subject to levy and bring a civil action under Internal Revenue Code § 7426 to recover property in which the institution claims a superior interest.
The general rule is that an institution’s right to set-off is valid only if exercised prior to service of an IRS notice of levy. Many institutions have attempted to obtain priority over an IRS lien by taking security interests in customer accounts, but the courts are divided on the issue, with the IRS generally prevailing notwithstanding an institution’s security interests.
IX. PENALTIES FOR NONCOMPLIANCE
Failure to surrender property upon which a levy is properly issued, results in a penalty equal to the amount of property levied upon, plus costs and interest (not to exceed the amount of the customer’s tax liability for which the property was levied upon) and plus 50% of such amount. These penalties are not applied if a bona fide dispute exists, regarding:
1. the amount of property subject to levy; or
2. the existence of a reasonable belief that the amount of property levied is incorrect or that the notice of levy is defective in any manner.
X. IRS REQUEST TO REVIEW CUSTOMER BOOKS AND RECORDS
The IRS is allowed to request access to a customer’s books and records relating to the customer’s property in cases where an IRS levy “has been made or is about to be made” on a customer’s property held by a financial institution.
If a financial institution has not received a notice of levy prior to receiving a request to review the customer’s books and records, an institution should determine whether a levy “has been made or is about to be made.” The institution should further request that the IRS agent confirm that a levy is about to be made and that an assessment has already been made. If uncertain, the request should be refused and the IRS should be required to issue a summons before examining the customer’s records.
XI. CONCLUSION
Since a bank’s right to set-off may run head-on into an IRS tax levy, it is important to understand the implications of notice and timing. Another related area involves IRS tax liens and bank set-off rights. NOTE: Please refer to the article entitled “Internal Revenue Service: Federal Tax Liens & Set-off”, found in Volume III, Secured Transactions Section of the NBA Compliance Handbook, for a discussion of priorities, lien foreclosure, bank set-off v. IRS liens and penalties.