I. INTRODUCTION
Frequently, a bank’s right to set-off will run head-on into a tax levy issued by the Internal Revenue Service (IRS). In the normal case, the IRS uses the levy procedures to assist its efforts in collecting taxes from a taxpayer who fails to pay an assessed tax. Once a notice of levy is validly issued, a bank’s response must be both timely and appropriate. Typically, service of the tax levy notice may trigger acceleration of the customer/taxpayer’s indebtedness with the bank, followed by the bank’s immediate desire to exercise its set-off rights.
II. NOTICE OF LEVY
Whenever 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 customer/taxpayer and notice given by way of a telephone call is not appropriate. A bank is deemed to have received the notice of levy when: (1) the IRS personally hands a copy of the notice to an authorized bank officer; (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 bank 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 the bank’s possession at the time the levy is made and does not cover subsequent deposits. However, the notice of levy is effective for all bank offices (main bank and branches) and property owned by the customer and held by the bank at any bank office.
III. BANK RESPONSE TO NOTICE OF LEVY
A bank must surrender all property of the customer/taxpayer 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. The requirement to pay interest on IRS levies commenced effective July 1, 1989 and banks should note the following points regarding the interest on levy payments:
A. If the account is non-interest bearing, no interest need by paid.
B. Never send the IRS more than the levy amount.
C. If the amount in the account when the levy is received is sufficient to satisfy the levy, no interest need be remitted.
D. 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.
E. 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 bank should send only the account balance and enough of the interest to equal the levy amount.
The 21-day period gives the taxpayer an opportunity to challenge the levy.
If the levy is satisfied in whole or in part, the bank is instructed to send a copy of the levy to the customer within 2 working days. If there are no customer funds at the bank, a customer notice is not required.
IV. PROPERTY SUBJECT TO LEVY
Generally all property in the bank’s possession at the time the levy is made is subject to the IRS levy. Once the customer’s property is surrendered to the IRS, the bank is discharged from any further obligation to the IRS and shielded from liability to its customer. However, if a bank improperly surrenders property which is not subject to levy, the bank may face liability from the property owner. A bank that improperly surrenders property before the 21-day holding period expires is not shielded from customer liability. To recover property mistakenly surrendered, the bank may sue under 26 Internal Revenue Code Section 7426 or seek administrative relief pursuant to Internal Revenue Code Section 6343.
The following is a brief description of various types of “accounts” or property which are subject to an IRS levy: (1) bank accounts, including money in the bank 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 bank at the customer’s request; (3) uncollected funds if, by custom/agreement, the customer has a legal right to draw against such funds; and (4) checks in process of clearance do not affect the amount subject to levy since the levy extends the funds in the bank’s possession at the time the levy is served.
V. PROPERTY EXEMPT FROM LEVY
A. Money represented by a negotiable Certificate of Deposit is not subject to levy by mere notice. A levy on such funds must be made upon presentation and surrender of the negotiable Certificate of Deposit to the maker.
B. Individual Retirement Accounts (except in rare circumstances).
C. Property in a safe-deposit box is not subject to levy if the safe-deposit box is leased by the customer. However, the IRS may take possession of the safe-deposit box by serving the bank with both a notice of levy and notice of seizure (if requested by the IRS to open the safe-deposit box, a bank may refuse in the absence of customer’s consent or a court order). If refused entry, the IRS may seal the safe-deposit box, disallowing access by the customer or any joint holder of the box. The bank is protected from liability for refusing entry to a customer after receiving notice of seizure and having the box sealed.
VI. TREATMENT OF CERTIFICATES OF DEPOSIT
Assume a situation whereas on the first day after notice is received that the customer has no right to the interest, but the CD matures during the 21-day period. On the day the funds are remitted, the bank is required to include the full amount. The IRS is entitled to any CD amount and the interest accrued during the holding period. Assume that the levy is for $1,000 and the CD is valued at $1,000 but is subject to a $50 penalty for early withdrawal. On the day the funds are remitted, the bank must send in $950. That 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.
VII. TREATMENT FOR JOINT ACCOUNTS
A joint account is subject to an IRS levy although only one party has an unpaid tax obligation. The bank has no duty to determine relative ownership rights of co-depositor funds prior to turning them over to the IRS.
When a bank is served with a notice of levy relating to a join account, the bank must temporarily freeze the accounts assets and notify the IRS of all co-depositors. The bank must provide the IRS with the following information on the back of the levy notice: (1) The exact title of the account; (2) the social security or employee identification number; (3) the address of all persons listed on such account; (4) the account balance. If the IRS does not request the bank 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, the bank must surrender the fund 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 section 7426. Any claim of ownership by a co-depositor is determined by the IRS in accordance with state law regarding account ownership and the bank must only surrender the appropriate portion of the account.
VIII. EXPIRATION OF 21-DAY HOLDING PERIOD
When the 21-day holding period expires, the bank remits the funds on the first business day following the 21st calendar day after the receipt of the levy, plus applicable interest, to the IRS unless a written release of levy is issued. The written release of notice of levy is from the IRS district direction also 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:
a: levy = $10,000
balance in noninterest bearing account = $5,000
bank sends $5,000 to IRS
b: levy = $10,000
balance in interest bearing account = $5,000
bank sends $5,000 plus 21 days interest as contracted
c: levy = $5,000
balance in interest bearing account = $10,000
only $5,000 frozen for 21-day period;
bank sends $5,000 without interest added
d: levy = $10,000
balance in interest bearing account = $9,999.99
as soon as interest is earned within 21-day period $10,000 is
frozen and remitted to IRS at expiration of 21 days
e: levy = $10,000
account subject to 31% backup withholding
bank remits levied amount plus 69% of accrued interest
Note that a customer may waive the 21-day holding period by notifying the bank. 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 asked in regard to the ability of a bank to charge a processing fee for a levy and then remit the balance to the IRS. The answer is no, so long as there are insufficient funds to cover the entire levy amount. The IRS has priority and the bank may not “pay itself first.”
IX. BANK SET-OFF VS FEDERAL TAX LIEN
When a banker asserts or claims a superior interest in the customer’s property which has been levied upon by IRS, the bank may attempt to protect its interest in one of the following manners:
A. Set off the amount owed to bank by the customer and turn balance of account over to IRS.
B. Surrender property subject to levy to IRS and bring a civil action under 26 Internal Revenue Code Section 7426 to recover property in which the bank claims a superior interest.
The general rule is that a bank’s right to setoff is valid only if exercised prior to service of the IRS notice of levy. Many banks have attempted to obtain priority over an IRS lien by taking a security interest in its customer’s accounts, but the courts are divided on the issue with the IRS generally prevailing notwithstanding the bank’s security interest.
X. IRS LIEN LEVIES – DEPOSIT ACCOUNTS
Revenue Ruling 2006-42 indicates that a bank’s right of setoff against a customer’s deposit account or its claim of a security interest that has priority over a federal tax lien does not relieve a bank of its obligation to honor a levy. The Revenue Ruling outlines the process that a bank must follow to lay claim to the depositor’s funds.
According to the Revenue Ruling, a bank must honor the levy and then contact the IRS, prove the priority of the bank’s interest under IRC Section 6323(b)(10) and “request that the levy be released.” Under the facts involved in the case addressed by the Revenue Ruling, the bank acted properly by contacting the IRS in a timely manner to resolve its dispute informally, with the IRS agreeing to release its levy upon proof by the bank of its super priority interest under Section 6323(b)(10). Had the bank not contacted the IRS informally, or in the absence of an agreement by the IRS to release its levy after such contact, the bank could have timely filed a wrongful levy suit in federal district court pursuant to Section 7426(a)(1).
Failure by a bank to timely act in following the process outlined above will subject the bank to IRS actions to enforce the levy. A bank must make its filing within 9 months of the levy or lose its ability to do so.
A copy of the Revenue Ruling is available by going to the IRS Website, www.irs.gov/ and searching for "Rev.Rul.2006-42."
XI. PENALTIES FOR NONCOMPLIANCE
Failure to surrender property upon which a levy is properly issued results in penalty equal to the amount of property levied upon plus cost and interest (not to exceed the amount of the customers tax liability for which property was levied upon) plus 50% of such amount. However, 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.
XII. IRS REQUEST TO REVIEW BOOKS AND RECORD OF CUSTOMERS
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 made” on a customer’s property held by the bank.
If the bank has not received a notice of levy prior to receiving a request to review the customer’s books and records, the bank should determine whether a levy “has been made or is about to be made”. The bank 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 required to issue a summons before examining the customer’s records.