IRS’s release of lien makes its debt unsecured

Where the Internal Revenue Service voluntarily released a lien after receiving notice of the debtor’s discharge, and the trustee later sold the debtor’s real property for the benefit of creditors, no tax lien existed on the date of the closing of the sale of the real property, and no lien attached to the proceeds of the sale.

Background

Between 2014 and 2016, the debtor accumulated various income tax obligations. The Internal Revenue Service, or IRS, assessed interest and penalties on the unpaid taxes. In 2015, the debtor and his mother acquired together real property in Fredericksburg, Virginia. In March 2019, the IRS recorded a notice of federal tax lien in the amount of $63,792.55.

In June 2021, the debtor filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code. On Sept. 27, 2021, the debtor received his discharge. On Dec. 22, 2021, the trustee filed a motion to sell the Fredericksburg property. In it, he stated that the property was encumbered by “a first lien mortgage in favor of Freedom Mortgage in the approximate amount of $236,839.14 [and] a lien in favor of the IRS in the approximate amount of $63,792.55.” The court granted the motion to sell.

Prior to closing the sale, the trustee contacted the IRS, requesting the payoff amount for the tax lien. The IRS replied that the “lien was released by the IRS on 10/25/2021” and included a copy of the release.

On Jan. 25, 2022, fifteen days after the claims bar date had passed, the IRS filed its proof of claim in the Bankruptcy Case. The proof of claim was filed in the aggregate amount of $94,796.82, of which the IRS claimed $77,925.26 was secured by a federal tax lien. 

The United States conceded that “upon receiving notice of the debtor’s discharge (September 27, 2021)” the “IRS released the liens in question.” It further acknowledged that “[t]he release has not been revoked, and the original liens have not been reinstated.”

The trustee’s objection seeks to reclassify the secured portion proof of claim filed by the IRS from a secured claim in the amount of $77,925.26 to a general unsecured claim in the amount of $81,827.90. The trustee does not object to priority portion of the claim asserted by the IRS in its proof of claim in the amount of $12,968.92.

Analysis

The United States asserts that the release of a lien after the commencement of judicial proceedings, like the Bankruptcy Case, has no effect on the validity or priority of the tax lien. In support of this position, the United States relies on section 6323(g) of the federal tax regulations. However that section concerns the process by which the IRS can re-assert a tax lien after expiration of the 10-year statutory period. In this case, the required refiling period for each assessment is years away. As such, section 6323 does not apply.

The release in this case arose from an affirmative act. As such, the court finds that section 6325 of the federal tax regulations governing the non-automatic release of tax liens is the legal standard that applies to this case. If a tax lien has been erroneously released, section 6325 makes provision for its reinstatement regardless of the pendency of judicial proceedings. 

In such an instance where the certificate of release was “issued erroneously or improvidently,” the IRS “may revoke the certificate and reinstate the tax lien.” The reinstated tax lien “is effective on and after the date the notice of revocation is mailed to the taxpayer;” it is not retroactive. Because the IRS has confirmed that it has not revoked the release nor reinstated the tax lien, the court finds that no tax lien existed on Jan. 26, 2022, the date of the closing of the sale of the real property, and no lien attached to the proceeds of the sale.

Regardless of whether section 6323 or 6325 applies, the United States contends, in the alternative, that because the IRS had a properly perfected secured tax lien on the petition date, the IRS is entitled to a secured claim throughout the pendency of the Bankruptcy Case. However bankruptcy courts have refused to apply the snapshot theory to determine the secured status of an IRS claim where the IRS has filed a post-petition certificate of release. 

Trustee’s objection sustained.

In re: Jason W. Litvinas, No. 21-31912, Aug. 15, 2022. EDVA Bankr. at Richmond (Huennekens). VLW No. 022-4-019. 11 pp.