The consequences of falling behind on your taxes are difficult for anyone, but when we are talking about businesses, sales taxes, and California’s California Department of Tax and Fee Administration (CDTFA), the results can be devastating.
The CDTFA is particularly aggressive about investigating and pursuing unpaid sales taxes, and will often demand immediate payment of any liability, no matter what other types of financial responsibilities or consequences the business may be facing.
One of the most powerful “weapons'' in the CDTFA’s arsenal of collection tactics is the tax lien. Understanding how liens work, why they happen, and what to do if one is recorded against you is important to know in order to protect your business during times of financial difficulty.
What You Need to Know About Tax Liens
Once the CDTFA has determined that you owe unpaid sales tax, they will begin collection processes. One of the most unpleasant collection actions available to the CDTFA is the tax lien. In essence, a tax lien is a public notice which states that the CDTFA has a legal claim to your personal or real property until your tax debt is paid.
This lien encumbers your property, and means that you cannot sell, refinance, or transfer the property through escrow. If you obtain new property after the lien is recorded, it automatically attaches to that property as well.
Recorded liens are public records, viewable by anyone, including credit bureaus, and their effect on your credit rating can be immediate and disastrous. Even if the lien is eventually released, it will remain on your credit reports for seven years, unless the lien was originally filed in error.
If you believe the lien was issued erroneously, then you can try to dispute it. Communicate with the CDTFA as soon as possible by phoning or writing to the CDTFA office that sent the bill, or by visiting the nearest CDTFA office.
If a state sales tax lien is recorded against you before you file for bankruptcy, the lien will remain even if the tax debt is discharged in the bankruptcy. California state tax liens have a 10-year lifespan. After 10 years, the lien expires and is unenforceable, however it can be renewed for another 10 years if the CDTFA files extension paperwork within 90 days of the expiration date. This renewal can be filed twice, for a total lifespan of 30 years.
The tax lien process effectively begins with a notice from the CDTFA, which they must send you 30 days before they intend to file the lien with the county recorder. If you receive such a notice, you must act quickly.
If you believe that the CDTFA has committed an error, you should contact them immediately, preferably after consulting with a qualified tax attorney to ensure that your rights are protected.
If you actually owe the CDTFA the amount they claim, it is in your best interest to pay the debt in full, as soon as possible. The faster you pay, the smaller the total amount of taxes, penalties, interest and other fees will be. If you pay within the 30-day period, you should be able to avoid having a lien recorded at all.
Unfortunately for many taxpayers, the difficult financial circumstances that led to the tax debt in the first place often make it impossible to pay the entire debt immediately.
While this situation understandably adds a lot of stress, it does not mean that a lien is inevitable. If you make contact with the CDTFA within the 30 days to pay what you can and to discuss a payment plan, you may still be able to avoid the recording of the lien.
The CDTFA may withhold a lien if it believes that the taxpayer can and will make payment arrangements in good faith. Short term payment plans are sometimes accepted.
The CDTFA will usually withhold a lien if you can pay the full amount within 12 months, if you have never had payment problems before, and if you fulfill the terms of the plan perfectly.
Payments are usually made weekly, and all of your tax returns and filings must be kept up-to-date. Longer term payment plans are more difficult to arrange and will require a thorough investigation into your finances to ensure that you do not have the means to pay off the debt more quickly.
Types of Tax Liens
Some taxpayers try to game the system by transferring property to another person in order to avoid having a lien placed. As you will read, this rarely is successful and can backfire badly.
If a person’s name is on a property title, but they are not the actual owner, then they are a nominee. A nominee lien is recorded against property when it is determined that the nominee is holding the lien for the benefit of the taxpayer.
There are three situations when either real or personal property not in the name of the taxpayer are subject to levy, lien, or some other enforcement procedure. These situations are:
- Liability of the community property for debts of either spouse
- Property that was subjected to a lien when owned by the taxpayer
- Property that the taxpayer has fraudulently conveyed
The lien compels the taxpayer to take the action to remove the resulting cloud on the title of its property rather than the CDTFA having to initiate action to set aside a fraudulent conveyance. A cause of action with respect to a fraudulent transfer is subject to the provisions of Civil Code section 3439.09.
Buying or Selling a Business Subject to a Tax Lien
Even though a business may be facing a tax lien, the opportunity to buy or sell your business may still appear as an attractive opportunity. However, a lien adds some considerations for buyers and sellers.
Both Federal and California tax liens remain on the business and are assumed by the buyer in a sale (CDFTA Collections Manual 732.100). It is important to understand that even if you did not create the lien, the lien is attached to the business assets, and the authorities can ultimately collect from those assets if the lien is not satisfied.
Even if the seller does not tell the buyer about a tax lien, the seller is still liable. There are some exceptions for fraud or negligence of the previous owner. Under RTC §6814, successors (buyers) may seek relief from prior tax liens if they were “beyond the successors control” and were not readily discoverable. However, obtaining a tax clearance involves a lot of time and can delay a transaction
An important first step as a purchaser is looking for any potential tax lien through an online record search. This will help you structure your deal to cover for the liability. Sellers and buyers may be able to negotiate the sale price to accommodate paying off a lien as part of the transaction.
The State will send the buyer a Successor’s Liability notice to inform of any liens. The statute of limitations of the liens run three years after the CDTFA has been aware of the purchase of the business (CDTFA 732.120).
Escrow and Audits
If the purchaser allows funds in escrow to be distributed without first securing a tax clearance from the CDTFA, the successor cannot be relieved of liability. CDTFA still needs to receive payment to cover the lien.
California tax authorities are authorized to conduct audits to determine tax liabilities. When businesses are being sold with outstanding tax liens, California may elect to do an audit of the business and request that the entire amount being withheld in escrow be turned over to the state pending the outcome of that audit.
The CDTFA will issue warrants to confiscate property in accordance with a legal judgment to enforce liens and to collect amounts due. Warrants are often issued upon property in which a third party has an interest, and the third party will often file claims objecting to the seizure.
The levying officer must release the property to the third-party claimant within five days after the claim is filed unless the amount of the claim is posted with the levying officer or the levying officer has been notified of the CDTFA’s opposition to it (CPPM 753.210). The CDTFA may also decide to pay off the third-party claim and still seize the original property if it is in its best interest and the claim is relatively nominal.
A third-party claimant may file a claim with the CDTFA office that issued the levy. That CDTFA is responsible for advising the third-party claimant of all requirements of a valid claim. Third-party claim must be signed under penalty of perjury and contain all of the following:
- Name and mailing address of the third-party
- Description of the property in which an interest is claimed
- Description of the ownership interest claimed, including a statement of the facts upon which the claim is based
- An estimate of the market value of the interest claimed
If the third-party claim cannot be resolved by the specific bureau of the CFTFA, it will be sent to the Litigation Bureau of the CDTFA for further consideration.
Notices to Third Parties Holding Taxpayer Property
RTC § 6703 and equivalent special taxes and fees statutes authorize the CDTFA to serve a Notice of Levy on a third-party holding property belonging to a taxpayer. Funds held in a joint bank account are presumed to be community property, and funds in some bank accounts in the name of the taxpayer’s spouse may be subject to levy as community property.
To reach community property interests, collectors must attach a spousal affidavit, and the state must investigate if the funds there are truly community property. Community property as opposed to separate property owned by just one spouse, is liable for debts of either spouse. You should consult an attorney if you have any questions as to the status of your marital assets.
Federal Third-Party Liens
Federal authorities can also place a lien upon a property. Any CDTFA lien is treated with equal priority. The state can seek payment of their lien only if the holder of the money is unaware of a federal lien that is to be paid out.
Generally, a fraudulent conveyance is a transfer of a property interest that is made for the purpose of preventing creditors from obtaining assets in satisfaction of a claim. The elements the state looks for in a fraudulent transaction are intent, insolvency, lack of fair consideration (i.e., unreasonable exchange in value), and larger bulk transfers. If the state suspects a fraudulent transaction, they must document their reasons why, and the taxpayer will receive notice of such.
So Much More To Tax
The 20th-century economy model of taxing goods being sold is still practiced in California. In some counties, the sales and use tax rates are as high as 10.25 percent. Still, the state does not tax basic needs such as groceries, rent, utilities and prescription drugs or for that matter, most services.
How long will it be before the CDTFA catches up to the 21st century? That’s hard to say. The sale of data products such as software, digital books, music and mobile applications remain tax free, as do services such as haircuts and doctor’s appointments.
For the time being, the CDTFA will continue to aggressively collect billions of dollars in sales and use taxes from businesses selling their products within its borders every year. If you are a business owner either within California or out of state and have run afoul of the CDTFA, give Brotman Law a call. We’ll set the record straight and help you to keep your doors open and the lights on.