The Federal Tax Lien: Rights to Future Payments
The United States has the power to place a lien upon a taxpayer’s “property and rights to property” when that taxpayer neglects or refuses to pay taxes. In Fidelity & Deposit Co. of Maryland v. Ohio Department of Transportation, the Sixth Circuit considered whether a contractor’s right to future payments under a construction contract can be considered “property” or “rights to property” under federal tax law subject to the attachment of an IRS lien. While the court did not directly decide whether such an interest was a property interest for purposes of federal tax law, it did provide guidance for district courts on how to analyze what interests can be subject to lien.
At issue in Fidelity was whether the IRS or a contractor’s surety was entitled to $589,049.49 arising out of construction contracts between general contractor Cosmos Industrial Services, Inc. (“Cosmos”) and the Ohio Department of Transportation (“ODOT”) from the years 2013-2015. The contracts provided that in exchange for performing various state roadway projects, Cosmos would receive monthly progress payments from ODOT based on the amount of completed work. Cosmos retained Fidelity and Deposit Company of Maryland (“Fidelity”) to act as its surety and provide payment and performance bonds to ODOT.
Not long after beginning work for ODOT in 2013, Cosmos began experiencing cash flow problems, resulting in failure to pay subcontractors and suppliers and failure to pay certain federal taxes and federally-mandated benefits. The federal Davis-Bacon Act required ODOT to withhold funds payable to Cosmos when Cosmos failed to pay certain fringe benefits required by the FHA. Similarly, Ohio state law required ODOT to withhold funds payable to the contractor to instead pay off the mechanics liens. ODOT withheld $553,590.71 to satisfy mechanics liens filed against Cosmos by jilted subcontractors and suppliers, but the amount ODOT withheld to satisfy Davis-Bacon obligations was in dispute at trial. By June 2015, the IRS had assessed taxes for the years 2013-2015, with penalties and interest, to Cosmos, who was still unable to pay. The IRS then recorded liens against Cosmos.
On September 1, 2015, Cosmos contacted Fidelity because it had no more funds to provide for the work required by the contracts. Soon afterward, Fidelity paid ODOT enough to satisfy the mechanics liens and the Davis-Bacon violations, but ODOT continued to withhold these funds, and payments to Cosmos for work completed after September 1, due to the IRS liens. Fidelity filed suit to resolve the conflict between it and the IRS over who was entitled to the total amount withheld by ODOT, specifically (1) progress payments for work done after September 1, and (2) funds withheld prior to September 1 due to Davis-Bacon violations and mechanics liens.
Fidelity argued that it was entitled to the money even though ODOT did not formally declare Cosmos in default until April 6, 2016, because Cosmos could not function without Fidelity’s assistance as of September 1, 2015; therefore, Fidelity stepped into Cosmos’s shoes on this date in regard to its contracts with ODOT under the doctrine of equitable subrogation, eliminating the IRS’s claim to the funds. In regard to funds withheld for work done after September 1, Fidelity argued that Cosmos did not have an interest in those payments sufficient for the IRS’s lien to attach. If this were true, then Fidelity would be entitled to these funds unencumbered by federal liens. Persuaded by this argument, the district court granted summary judgment for Fidelity, relying primarily on its understanding that equitable subrogation eliminated Cosmos’s potential interest, if any, in the funds.
The Sixth Circuit reversed, finding that the district court’s holding lacked any analysis of whether future payments to Cosmos were “property or rights to property” under federal law. This inquiry was crucial to deciding which party has a superior right to the funds withheld by ODOT because § 6321 only allows for the IRS to attach liens to “property or rights to property,” and “[n]ot all interests . . . are property or rights to property under federal law.” If Cosmos’s right to future payments constituted property or rights to property under federal law, then the IRS’s liens attached to this interest at the time it assessed the taxes, which was before Fidelity stepped in as performing surety on September 1, 2015. The transfer to Fidelity of Cosmos’s right to future payments under equitable subrogation would not alter the status of the preexisting lien.
Thus, the Sixth Circuit found that this case hinged on determining whether Cosmos’s interest in future payments under the contract with ODOT was a federal property right. This is a question ultimately of federal law, but informed by state law. Pulling from Supreme Court precedent, the Sixth Circuit announced a two-part test. First, the court must look to state law to “determine what rights the taxpayer has in the property the Government seeks to reach.”Second, the court asks whether this state-delineated right qualifies “as ‘property’ or ‘rights to property’ within the compass of federal tax lien legislation.”
The Sixth Circuit did not itself undertake this analysis, but directed the district court on remand to address what rights Cosmos had in future payments, if any, and whether those rights would qualify as property or rights to property under federal law. The Sixth Circuit identified two Supreme Court cases—Drye v. United States and United States v. Bess—to aid the district court in its analysis. The Court held in Drye that an heir’s interest in his mother’s estate constituted a federal property interest under § 6321 because it was a “valuable, transferable, legally protected right” to property that the heir could presently exercise dominion over. In contrast, the Court held in Bess that a person’s proceeds from his own pay-on-death life insurance policy did not constitute a federal property right because he had “no right to receive the proceeds while he live[d],” leaving the proceeds presently out of his reach. Thus, it would appear from these goalposts that whether an interest is property or rights to property for purposes of § 6321 turns on the level of control the interest holder can presently exercise over the property.
A proper consideration of this issue would also resolve the dispute as to the second category of withheld funds related to the mechanics liens and the Davis-Bacon violations. ODOT began assessing mechanics liens in August 2015, after the IRS had assessed Cosmos’s deficient taxes. Thus, if the tax liens attached to a federal property interest, then the mechanics liens are subject to the tax liens. Similarly, the timing of when ODOT placed holds on Cosmos’s funds due to the Davis-Bacon violations is crucial to determining which claim to the withheld funds takes precedence if the tax liens attached to a federal property interest. Since the timing of ODOT’s hold on funds due to the Davis-Bacon violations was in dispute, the Sixth Circuit directed the district court to make more findings on this issue after resolving the tax liens issue.
 26 U.S.C.A. § 6321.
 Fidelity & Deposit Co. of Maryland v. Ohio Dep’t of Transp., 2020 WL 1131665 (6th Cir. Mar. 9, 2020).
 Id. at *1.
 Id. at *2.
 40 U.S.C. §§ 3141–48
 Fidelity v. Ohio Dept. of Transp., at *1.
 Id. at *2.
 Id. at *3.
 See id.
 See id.
 Id. at *3-*4.
 Id. at *4.
 Id. at *4-*5.
 Id. at *4.
 See id. at *5.
 See id.
 See id. (citing Drye v. United States, 528 U.S. 49, and United States v. Craft, 535 U.S. 274).
 Id. at *6.
 357 U.S. 51.
 See Fidelity v. Ohio Dept. of Transp., at *5.
 Id. (quoting Drye, 528 U.S. at 60-61).
 Id. (quoting Bess, 357 U.S. at 55-56).
 Id. at *7.
Need assistance in managing the Tax Compliance process? With our unique substantive and procedural knowledge, we can provide a comprehensive approach to the tax dispute resolution process, often collaborating with clients’ existing tax professionals to formulate creative solutions to the most complex tax problems. Freeman Law offers value-driven legal services and provides practical solutions to complex tax issues. Schedule a consultation now or call (214) 984-3410 to discuss your tax concerns and questions?