United States v. Bell Credit Union, 860 F.2d 365, 369 (10th Cir. 1988)

In United States v. Bell Credit Union, the District Court for the District of Kansas addressed whether credit unions were liable for failing to honor IRS levies on members’ accounts, and whether a 50% penalty under 26 U.S.C. § 6332(c)(2) should be imposed.

Facts:

• The IRS served notices of levy on two credit unions (Bell Credit Union and Golden Plains Credit Union) for funds held in accounts of certain members who owed taxes.
• After receiving the levies, the credit unions declared defaults on the members’ loans and applied the account balances to the outstanding loans, leaving no funds to satisfy the IRS levies.
• The United States sued to recover the levied funds and to impose a 50% penalty for failure to honor the levies.

Credit Unions’ Arguments:

• The credit unions claimed they had a superior security interest in the accounts, based on both statutory (Kansas law) and contractual liens, and thus their interest was prior to the IRS levy.
• They argued that, unlike banks, credit union “shares” are not deposits but part of the capital stock, and that their liens were both statutory and contractual.

Court’s Analysis:

• The court rejected the distinction between credit unions and banks, finding that the statutory “lien” was in substance an equitable right of setoff, not a true perfected lien.
• The court explained that, under federal law, for a state-created lien to have priority over a federal tax lien, it must be “choate”—meaning the identity of the lienor, the property, and the amount must be established and nothing further must be required to perfect the lien.
• Here, the credit unions’ interests were not choate because the members could withdraw funds at will before the levy, so the property subject to the lien was not fixed.
• Even if the credit unions had a prior lien, the proper procedure would have been to surrender the funds to the IRS and then litigate the priority of the liens, not to refuse to honor the levy.

Penalty:

• The court found no reasonable, bona fide dispute as to the law and imposed the 50% penalty under 26 U.S.C. § 6332(c)(2), which applies when a person required to surrender property under a levy fails to do so without reasonable cause.

Holding:

• The court denied the credit unions’ motion for summary judgment, granted the United States’ cross-motion, ordered the credit unions to pay the amount of the levies plus interest, and imposed the 50% penalty.

Key Legal Principles:

• A state-created lien must be choate and first in time to have priority over a federal tax lien.
• The right of setoff or an unperfected lien does not defeat an IRS levy.
• The proper procedure is to surrender the levied funds and then litigate lien priority.

Failure to honor a levy without reasonable cause results in a 50% penalty under § 6332(c)(2).