February 19, 2008
Levy rights of taxing authorities subject to the tax levies are often served on construction owners whose contractors are not paying their laborers, subcontractors and suppliers. If the owner pays the taxing authorities in response to these levies, he or she may deduct the amount from the contract or subcontract price. A.F.A.B., Inc. v. Town of Old Orchard Beach, 777 A.2d 831 (Me. 2001).
The levy rights of the taxing authorities, however, are subject to the owner’s right to withhold money to satisfy the claims of the contractor’s unpaid subcontractors and suppliers. United States v. Durham Lumber Co., 363 U.S. 522 (1960); Victorie Ins. Co. v. City of Bowie, 23 S.W.3d 499 (Tex. Civ. Ct. App. 2000). Most contracts and subcontracts require the contractor and subcontractor to pay all laborers, subcontractors and suppliers; the failure to do so is a breach of contract entitling the owner or contractor to withhold unpaid amounts. Additionally, Minnesota’s Mechanic’s Lien Law entitles a property owner to pay subcontractor and suppliers directly and to withhold payment for improvements for 120 days to make sure that all potential lien claims have expired before making final payment. See Minn. Stat. § 514.07.
The IRS has adopted an internal policy acknowledging the priority of mechanic’s liens: “[T]he mechanic may still be entitled to contract proceeds on the theory that the contractor-taxpayer by failing to pay the mechanic may be deemed to have no property right in the contract proceeds to which the federal tax lien could attach.” See Legal Reference Guide for Revenue Officers, Internal Revenue Manual, at 5.17.2.5.2.3 (10-31-2000) (available at www.irs.gov/irm/part5/ch17s03.html). The IRS’s position, of course, will depend upon the particular facts. When served with a tax levy for unpaid contract funds, therefore, the owner may usually satisfy mechanic’s liens (and potential mechanic’s lien claims) before paying anything to the taxing authority.