There are really a couple of issues here and one has to do with lien priority. This is a battle between the Uniform Commercial Code (UCC), Article 9, and the Internal Revenue Code (IRC). Because we have a limited amount of space, suffice it to say what matters is whether the bank perfected its security interest in the certificate of deposit (CD) or other collateral prior to the notice of federal tax lien (NFTL) being filed. There are other variables that also matter, but in most cases that is the bottom line. However, that is not the whole story. An equally important issue is  whether just an IRS notice of bank levy is enough to get the CD. In some cases the IRS has to jump through a few more hoops.

If intangible property is represented by a negotiable document, actual seizure of the document must be made. Service of notice of levy upon the maker of the note, the corporation or the bank is ineffective to reduce the property right to possession. Money on deposit in a bank represented by a nonnegotiable certificate of deposit in the hands of a delinquent taxpayer is subject to the levy. Rev. Rul. 73-12, 1973-1 C.B. 601. The holding in Rev. Rul. 73-12 is not applicable to negotiable certificates. Rev. Rul. 75-355, 1975-2 C.B. 478. A levy by the government on funds represented by a negotiable certificate of deposit must be made by presentation of the negotiable certificate and surrender of such certificate to the maker.

A second and more common issue is what happens when a bank receives a notice of bank levy and the funds in your savings account are subject to setoff pursuant to a security agreement with the bank. In this case, if the federal tax lien attached to a taxpayer’s property prior to setoff, then a bank takes funds encumbered with a federal tax lien. The government may still levy on the bank to obtain the encumbered funds. United States v. Donahue Industries, Inc., 905 F.2d 1325 (9th Cir. 1990); Rev. Rul. 2006-42. See also IRM 5.17.3.9.4.

Conclusion:

Pledging collateral to a bank does not make it immune from IRS collection activity. Be mindful  that the IRS has a very long reach and your bank might be surprised to learn that it is not always first in line! If the bank loses its collateral to the IRS, your loan may go into default and the bank is then likely to call the loan. If you are a small business owner that owes back taxes to the IRS and don’t have an installment agreement (IA) in place or a collection hold, you and your bank may be in for a nasty surprise.