You have settled the case, the carrier has cut the draft, and your trust account is holding proceeds you thought were spoken for by a health lien and your fee. Then a Notice of Levy from the IRS arrives, or an Order to Withhold from the Franchise Tax Board, and the arithmetic changes. Tax collectors do not stand in the ordinary line of medical and statutory lienholders. They attach by operation of law, they attach early, and once you have notice, paying your client over them can make you the collector's next target.
The doctrine here is not complicated, but it is unforgiving. A tax lien reaches "property and rights to property," and a cause of action that has ripened into a settlement is squarely both. What follows is how the federal lien, the FTB, and local agencies actually reach a personal-injury recovery, and the two or three moves that keep the disbursement clean.
How the Federal Tax Lien Attaches Before You Ever Get the Check
Under 26 U.S.C. § 6321, once a taxpayer neglects or refuses to pay an assessed liability after demand, a lien arises in favor of the United States on all property and rights to property belonging to that taxpayer. It arises automatically at assessment and relates back under § 6322. It does not require a recorded notice to exist — recording a Notice of Federal Tax Lien under § 6323 only fixes priority against competing purchasers, judgment creditors, and other lienholders.
The point people miss: your client's chose in action is "property" the moment it has value the government can identify, and the settlement proceeds plainly are. So when your client owes the IRS, the lien has already fastened onto the recovery before the funds hit your trust account. You are not deciding whether the lien reaches the money; you are deciding what to do about a lien that is already there.
Priority against the other claimants on the file turns on the first-in-time rule and the § 6323 exceptions. An NFTL recorded before a competing lien was perfected generally beats it. This is the same priority analysis you run for other statutory claimants, and it belongs on the same ledger you use when building an allocation worksheet that survives carrier and DHCS review — the tax claim is a line item with a date, not an afterthought.
Lien Versus Levy: Know Which Paper You Are Holding
A lien secures the debt; a levy collects it. The document that actually forces money out of your trust account is usually a Notice of Levy under 26 U.S.C. § 6331, served on you as the party holding the taxpayer's property. Section 6332 then obligates you, as the custodian, to surrender the levied property. Fail to honor a valid levy and you become personally liable under § 6332(d)(1) for the amount you should have turned over, plus a potential 50% penalty.
That personal-liability exposure is the reason a levy cannot be treated like a demand letter you negotiate at leisure. A levy reaches property you hold on the date it is served and obligations then fixed; funds already in your possession that belong to the delinquent client are within its grasp. If the proceeds have not yet arrived when the levy lands, the analysis is narrower, but do not assume timing saves you — a settlement obligation that is fixed and determinable can be caught.
The Attorney Fee Superpriority Still Holds — Within Limits
Here is the provision that protects your fee. Section 6323(b)(8) grants a superpriority to an attorney's lien, to the extent of reasonable compensation, for securing a judgment or procuring a settlement of a claim — and it takes priority even over a federal tax lien filed first. Congress recognized that the recovery would not exist for the government to grab without the lawyer who created it. Your contingency fee, if reasonable and tied to the recovery, generally sits ahead of the IRS on the very fund you produced.
The protection is not unlimited. It runs to reasonable compensation, not to costs advanced without a proper lien, and courts have declined to extend it where the fee arrangement is a device to shelter the client's share. It also does not cover the client's net. So structure the fee agreement to create a clear charging lien on the recovery, keep your reasonableness documentation ready, and do not let a padded cost line invite scrutiny of the whole claim. When federal money is on the other side of the case, the calculus shifts again in ways worth reading alongside the sovereign-immunity questions in recent California rulings on government-defendant immunity.
The Franchise Tax Board: Recorded Liens and the Order to Withhold
California's tax collector reaches settlements through parallel machinery. Under Revenue and Taxation Code § 19221, an unpaid, assessed state income tax becomes a perfected and enforceable lien for the amount due, and the FTB records a Notice of State Tax Lien governed by the state's statutory-lien recording scheme in Government Code § 7170 and following. Priority again runs first in time from perfection.
The FTB's collection tool that lands on your desk is the Order to Withhold under Revenue and Taxation Code § 18670. An OTW is served on a third party — a bank, an employer, or an attorney holding client funds — and directs that party to remit property or credits belonging to the taxpayer, up to the amount stated. Like a federal levy, it is not a suggestion. A party served with a valid OTW who instead pays the taxpayer can be held liable for the amount that should have been withheld. The FTB also uses continuous earnings withholding for wages, but for a lump-sum settlement in trust, the OTW is the instrument to watch for.
Two practical notes. First, the FTB and the IRS can both be on the same client, and their claims do not merge; you may be juggling a federal levy and a state OTW against one recovery. Second, treat the FTB claim with the same date-stamped priority discipline you give a child-support lien on a PI settlement — both are statutory, both can carry personal exposure for the disbursing attorney, and both reward the lawyer who fixed the priority order before cutting checks.
Local Tax Liens Rarely Reach the Proceeds — But Confirm It
County and municipal tax liens are the least likely to touch a settlement, and the reason is mechanical. Property tax liens under the Revenue and Taxation Code attach to the assessed real property, not to the taxpayer's unrelated intangible rights, so a delinquent parcel does not by itself pull from a personal-injury fund. Local business-tax or unsecured-property obligations can be reduced to a judgment and collected like any other, but at that point the county is an ordinary judgment creditor subject to ordinary priority, not a taxing authority with a self-executing hold on your trust account.
The exception worth a phone call is any local agency that has already recorded an abstract of judgment or obtained a writ. Run the client's name and confirm nothing is recorded that predates and outranks the claims you are already tracking. The cost of the search is minutes; the cost of guessing wrong is a disbursed fund you cannot claw back.
Disbursing Without Making Yourself the Defendant
The through-line in every one of these mechanisms is that the burden of getting it right sits on the lawyer holding the money. Once you have notice of a valid tax lien or you are served with a levy or an OTW, releasing the client's share ahead of the collector converts a client debt into your problem. The safe sequence is to identify every claimant early, request payoff or balance figures in writing, fix priority by perfection date, honor valid levies and withholding orders as to the amounts they cover, and protect your § 6323(b)(8) fee with clean documentation.
When the claims exceed the fund or the priority is genuinely contested, do not referee it from trust. Interplead the disputed proceeds and let the claimants fight over them with the court holding the stakes. Interpleader discharges your custodial exposure and stops the § 6332 or OTW liability clock, which is a far better outcome than a good-faith guess that turns out to favor the wrong party. The same defensive instinct that drives careful Medicare conditional-payment recovery applies here: verify, document, and never disburse over a claim you have actual notice of.
Tax liens are not louder than other liens, but they are earlier and they carry personal teeth. Treat the collector as a first-position claimant until the perfection dates prove otherwise, and the settlement that felt like a payday for your client will not become a liability for you.