IRS Federal Tax Lien – Definition, Effects, & What To Do
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A Tax Lien is the first major step the IRS takes against individuals in order to collect back taxes. A Tax Lien gives the IRS a legal claim to your property as security or payment for your tax debt. It is used in order to protect the government’s interest in your assets.
When and Why is a Tax Lien Filed?
If you have unpaid back taxes and have not cooperated with the demands of the IRS to make the payments of the tax amount owed, it is likely that eventually you will receive a tax lien, which will then lead to a tax levy. Recently, the IRS will raise the debt threshold for issuing tax liens in most cases from $5,000 to $10,000 (policy change announced in 2011) largely due to the fact that tax liens can hurt taxpayers further and lessen their likelihood of getting into compliance with the IRS.
Here is how the process works. The IRS will first send you a letter with an assessment of your tax liability. This letter will typically state the amount that is unpaid as well as late payment penalty and interest. If the assessment letter is ignored, the IRS will follow up with four more letters, CP-501, CP-CP-503, CP-504, and finally LT11/L1058 in most cases. These letters will get more and more threatening as the numbers get higher. The final one of the CP letters mentions it’s intent to levy. After these letters are sent to the taxpayer and there is no response or the tax amount is not paid, the IRS determines that they are not able to collect the tax the conventional way, so the IRS will then file a Notice of Federal Tax Lien (NFTL) and potentially move forward with a levy. Once you receive this tax lien, the lien has already been attached to your property. The purpose of the tax lien is to prevent you from selling or borrowing against any of the major assets that you own. With a tax lien in place, it gives legal claim to the IRS over that piece of property that the lien was placed and removes your rights to the property. Moreover, tax liens are public records.
Effects of a Tax Lien
A tax lien makes it very difficult to get any credit to make additional large purchases, such as a boat, car, or house. Having a lien placed on you by the IRS can be financially crippling for the time it is in place, it pretty much means you can’t hold any assets in your name and you have to rely on other people for financing (as lien is on your credit too). All creditors would be notified including your mortgage company. A tax lien will stay in place as long as the IRS can legally enforce action against you (typically 10 years statute of limitations), or until your tax liabilities have been paid or settled with the IRS. The IRS becomes the highest of priority of creditors, so if you sold your house, car, or whatever property the lien was one and you had other liens on that property, the IRS would be the first to be paid.
If you do nothing about the tax lien, the IRS will eventually begin to seize your assets and sell them at a public or private sale. Once the IRS actually starts seizing your assets to satisfy the back tax liability, this is known as a tax levy. A tax levy is the most lethal weapon that the IRS possesses for collecting taxes.
One thing to note, is even when a tax lien is “released,” and your public records are updated as showing the tax lien was released, the history or the fact that you received a tax lien the first place may still hinder your ability to borrow, get a job, rent a house and so forth. The IRS in February of 2011 announced policy changes, whereby in most cases tax lien can be withdrawn or expunged from public records if the taxpayer sets up a direct debit installment agreement (DDIA), has one already setup (they can just request to have lien withdrawn), and owes $25,000 or less. Of course, exceptions do happen.
What To Do About a Tax Lien?
It is best to take action as soon as possible when a lien is put in place. It is not a good idea to try to wait it out until the statute of limitations expires because most likely you will get a levy placed on you before then and the IRS will seize your assets before the statute of limitations expires. In order to release a tax lien you will have to file a tax return or file your back taxes (if you have not), then decide whether you want to pay your back taxes in full, setup a payment arrangement with the IRS, or settle your back taxes if your financial situation qualifies you.
How to Release a Tax Lien
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An IRS tax lien will remain in place until you pay off taxes owed, prove financial hardship, or until the IRS has levied enough of your assets to call it even. With just a tax lien, the IRS cannot take assets, but they will eventually place a levy on your assets if no action is taken when a tax lien is given. A tax levy is highly likely if you do not resolve your taxes after the lien is placed. A lien ensures that the IRS has a legal claim on your property so you cannot sell or dispose of property without the IRS taking its share first.
Recently in February of 2011, the IRS announced policy changes whereby they would increase the threshold for when a tax lien is issued. Moreover, they will even withdraw tax liens in most casts if you owe less than $25k and setup an IRS Installment Agreement with a direct debit monthly payment (read below).
Ways to Release or Remove a Tax Lien
When the tax amount is paid in full, the tax lien will be released (and now withdrawn with a request to the IRS) and you will be back on good terms with the IRS. Some possibilities to paying off the taxes owed could be to borrow from friends and family, take out a loan, do a home equity loan, borrow the money on credit or sell some of your assets.
The IRS readily accepts payment plans. The most typical form of payment plan is an installment agreement. In the past, generally tax liens were not released until all taxes, penalties and interest were satisfied. In February of 2011, the IRS announced that in most cases a taxpayer who owes $25,000 or less can enter into Installment Agreement with a direct debit payment arrangement and get tax liens withdrawn (removed from credit altogether). Current taxpayers setup on a direct debit Installment Agreement can request to have the tax lien withdrawn.
File for an Offer in Compromise – A tax lien will be released when your Offer is Accepted. With an Offer in Compromise, you can possibly settle your back taxes owed for a fraction of the total taxes owed but your financial situation must be the right fit. The catch with this is that you will have to prove that the amount you offer them is more than or equal to the amount they are likely to collect from you if they enforced collection actions against you or your reasonable collection potential.
Post a Bond
Once you post a bond the lien will be released. This is highly unlikely way to settle though because if you can post a bond, then you can probably pay the back taxes owed and you wouldn’t need a bond.
The IRS has five business days after filing the lien to provide you with written notice. The written notice must include “Notice of right to request a hearing”. That hearing must be within 30 days from the sixth day after the Lien filing. If you win the appeal, the lien will be withdrawn. However, the filing of the lien will still appear on your credit report. This method would not be practical for those out to protect their credit.
Request Partial Discharge
You may own several assets that are encumbered by the tax lien. You can use one of these assets to pay off the IRS. If you want to do this, be sure to ask for a discharge from the tax lien. There is no pre-printed form for you to fill out, so you will need to send a detailed letter to the IRS. IRS Publication 784, “Application for Subordination of Federal Tax Lien” lists all the information you will need to include in your letter.
With this option you can wait until the IRS statute of limitations expires, but that generally does not start ticking until you have filed. The IRS normally has a 10 year period to collect back taxes owed from the date that they were originally assessed. This is normally not a good option because the IRS can then enforce a tax levy on you and forcibly take your assets. Another downside to this is that the tax lien will show on your credit report forever if you never actually paid anything to get the tax lien released or with withdrawn.
Other Tips on Dealing With a Tax Lien
Tax Lien Help from a Professional Tax professionals are a great option for dealing with complicated tax issues like a tax lien especially if you do not have time to resolve the matter. Not only can a tax professional help get a tax lien released, they will completely analyze your financial situation and find the best possible solution for you. Find out more about how the services work and understand why it is important to use a tax professional when dealing with a tax lien. Avoid Bankruptcy Contrary to popular belief, filing Bankruptcy will not wipe out a tax lien. If your tax debts qualify for a discharge under any type of bankruptcy, the lien will remain. If you owned any property going into bankruptcy, the property is still subject to a tax lien. The IRS could seize the property after your bankruptcy is over.
What to Do if the IRS Files a Tax Lien in Error
The IRS occasionally files a tax lien notice when you don’t owe anything. Perhaps you paid your bill late, and the IRS neglected to update your account. If this happens, under the Taxpayer’s Bill of Rights you are entitled to a “Certificate of Release.” The “Certificate of Release” will state that the lien was filed in error. It will then be your job to mail or deliver photocopies of the release to the three credit bureaus- Experian, TransUnion, and Equifax. This will minimize the damage to your credit rating caused by the IRS error.
When the Lien is Released or Withdrawn
Once the tax amount is paid or settled in any of the above ways, the IRS will issue the Certificate of Release (Form 668Z) within 30 days. You will have to record this certificate which means you will have to pay the recording fee in the county where the lien was filed. It is also important to send to the credit bureaus so it makes it into your credit file. This will not remove the lien from your credit report. Your credit report will show the existence of the lien, but once the certificate of release is received, it will show the release of the lien as well. This will stay on your credit report for up to 10 years after the release.
Update February 2011 – The IRS announced that it would begin making it easier in most cases for the existence of a tax lien to be withdrawn from a taxpayer’s credit (instead of being shown as released or paid) if he or she resolves their taxes by paying in full or by setting up and providing some payment history with a direct debit installment agreement (DDIA).
Notice of Federal Tax Lien: What This Letter Means & What to Do
If the IRS has sent you a Notice of Federal Tax Lien, the worst thing that you can do is ignore it. A Notice of Federal Tax Lien should be taken very seriously. There are many things that can happen as a result of receiving a Notice of Federal Tax Lien, and if you are not aware of what this letter means for you, how to address it and what the consequences of it may be, you will likely worsen your situation.
The IRS will release and/or withdraw a tax lien if you:
- Pay Your Tax Debt. By paying your tax debt in full – which means paying all accrued interest and penalties in addition to the original amount owed – you can have the IRS release your tax lien within 30 days. The option to have the tax lien withdrawn is not available under this circumstance.
- Submit a Bond. If you submit a bond that guarantees your willingness and ability to pay back what you owe the IRS, your lien will be released within 30 days. In this case, you may also be able to successfully request that the tax lien be withdrawn by the IRS.
- Set Up an Installment Agreement. If you set up a direct debt installment agreement with the IRS and you owe less than $25,000, you are able to have the tax lien completely withdrawn from your credit report – or not added to your credit report at all if it has not been already – after a certain period of successful monthly payments.
Simply put, the only way to release a lien filed against you is to either pay the IRS what you owe or show the IRS that you plan on paying in the near future.
What If I Disagree with the Tax Lien Filed Against Me?
You reserve the right to appeal a tax lien filed against you. By law, the IRS is obligated by notify you in writing within five days after filing the lien. The Notice of Federal Tax Lien will be mailed to your address, delivered in person or left at your home. If you believe that a mistake has been made, you can ask the IRS to review your case. Additionally, you can request a Collection Due Process hearing. If granted, once the hearing is complete you will receive a determination from the IRS, either that the tax lien is staying in place or that it is being withdrawn or released.
If you have received a Notice of Federal Tax Lien from the IRS, you should deal with it immediately. You can have the lien released by paying what you owe, or – if you feel there was a mistake – you should begin the appeal process. Regardless of the path you choose to take, be sure to take the severity of this situation seriously.