A federal tax lien is the government’s legal claim against a taxpayer’s property when taxes are owed and the IRS intends to collect these taxes. The federal tax lien attaches to your property, including financial assets, until the tax debt is paid.
The purpose of a federal tax lien is to protect the government’s interest in the taxpayer’s assets. A federal tax lien informs the public that the government’s interest has first priority. Meaning that the IRS (the Internal Revenue Service) will receive payment first when the property is sold.
How A Lien Attaches to the Taxpayer’s Property
A federal tax lien only applies to the person whose name is listed on the lien. Thus, if the federal tax lien names one spouse and the other spouse owns the family home, then there is no impact on the title of the home. The same concept applies to all your property.
A federal tax lien attaches to all your property, including the taxpayer’s real or personal property, business property and financial assets. This shows the powerful nature of the government’s claim. Also, a federal tax lien attaches to all your property, including financial assets and business property, that are acquired in the future.
Exceptions to the Power of Federal Tax Liens
A federal tax lien is often superior to other types of creditor liens. However, they do not automatically jump ahead of mortgages, Uniform Commercial Code (UCC) filings, or previously filed liens.
When Does a Federal Tax Lien Start?
A tax lien starts with a warning about taxes owed.
First, the IRS files a notice or letter about your tax debt. This notice or letter will come in the mail and contain a request for payment for the tax debt. If a taxpayer fails to respond within 10 days after the IRS files a request for payment of the tax debt, then a federal tax lien goes into effect.
A federal tax lien becomes effective automatically at that point and the lien attaches to all assets.
When does the IRS Lift or Remove a Federal Tax Lien?
Whether relating to financial assets, real estate or business property, a federal tax lien is lifted (or removed) in one of two ways:
- The IRS will lift a federal tax lien when the tax debt expires at the end of the 10-year Statute of Limitations period. This is called the CSED, or collections statute expiration date. A tax lien is also lifted when the tax debt becomes legally unenforceable.
- A federal tax lien is lifted when the tax debt is paid in full, or the IRS agrees to compromise the tax debt with an Offer in Compromise.
Preventing a Federal Tax Lien
The best way to prevent a federal tax lien is to pay your tax debt to the Internal Revenue Service. Staying current on all estimated tax payments is crucial to maintaining good standing with the IRS and preventing a federal tax lien. If you cannot afford to pay your tax debt in full, request an installment agreement or payment plan. Depending on the amount of the tax debt and the length of time covered by the installment agreement, you may be able to avoid a federal tax lien entirely.
CPA Tax Tip: Do not ignore notices from the Internal Revenue Service. And don’t put mail from the IRS in a drawer and forget about it. That only makes things worse. And you will surely end up with a federal tax lien, as well as a host of other tax problems.
The IRS Files a Notice of Federal Tax Lien to Alert Creditors
The Internal Revenue Service typically files a Notice of Federal Tax Lien when a taxpayer has a tax debt of $10,000 or more. This is part of the broader category of IRS tax liens. The intent of the Notice of Federal Tax Lien is to alert creditors that available money will be paid to the IRS first, to cover the tax debt. These funds are used to secure payment to the government.
Payment to the IRS will happen before any other debts are paid. Unsecured creditors will be behind the IRS in priority.
Government’s Legal Claim
A federal tax lien exists as the government’s legal claim on an individual’s personal property and other assets when there is a tax liability. The Notice of Federal Tax Lien is a public document, intended to alert creditors. It will be filed in the land records where the taxpayer lives.
Public Record
The Notice of Federal Tax Lien is a public record. It is filed with the Secretary of State where the taxpayer lives. Banks, credit card companies and other creditors check these records for the existence of a federal tax lien when considering whether or not to issue a loan or line of credit.
Because it is a public document, the notice of tax lien will alert creditors as well as national tax resolution companies who buy list of anyone with a federal tax lien. The resulting flood of mail is a pain, but there is nothing you can do about it.
There is little you can do to the stop the Internal Revenue Service from its mission to alert creditors of the government’s legal claim. That is the purpose of the Notice of Federal Tax Lien. The best thing to do is to work with the IRS to resolve your tax debt.
Once the tax debt is resolved and tax assessment is paid, the government’s legal claim will go away. And, the federal tax lien will be released within 30 days.
If the Internal Revenue Service deems a taxpayer to be uncollectible due to a financial hardship, the federal tax lien remains in place until the tax debt is paid, or the statute of limitations expires. The government’s legal claim continues to exist. The same is true for taxpayers who are paying a tax debt or tax assessment though an installment agreement.
Collection Due Process Hearing
When the Internal Revenue Service files a Notice of Federal Tax lien, this provides the taxpayer with a right to a Collection Due Process Hearing (also called a CDP Hearing). The IRS generally handles Collection Due Process Hearings by allowing the taxpayer to present their case and discuss potential resolutions. During the hearing, the taxpayer meets with a Settlement Officer to discuss the tax assessment, the government’s legal claim and the federal tax lien.
The taxpayer may also use the hearing to discuss one of the IRS Tax Relief methods to resolve the tax assessment and the tax debt owed. These methods include the Offer in Compromise, Installment Agreement or Uncollectible Status. These methods represent methods to resolve the government’s legal claim.
The request for a hearing must be filed within 30 days after the IRS files a Notice of Federal Tax Lien.
Withdrawal of a Federal Tax Lien: Installment Agreement
As a result of the Fresh Start Program, taxpayers with a tax debt of $25,000 or less to the Internal Revenue Service may request their federal tax lien to be withdrawn. This requires that they enter into a direct-debit installment agreement to pay off their tax debt. Also called a payment plan, an installment agreement means that the IRS withdraws a fixed sum of money from the taxpayer’s bank account on a given day each month.
To request a lien withdrawal, taxpayers need to complete IRS Form 12277 and IRS Form 9465.
Installment agreement payments are used to pay off the tax debt and resolve the legal claim of the government.
The Internal Revenue Service will require that three electronic monthly installment agreement payments have been made.
If taxpayers meet this exception for an installment agreement or payment plan, then they may request that their federal tax lien be withdrawn after making three monthly installment payments to the IRS.
CPA Tax Tip: For taxpayers who do not qualify for a withdrawal, a great strategy is to pay off the amount of the tax debt to below $25,000. The IRS will then withdraw the lien, assuming the other requirements are met.
Release of Federal Tax Liens After 10 Years: Collection Statute Expiration Date
A federal tax lien is released after 10 years, when the statute of limitations on the tax liability expires. The collection statute expiration date is commonly called the CSED. There is no need to request that the federal tax lien be released. It will be done automatically.
The IRS files a Certificate of Release of Federal Tax Lien for the taxpayer when the liability is paid or the tax debt is compromised (which happens in an Offer in Compromise). The Certificate of Release is your proof that the federal tax lien has been removed.
However, the IRS does not automatically send the Certificate of Release of Federal Tax Lien to the taxpayer when the federal tax lien expires at the end of the 10-year Statute of Limitations period (the CSED). In such case, the taxpayer or their CPA may submit a written request to the IRS Lien Unit to obtain the Certificate of Release. Once received, the Certificate of Release should be filed with the land records of their county and the Secretary of State where they live.
Banks or other lenders may also request a copy of a Certificate of Release of Federal Tax Lien when issuing a loan or line of credit.
Federal Tax Lien Discharge
A federal tax lien attaches to all your property, including real estate, personal belongings, business property and financial assets. Obtaining a lien release can be challenging, but it is possible. Homes on which there is a federal tax lien may still be sold. This is done by “discharging” the house from under the federal tax lien.
Here are three examples that illustrate how it is done:
- If there is equity in the house which can pay the tax in full, the IRS files a payoff letter and, once the house is sold and the tax debt is paid, will issue a release of the federal tax lien.
- If there is equity in the house but not enough to pay the tax debt in full, the IRS files a federal tax lien discharge upon proof that the IRS is receiving all available equity in the house to pay the tax debt. The IRS files a release of the federal tax lien once the house is sold and the funds are received to pay down the tax.
- If there is no equity in house, the IRS files a release of federal tax lien when the sellers prove that they are not receiving any equity from the sale.
In all three cases, the IRS will not hold up the sale provided that the above steps relating to the federal tax lien are followed. The same concept applies to business property.
Federal Tax Lien Subordination
In the context of a federal tax lien, subordination refers to the government allowing the federal tax lien of another lender to take precedence over its lien on the taxpayer’s property (both business property as well as personal property). This applies to a specific property.
The relevant provisions of the Internal Revenue Code influence the process of lien subordination.
Here are three examples of how a subordination works:
- In the case of a loan refinancing on the taxpayer’s home or other specific property, the IRS will agree to subordinate its federal tax lien to a bank or other mortgage lender if the new loan will be used to pay down the tax debt.
- The IRS will also agree to a federal tax lien subordination if the new loan is used to improve the property or other specific property and thereby create additional equity to secure the tax debt.
- Lastly, the IRS will subordinate their federal tax lien if the new loan reduces the monthly mortgage payment, allowing the taxpayer to increase their monthly payments to the IRS to pay off the tax debt.
A judgment lien must be perfected by a court judgment to achieve priority over a federal tax lien.
Federal Tax Liens and the Credit Report
Prior to 2018, a federal tax lien had a significant impact on the credit report of taxpayers, typically pushing scores down by more than 100 points.
In 2018, the three major credit bureaus – Equifax, Experian and TransUnion – decided to remove the federal tax lien from their credit reports. This means that a federal tax lien will no longer influence credit scores.
If you do see a federal tax lien on your credit report, be sure to dispute it with the credit bureaus.
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