Occasionally someone will call our office freaking out about an IRS letter stating that a lien is being filed against them. In this post, we’ll discuss what a lien is and isn’t and how to deal with it.
What does a lien actually mean/do?
When you owe back taxes to the IRS, they will generally file a tax lien notice against you. Tax liens are a matter of public record and available for anyone to look up. They are typically filed for any balance due that exceeds $10,000. However, new tax liens are usually filed for less than that amount if you continue to pile on additional tax debt in the future.
So what exactly is a tax lien? Basically, it’s a claim against your property. A tax lien takes a higher priority over most other kinds of liens, and after 180 days jumps ahead of some lien types it doesn’t automatically supersede. A Federal tax lien will not jump in front of a mortgage, or a local property tax lien, but it can jump ahead of just about everything else.
The important aspect of a Federal tax lien is that it covers ALL of your property. For example, the mortgage on your house is usually only secured by the house itself. But when it comes to a tax lien, it is actually “secured” by everything you own. This means the clothes on your back, the money in your checking account, your retirement accounts and even your paycheck. That’s right; a Federal tax lien provides the government with the ability to claim your paycheck. That doesn’t mean they’re going to take it, it just means that they can.
A Federal tax lien also shows up on your credit report. This can impact your credit score, and make it difficult to obtain employment, as many employers will use this information in their hiring decisions.
It is important to understand that a lien is NOT a levy. A levy is an administrative order directing a 3rd party to physically hand over cash or property to the government that is covered by the lien. Thus, for 99% of people, a Federal tax lien is actually harmless, and has zero impact on their life or business. Sometimes, however, the lien itself creates a bad situation. In those cases, there are things that can be done with the lien that can help put you in a better position.
In extremely rare circumstances, it may be possible to obtain the complete removal of a Federal tax lien. In order to achieve this, the taxpayer (or their hired professional) must demonstrate two things:
- The lien is creating an undue economic hardship upon the taxpayer
- Removing the lien will help facilitate collection of the tax debt
Basically, you have so show the IRS that the pure existence of the lien will cause a dramatic loss of income. For a business, a lien may interrupt a factoring agreement or a line of credit, which is required for them to operate. For a person, the existence of a lien might mean the loss of a security clearance, and therefore loss of a job.
Typically, if one can prove the first bullet, then they can often prove the second. For example, if a business continues to operate, and you get to keep your job, then you both can make payments to the IRS, which is what is meant by “facilitate collection.”
Another tactic that one can sometimes take is to keep the IRS tax lien in place, but subordinate the government lien to some other lien. When we do this, we essentially get the IRS to place themselves in second priority position, underneath somebody else.
The most common reason for doing this is to place the IRS lien secondary to a bank financing lien, such as a factoring agreement, line of credit, or an operating capital loan. Many banks will cut off funding on a loan or line of credit if they are not in first position. Thus, subordinating the tax lien keeps the bank happy by keeping their lien in first priority over the IRS. This keeps you operating, and thereby “facilitates collection.”
It is not uncommon for somebody to have one particular asset that is worth a bit of money. Sometimes selling that asset can bring in enough money to help pay down the tax debt, or selling the asset will eliminate the monthly payment on the asset, thereby allowing you to put that money towards the IRS bill each month. See how this all keeps coming back to that “facilitating collection” point mentioned above?
Let’s say you own a vintage 1957 Chevy. It’s worth $60,000 but you still owe $25,000 on it. You’re currently making monthly payments of $500 toward the balance owed. You obviously don’t want to sell this car, but it will make life a lot easier if you did, since you owe the IRS $100,000 and they are going to start taking your paycheck via wage garnishment if you don’t do something.
So, you decide to sell the Chevy. The problem is that the IRS lien prevents you from selling it. Not only does your loan company have a lien on the car, the IRS lien covers it, too. Thus, we need to remove the IRS lien in order to sell the car. The process of removing the IRS lien from this one piece of property is called a lien discharge, and you obtain a Certificate of Discharge releasing this one asset only from the lien.
With the Certificate of Discharge in hand, you can sell the car. This in turn allows you to pay off the loan without the IRS making a stink about that $25K going to the bank. Furthermore, you then you have $35K profit from the sale that you give to the IRS, plus free up $500 per month to pay the government. This is not an ideal scenario for most people, giving up a beloved possession. But it’s far better than the IRS seizing 70% of your paycheck every month.
By itself, an IRS tax lien itself really has no teeth. It’s the things that come several months after the lien filing (e.g. a tax levy) that really cause trouble. However if you have a tax lien, it’s probably best to deal with it using one of the options above. Especially if the path to resolving the tax debt itself involves doing things with assets, banks, keeping financing open or preventing the loss of your job or business revenue.