Before you can understand what a tax lien is, it is important to first understand what a ‘lien’ actually means. In simple words, a lien is a security interest in an asset, securing the payment of a debt of other financial obligations. Think of it as collateral being used to make sure that the payee doesn’t default on repayment of his or her debts.
A tax lien can therefore be defined as a legal claim against a taxpayer’s assets to make sure that a tax debt is paid in full. If a taxpayer fails to pay their taxes for an extended period of time, the IRS will apply a tax lien against his or her assets to ensure that they pay in full. This is usually done only as a last resort since getting rid of a tax lien is a very tedious process. As a result, a tax lien can leave a somewhat permanent mark on someone’s credit history.
Tax liens can be placed by either the Federal, state or local governments, depending on the severity of the situation. Tax liens resulting from unpaid Federal and state taxes are placed by the respective governments. Local governments can place liens for unpaid local income or property taxes. As mentioned above, tax liens are public record. This means that the asset controlled by a lien cannot be sold, purchased, refinanced or borrowed against in any way. Essentially, the asset becomes untouchable unless the tax debt is satisfied in full.
What happens when the tax debt remains unpaid for an extended period of time after the tax lien is issued? In this event IRS can use a tax levy to legally seize these assets to satisfy the debt in part or in full. This scenario is one that any taxpayer would want to avoid. The situation where your assets are seized for defaulting on tax payments should be avoided at all costs.
The most basic way to prevent an IRS tax lien is to not default on tax payments. Filing your taxes properly and on time and paying in full ensures that the IRS will never issue a tax lien against you. In the unfortunate circumstance that a financial hardship causes you to be unable to settle your tax debts on time, you can simply set up an installment payment plan. In this way the IRS knows that you will pay your debt tax in full over time. While there are certain terms and conditions that apply, this is the safer route than risking having a lien placed on your assets.
What can you do if a tax lien has already been placed on your property? You can still get a tax lien removed without having it get to the point of having the IRS resort to something like issuing a bank levy. Here are some ways an IRS tax lien can be removed:
- If the IRS is notified of a filing error, the tax lien must be withdrawn. This can occur in cases where there are documentation or calculation errors, but does happen frequently.
- Either paying off the tax lien amount in full, or settling the debt with an offer in compromise will cause the tax lien to be removed.
- The tax lien may become unenforceable due to the expiration of the 10 year statute of limitations, and then must be removed.
The IRS does one of two things in these types of situations. It will either withdraw the tax lien, or it will remove it. While both of them ensure that you don’t have to be troubled anymore with pending debts, the particular method that the IRS uses can affect your future.
- Withdrawal of tax liens: when using this method the IRS treats it as if there was no lien in the first place, and all records are removed. This is done only if there was an error committed by the IRS, so this is obviously not common. If a tax lien was incorrectly filed against you, make sure to contact the IRS as soon as possible to get it rescinded.
- Release of tax liens: If the lien was paid off or settled in time, it will be lifted within 30 days of receipt of full payment of funds. Lien release is automatically done once all debts are paid, but it can stay in your credit history for up to 10 years. Obviously it’s a good idea to avoid getting a tax lien in the first place.
Under the IRS Fresh Start program, a tax lien may be withdrawn if certain provisions are met, provided their outstanding balance is less than $25,000.
Tax liens are public record and can remain in your credit history for a long period of time. Obviously it’s good practice to pay your taxes on time. Even when you ultimately pay off your back taxes and the tax lien is removed, your credit history can still be affected. Emergencies can arise and the inability to access credit can cause big financial problems. The adage ‘an ounce of prevention is more valuable than a pound of cure’ was never more appropriate.