When you owe back taxes to the IRS, it is inevitable that they will file a Form 668-Y, Notice of Federal Tax Lien, with your local county clerk and/or Secretary of State. A Federal tax lien is public record, so anybody can look it up. Also, a de facto tax lien exists under Federal law as soon as a tax bill is assessed, even if they haven’t actually filed the lien notice against you.
In this article, my goal is to give you a solid overview of the lien process, including what a lien is, how it impacts you, and the most common options for dealing with the lien when it creates a problem.
What does a lien do?
A tax lien works just like any other lien. Basically, it is 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 supercede. 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.
What this really means in practice is that if your possessions end up being sold off by a court, or in a bankruptcy proceeding, whomever has highest lien priority gets paid first. Then, if there’s anything left, the second place lien gets paid next, etc.
When a Federal tax lien exists, it covers ALL of your property. Whereas the mortgage on your house is usually only secured by the house itself, rather than your car, tools, collections, paycheck, etc., a Federal tax lien is “secured” by everything you own. This means the clothes on your back, the money in your checking account, your retirement accounts, even your paycheck. That’s correct, a Federal tax lien provides the government with a claim over 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. The vast majority of levies take one of the following forms:
- Ordering your employer to hand over the majority of your paycheck.
- Orders your bank to take all the money out of your bank accounts at that bank, hold it for 21 days, then send it all to the IRS.
- If you are a business, directs your customers to send any money they owe you to the IRS instead of to you.
Obviously, all three of these things are on the “really, really bad” list. However, the lien itself doesn’t do any of these things.
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 (and I mean EXTREMELY rare) circumstances, it may be possible to obtain the complete removal of a Federal tax lien. In order to achieve this, we 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.
Remember, the legal definition of “undue economic hardship” is very specific, and it does not mean “an inconvenience”. Basically, it must be demonstrated 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 the hardship case can be made, so can the 2nd part. If a business continues to operate, and you get to keep your job, then you can make payments to the IRS, which is what is meant by “facilitate collection”.
Another tactic that we can sometimes take is to keep the IRS tax lien in place, but subordinate the government lien to some other lien. What this means is that we 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. Selling that asset can bring in 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 keeps coming back to “facilitating collection”?).
Here’s an example: Let’s say you own a vintage 1965 Ford Mustang. It’s $60,000, and you still owe $30,000 on it, and are making $500 per month payments. 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 Mustang. 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. So, 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. That Certificate is proof to everybody else that the lien won’t follow the asset.
With the Certificate of Discharge in hand, you can sell the car, pay off the loan without the IRS making a stink about that $30k going to the car loan company, and then you have $30k 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 better than the IRS seizing 70% of your paycheck every month.
Remember, an IRS tax lien itself really has no teeth. It’s the things that come several months after the lien filing that really cause trouble. However, since the lien is there, if the path to resolving the tax debt itself involves doing things with assets, or banks, keeping financing open, or preventing loss of your job or business revenue, there are options available to address the lien.