What Is a Tax Lien?
You may have heard of the contractor's (or mechanic's) lien, but what is a tax lien? Generally, it is a legal claim against an asset or assets in order to guarantee the payment of a debt or the performance of some obligation. Liens make it difficult to sell the assets or secure lines of credit, so they offer a powerful incentive for the property owner to pay the bill or perform the action necessary to remove the lien. For example, if you hire a contractor to remodel your kitchen but refuse to pay the bill, the contractor can take out a workman’s lien on your property to force you to pay the bill. Until you do, you won’t be able to sell your property or take out a second mortgage on it.
A tax lien is exactly what it sounds like: a lien placed on an asset based on a taxpayer’s refusal or inability to pay their tax bill. And since this is the IRS we’re talking about, the tax lien will take priority over almost any other debt or obligation that is secured with that asset. Also, an IRS tax lien isn’t tied to any particular asset. Instead, it attaches to all of the taxpayer’s assets, which can shut down an individual’s financial life until they settle up with the IRS.
The Lien Process
There are three steps the IRS goes through before it imposes a tax lien: first, the IRS will asses a taxpayer’s debt. Next, the IRS sends a “Notice and Demand for Payment” that explains the tax debt and informs the taxpayer that they must pay it. Finally, the IRS files a “Notice of Federal Tax Lien” that alerts the taxpayer and their creditors that the government has a legal interest in the taxpayer’s assets.
How to Avoid a Tax Lien
The easiest way to avoid a lien is to pay your tax bill on time. If that isn’t possible, however, there are still a few options available that could lessen the impact of a tax lien. The IRS will allow taxpayers to utilize these options if it fits with the agency’s interest in getting the most money possible from the taxpayer. Taxpayers can:
- File for a discharge of property. This allows a taxpayer to sell property free of the lien (most likely to pay off their tax bill). See Publication 783, Instructions on How to Apply for Certificate of Discharge From Federal Tax Lien.
- Apply for a Certificate of Subordination. The lien stays in place, but the IRS takes a backseat to other creditors. This can make it easier for the taxpayer to secure lines of credit. See Publication 784, Instructions on How to Apply for a Certificate of Subordination of Federal Tax Lien.
- Apply to have the lien notice withdrawn. This erases the lien and makes it as if the lien had never been there in the first place. See Form 12277, Application for the Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien.
Lien Withdrawal vs. Lien Release
A lien withdrawal differs from a lien release in two important ways: first, a lien release occurs automatically when a taxpayer pays off their debt to the IRS, while a taxpayer must apply for a lien withdrawal. Second, a taxpayer doesn't necessarily have to pay off their debt to obtain a lien withdrawal. A tax adviser may be able to secure a withdrawal if the lien was filed incorrectly or if the taxpayer’s situation warrants it.