There are a number of misconceptions surrounding federal tax liens. Oftentimes, when a taxpayer receives notification that the IRS has filed a lien against them, their first instinct is to call the IRS to attempt to have the lien removed. However, this may not always be the best course of action, and understanding how IRS liens work is important in deciding how best to proceed with resolving the balance undergirding the lien, and ultimately, having the lien removed.
In general, a lien is a charge or encumbrance that one person or entity has on the property of another as security for a debt or other obligation. Statutory liens arising in favor of the Internal Revenue Service are authorized by operation of §6321 of the Internal Revenue Code. A federal tax lien arises after the IRS sends a notice of demand to the taxpayer (typically the first balance due notice after a liability is generated), and dates back to the date of assessment. Because the lien arises by operation of law, the IRS is granted a secured interest in the taxpayer’s property and right to property back to the date of assessment.
However, the statutory lien that arises automatically is sometimes referred to as a “secret lien,” as until the IRS perfects its security interest by the filing of a Federal Notice of Tax Lien, the statutory lien that arises automatically generally does not afford the IRS priority over other creditors. However, once the IRS files a Notice of Federal Tax Lien (“NFTL” - typically filed on IRS Form 668(Y), the existence of the IRS lien will be recorded at the local recording office where the IRS believes the taxpayer owns property. Thereafter, for as long as the lien remains valid and in place, the lien will cloud the title of a taxpayer’s assets, particularly real property, which can frustrate the sale of property if the IRS liens are not addressed in advance of, or during, the closing process.
In the past, the filing of a Notice of Federal Tax Lien could have a severe negative impact on your credit score, making it more difficult to obtain financing. Fortunately, the IRS recognized the conundrum of restricting the financial liquidity of a taxpayer from whom they’re looking to collect and changed the rules in 2018 so that NFTLs are no longer reported to credit reporting agencies. However, just because the existence of IRS liens will no longer impact your credit score, they can still frustrate your ability to sell or refinance your home, and depending on the field that you work in (FINRA-regulated industries, for example), liens can still have a major impact on your ability to continue working.
Options for Dealing with an IRS Lien:
Release of Lien (IRC §6324(a)):
In general, liens will be released automatically by the IRS within 30 days of the full payment of all liabilities covered by the NFTL, including penalty and interest amounts (or an adjustment or abatement to the account results in the liability being reduced to zero). It bears mentioning that, when filed, a NFTL will reflect the current assessed balance owed at the time the lien is filed. Therefore, paying the amount shown as owing on the NFTL itself will generally not result in an automatic release, as additional amounts that have accrued since the lien was filed will need to be satisfied as well. In addition, the IRS may file one NFTL that covers multiple balances. In most instances, resolving one of the several outstanding balances covered by a lien will not result in the lien being released automatically. It is possible to request a partial lien release, whereby the IRS will issue a release certificate related to the specific liability that has been satisfied, but in most instances, there’s limited to no benefit to requesting a partial lien release.
A Notice of Federal Tax Lien will also be released when a debt becomes legally unenforceable. This generally means that the Collection Statute Expiration Date has expired on the underlying liability and the IRS becomes time-barred from collecting. Bear in mind, however, that even if a tax debt is discharged in bankruptcy, an IRS lien will continue to attach to pre-petition bankruptcy property that survives bankruptcy.
Finally, the IRS will release a lien in exchange for the taxpayer obtaining a surety bond in favor of the IRS for the amount of the covered for the amount of assessed tax, plus accruals. In my experience, the process of obtaining a bond in order to secure a lien release or to forestall a lien filing can be difficult to navigate, given the somewhat arcane, often outdated directives, and few IRS employees that are familiar with the procedure. While it’s seldom a great option for securing a lien release, it may be the best option for a taxpayer to prevent the filing of a lien, which can be critical for people whose livelihood can be severely impacted by a lien filing (such as FINRA-regulated professionals).
Discharge of lien (IRC § 6325(b)):
Even in cases where the underlying has not been satisfied, the option exists to petition the IRS to remove or “discharge” the lien as it pertains to specific property. The IRS will generally grant a taxpayer’s request for a certificate of discharge in two circumstances. First, the IRS will grant a discharge if the taxpayer verifies to the IRS that, excepting the property sought to be excluded from the lien, the taxpayer’s equity in property remaining subject to the lien is at least double the amount of the unsatisfied liability secured by the lien. Second, the IRS will general discharge property from the lien if the taxpayer pays in to the IRS an amount equal to the value of the property sought to be discharge, or otherwise can demonstrate to the IRS that the value of the United States’ secured interest in the property is zero.
A lien discharge is most commonly used in situations where the taxpayer is looking to sell real property that is secured by an IRS lien, but the proceeds from the sale of the property is unable to satisfy the liability in full. In these instances, the IRS will generally grant a discharge of the lien as it pertains to the real property, contingent on the proceeds of the property sale being escrowed into an account in favor of the IRS. The most common issue encountered by taxpayers attempting to secure a lien discharge in order to sell real property is navigating the timing issue. You generally need to wait until there is an accepted offer to purchase the home prior to petitioning the IRS for a lien discharge. That means that there is typically a very short window prior to closing during which the taxpayer can secure a lien discharge from the IRS in order to allow the property to be passed free and clear at closing. While the IRS has units dedicated to processing lien-related requests, as with any large bureaucracy, delays and mistakes do happen. Having an experienced tax professional navigate the discharge process on your behalf can mean the difference between the sale of a government-liened property going off without a hitch, or the sale being scuttled because of delays or concerns from the buying party related to the lien filing.
Subordination of lien (IRC § 6325(d)):
In certain circumstances, the IRS can be convinced to “subordinate” their priority creditor position to that of a junior lender. In layman's terms, the IRS allows another creditor to jump ahead of them in line when it comes time for collection. In most instances, a taxpayer will pursue a lien subordination in order to refinance or secure additional financing on a piece of real property covered by the IRS lien
For example, if a taxpayer has a home with a fair market value of $300,000 that is secured with a primary mortgage in the amount of $200,000, leaving the taxpayer with $100,000 of equity in the property, which is covered by an IRS lien in the amount of $150,000. If the taxpayer wants to refinance the property or take on a second mortgage, they will find it extremely difficult to find any lending institution that is willing to take a mortgage on the property, because, as the NFTL was filed prior to the new mortgage, the lending institution’s secured interest will be junior to that of the IRS. In this instance, the IRS is unlikely to agree to a discharge, because the liability will not be satisfied in full from the refinancing. The IRS has recognized that it is not in their best interest to frustrate a taxpayer’s ability to access the equity in the property, so long as the taxpayer is willing to use that equity towards the satisfaction of the underlying liability. This generally means that in exchange for issuing a certificate of subordination, the taxpayer will need to pay over to the IRS the proceeds of the refinancing, save for an allowance for the costs associated with doing so.
Subordination can come into play in other instances as well, such as obtaining a reverse mortgage on a liened property or in instances where a business owner is seeking to enter into a factoring agreement for accounts receivable that are covered by IRS liens.
Non-attachment of lien (IRC § 6325(e):
Requesting a certificate of non-attachment is typically used by a third-party when an IRS lien that has been filed against a different person, but because of similarities between both parties names or other attributes, the IRS lien that has been filed against the liable taxpayer is frustrating the non-liable party’s ownership in assets not properly encumbered by the lien. These circumstances are rare (especially now that IRS liens are not reported to credit agencies), but they do arise, and can be particularly unsettling for an unsuspecting third-party who becomes aware of an IRS lien that appears to have been filed in their name. Things get especially complicated in situations involving interests in real property by liable and non-liable spouses or liable and non-liable family members. Generally speaking, so long as the non-liable third party can demonstrate to the IRS that the lien filing in question does not attach to the property in question, they will agree to issue a certificate of non-attachment.
Withdrawal of NFTL (IRC § 6323(j)):
Another option for dealing with a NFTL is to request a withdrawal of the lien. A lien withdrawal is distinct from a lien release, in that a withdrawal removes the effect of a filed Notice of Federal Tax Lien, without extinguishing the underlying statutory lien (the “secret lien” discussed above). In the past, a withdrawal of the NFTL was most useful in removing the record of lien filing from a taxpayer’s credit report, and concomitantly, reversing the negative impact of the lien filing on their credit score. However, because credit agencies no longer report the existence of NFTLs, this is rarely necessary anymore. However, as NFTLs are still recorded in public recording offices, some financial institutions may still use the existence of a NFTL to negatively evaluate the taxpayer’s credit-worthiness. Should you find yourself in this situation, requesting a withdrawal of a filed NFTL may be advantageous.
More frequently, requesting a withdrawal of a NFTL is used to remove the NFTL prior to the liability being paid in full or becoming legally unenforceable (requirements for a release of a NFTL). Under IRC §6323(j)(1)(B), the IRS will generally agree with a taxpayer’s request to withdraw a NFTL if the taxpayer’s assessed balance (not including accruals) is $25,000 or less, the taxpayer has entered into a Direct Debit Installment Agreement (DDIA) that provides for the repayment of the outstanding liability in 60 months or before it expires, whichever comes first, and the taxpayer has made at least 3 consecutive electronic payments under the established DDIA.
If the IRS has filed a Notice of Federal Tax Lien against you, and it is impacting you financially, please reach out to us to discuss your situation and determine whether avenues exist not only to resolve your outstanding tax balance with the IRS, but also to mitigate the impact the IRS lien filing may be having on you.