What Is A Tax Lien? Lien on me

Tax Liens are a powerful weapon in the arsenal of the IRS and other taxing agencies including the Franchise Tax Board (FTB), California Department of Tax and Fee Administration (CDTFA), and Employment Development Department (EDD).  A Notice of Federal Tax Lien (or notice of State Tax Lien) can cause a great deal of trouble and difficulty to many people and businesses.  What are tax liens and how may a taxpayer remove them or lessen their impact.  This article will focus primarily on IRS Liens, but keep in mind that many state tax agencies like the Franchise Tax Board often have similar rules and procedures. 

There are two types of tax liens, there is an “invisible” lien and a notice of federal tax lien (or notice of state tax lien).  The so-called invisible lien arises when the IRS sends a notice demanding payment of taxes and the taxpayer does not pay the taxes.  This invisible lien is not a matter of public record (which is why it is an invisible lien) and has minimal impact on most taxpayers. 

The lien that causes many people to lose sleep at night is the Notice of Federal Tax Lien (or Notice of State Tax Lien).  This lien is a public record that the IRS (or state taxing authority) records at the County Registrar, Secretary of State, and other offices where liens and mortgages are recorded.  A notice of federal tax lien can make it more difficult for a person to sell property or obtain loans. 

A notice of federal tax lien is like second mortgage or a recorded judgment.  It is an obligation that attaches to a taxpayer’s property and often does not get released until a taxpayer pays the tax off in full.  If a taxpayer attempts to sell property, the lien usually needs to be paid off for the property to clear escrow.  Unlike a second mortgage which usually attaches to a single property, a federal tax lien attaches to all of a taxpayer’s property.  The  lien not only attaches to real estate, but also attaches to any type of asset including equipment and intellectual property.  The IRS can foreclose on a property subject to lien, but this is relatively rare. 

A tax lien should be distinguished from a levy.  A lien involves the IRS merely asserting a claim to property, while a levy involves the IRS actively seizing money and other property.  A levy usually involves the IRS taking money from people’s bank accounts or pay checks. 

Once the IRS (or other taxing authority) files a notice of tax lien, it is quite difficult to remove the lien without paying the tax in full.  However, there are several ways to avoid or mitigate the damage liens cause. 

Avoiding the Lien

The best way to avoid all the negative repercussions of a tax lien is to avoid the lien altogether.  Timely meeting all tax obligations is of course the best way to avoid a tax lien.  However, if one finds themselves getting behind on taxes, all hope is not lost.  Engaging the IRS (or other taxing authorities like the Franchise Tax Board) can be an effective way of avoiding a notice of tax lien.  It is often possible to negotiate payment plans with the IRS (and other agencies) that avoid a notice of federal tax lien (or notice of state tax lien).  You should be prepared, however, to open your wallet and make payments.

Payment Plan or Offer in Compromise to Remove a Lien

The IRS will withdraw a notice of federal tax lien for some taxpayers who enter into certain payment plans.  These payment plans require (1) the taxpayer pay their total balance off within 60 months, (2) the taxpayer make at least three direct debit payments, and (3) the taxpayer’s total balance drop below $25,000.  The IRS will also withdraw a notice of federal tax lien after an Offer in Compromise is accepted and its terms are completed. 

Withdrawal of the Tax Lien

In some circumstances, the IRS will withdrawal a lien when doing so will promote the collection of a tax.  By example, if a defense contractor’s security clearance might be revoked because of a lien, the IRS may withdraw the lien as the IRS cannot collect the tax if the defense contractor loses their business or job.  Hence withdrawing the lien promotes the IRS’ collection of tax.  Professionals like securities brokers whose FINRA licenses can be jeopardized by liens may also have their liens withdraw by the IRS for similar reasons. 

Lien Subordination

A Lien Subordination does not remove a lien, but it can be the next best thing for many taxpayers who are looking to refinance a home or take a loan out on their home. In a lien subordination, the IRS agrees to subordinate (or lower its priority to second or third place) to a lender.  The IRS does not do this out of the goodness of its heart and only does so when there will be some benefit to the IRS.  A classic example of a lien subordination involves a taxpayer refinancing his or her home to get a lower monthly mortgage payment.  The IRS will subordinate its lien so the taxpayer can refinance, but the IRS will expect the taxpayer to give at least some of its mortgage savings to the IRS in the form of an increased monthly payment to the IRS. 

Tax Lien Discharge

A lien discharge involves the IRS discharging a particular property from the  lien.  The lien remains in place on the remaining property a taxpayer has.  There are three main reasons the IRS grants a discharge.  The first reason is the IRS’ interest in the property is zero.  This could be when the mortgage or mortgages that have priority to the tax lien exceed the value of the property.

The second ground is when the IRS will receive proceeds from a sale are equal to its interest in the property.  For example, let us assume a house is worth $500,000.  The seller has a $350,000 mortgage on the home and a $200,000 tax lien.  The value of the IRS’ interest in the property is $150,000 (the fair market value minus the mortgage).  Although $150,000 will not satisfy the $200,000 tax lien, the IRS will discharge the house from the lien if it gets $150,000 at escrow. 

A third ground is if the taxpayer has other properties whose value is double the IRS lien and other encumbrances.  The idea behind this provision is if there is sufficient equity in other properties to protect the IRS’ interests, the IRS may be open to discharge or let go of one property. 

To give an example of how this works, let us say a taxpayer has a primary residence worth $600,000 with a $320,000 mortgage on it and a lien of $40,000.  The taxpayer has vacation home that is worth $300,000 and has a $45,000 mortgage. 

The IRS lien and mortgage on the primary residence is $360,000.  Doubling this is $720,000 which more than the $600,000 value of the primary residence.  The vacation home cannot be discharged from the lien because the encumbrances and value of the primary residence do not meet the formula. 

The tax lien and mortgage on the second residence totals $85,000.  Double this $170,000 which is less than the $300,00 value of the vacation home.  The primary residence can be discharged from the lien because the amount of equity and mortgage on the vacation home meet the criteria (even though the equity in the vacation home is less!) 

Tax Liens filed by the IRS, Franchise Tax Board, or any other tax authority can certainly make life difficult for taxpayers and may have catastrophic effects for others.  If a lien has been filed against you or you believe a lien may be filed against you, not all is lost.  There are several remedies that could potentially be at your disposal.  Tax attorneys at RJS Law have helped hundreds of taxpayers avoid and manage life with liens.  Give us a call now as the earlier you address the problem, the more options you may have available. 

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Published by Joseph Cole, JD, LL.M