If a previous tax lien has been filed on one of your assets, then filing for bankruptcy will not erase the lien. However, filing for bankruptcy does protect you against liens filed against you during the bankruptcy proceedings, as well as future liens related to the debt in question. There are also some instances when tax liens can be wiped out, such as if the IRS made an error or the lien is past the statute of limitations.
Having a lien filed against you can feel like a dark cloud hanging over your future. If your property value has gone up, you should be able to celebrate that. But if you have a tax lien on the property, you might have nothing to show for that appreciation when you go to sell and have to hand over the profits to the IRS. And chances are, this lien will stick around even if you file for bankruptcy. If you file Chapter 7 bankruptcy, for example, then the lien most likely won’t go away until you pay off your entire tax debt. There are some situations, however, when you might be able to wipe out the lien along with your tax obligation. We’ll help you make sense of this process below.
What exactly is a tax lien?
A tax lien is a legal claim filed by a governmental body — in most cases the Internal Revenue Service — to the assets of an individual or business until their tax debt is repaid. In the case of federal income tax debt, the IRS will simply file a lien against all property owned by the debtor. This includes real estate, financial assets, personal property, and anything else under the sun that belongs to the owner and has value. This is in addition to the IRS being able to take wages directly from a debtor’s bank account, which is not considered a lien but a garnishment. In some rare cases, the IRS can even exercise its right to force a sale of an asset or assets. Either way, a tax lien is something you want to avoid at all costs. The graph below shows that although the number of liens the IRS is filing is trending down, the IRS is getting better at collecting the from the liens it does file.
Tax liens and bankruptcy (Chapter 7 example)
Bankruptcy is the legal process that enables one to discharge multiple types of debt, including tax debt. Under IRS guidelines, both federal tax debt and state tax debt are dischargeable under bankruptcy. The IRS won’t be able to go after your income anymore. However, if a tax lien was placed on your property before you filed for bankruptcy, it’s most likely there to stay. This is because even though going through a Chapter 7 bankruptcy will discharge tax debt, it doesn’t discharge the lien. You won’t be able to sell your property until you actually pay the debt and the lien is removed.
When a person files for bankruptcy, the court issues what’s called an “automatic stay.” The automatic stay stipulates that creditors must freeze and are not allowed to go after assets related to debt that are part of the bankruptcy proceedings. When the automatic stay issue is ordered, the law implements a full stop on any requirement to pay creditors. This means that once the bankruptcy is filed, the IRS can’t enact any new liens on the assets you already have.
However, previous liens aren’t usually discharged in bankruptcy. Therefore, clients need to figure out how to pay off the debt, according to Derek Jaques, a lawyer at the Mitten Law Firm who has experience with personal bankruptcy cases. “Tax liens are pretty straightforward. I have had clients sell property to pay the lien off so they can move forward with their bankruptcy case,” he says.
“Another option is dealing directly with the IRS to have a payment plan established. You need to complete the arrangement, but it is an easier way to manage the lien.”
There are certain cases when you can potentially have a tax lien wiped out if you decide to declare bankruptcy. These are as follows:
- The IRS never officially filed the tax lien, or there were errors in the document and process.
- The lien was filed after the bankruptcy was initiated and the automatic stay was issued. Remember, once the bankruptcy and automatic stay are filed, then no lien can legally be placed.
- The lien exceeds the statute of limitations (10 years).
Buying or selling property that has a tax lien
So what do you do if you want to sell your house and you have a tax lien on your property? Or what if you discover a tax lien while doing your due diligence on a house you want to buy?
Alex Capolozzo, the founder of Brother Love Real Estate in Philadelphia, has been there before. “If you discover that there is a tax lien on a property that you are interested in, you might find that it has already been paid off,” he says. “You need to contact the creditor with proof of the payment to secure a release against the lien. If you are buying or selling the property, the debt has to be settled to get the lien released. This is so that you can continue with the transaction.”
Capolozzo says it is generally advised not to continue with the sale if tax liens are involved, at least not without seeking professional assistance.
“A lien can specifically create problems when it comes to government-backed mortgages such as VA and FHA loans. Other than paying the liability in full, the second-best option is to set up a payment plan with the IRS before they officially file the lien and it becomes public record.”
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What are the negative consequences of declaring bankruptcy?
There are various negative consequences to declaring bankruptcy. You will need to deal with the hassle of bankruptcy court and make sure you have the proper documentation and evidence. Second, it can have tremendously negative effects on your credit score and your ability to get a loan in the future. However, you must always deal with tax debt in an honest fashion when declaring bankruptcy. If not done properly, you could be on the hook for tax evasion.
What can you write off in bankruptcies?
This all depends on what type of bankruptcy you file. Is it Chapter 7, Chapter 11, or something else? Generally, you can write off state and federal tax debts, credit card debt, various other forms of debt to creditors, as well as certain administrative expenses such as accounting and legal fees. It’s best to contact a bankruptcy attorney to clarify your specific situation if you consider filing for bankruptcy or will file for bankruptcy in the near future.
What if I owe the IRS and can’t pay?
Then the IRS has the right to file a federal tax lien against you. However, the IRS has several programs that assist people who need help paying their taxes, such as forming a monthly payment plan or reaching a dispute resolution.
How to reduce taxes owed to IRS?
The IRS has several methods of reducing your tax burden if you can’t pay or you paid in error. You can try to work out a debt settlement, including an offer in compromise. Or if you disagree with the amount, you can file a dispute or even sue the IRS as a last resort.
Does bankruptcy clear tax debt?
Yes, it does, but not always, and not for all types of debt. In most cases, you are able to discharge federal tax debt and state tax debt after you make a bankruptcy filing. However, other taxes and fees owed, such as payroll taxes, cannot be discharged.
- A tax lien is a legal claim filed by a governmental body, in most cases the IRS, on the assets of an individual or business until they pay their tax debt.
- In bankruptcy court, tax debt can be discharged. But if the lien was filed before the bankruptcy, it can’t be wiped out until the debt is paid off.
- If the IRS made an error, the lien was never properly filed, or it passed its statute of limitations, then the lien can be removed during bankruptcy.
- There might be a lien on your home or a home you want to buy. This is why it’s important to do due diligence on the title.
- If you do encounter a lien during a home purchase, the debtor must pay the debt and have the lien removed to complete the sale.
View Article Sources
- Tax Relief Industry Study – SuperMoney
- Understanding a Federal Tax Lien – IRS.gov
- What if there is a federal tax lien on my home? – IRS.gov
- Bankruptcy – IRS.gov
- Does Bankruptcy Clear Tax Debt? Everything You Need to Know – SuperMoney
- The Definitive Guide to Chapter 7 Bankruptcy – SuperMoney
- Can I Sell My House With a Tax Lien? – SuperMoney
- Buying a House With a Tax Lien? Here’s What You Need to Know – SuperMoney
- IRS Installment Agreement – SuperMoney