Regardless of the stigma and the devastating effect they have on credit, bankruptcies are still popular with debtors. In 2015, 833,515 bankruptcies were filed in U.S. Bankruptcy Courts. One of the reasons bankruptcies are so popular is their ability to put an automatic stay on creditors’ collection efforts.
What Is an Automatic Stay?
An automatic stay is like a debt pause button that automatically stops lawsuits, garnishments, foreclosures, and other types of collection activity against debtors the moment they file a petition for bankruptcy.
Does this automatic stay also work with tax liens? The short answer is yes, but there are plenty of exceptions. Read on to find out if a bankruptcy’s automatic stay would work on your tax lien.
What Is a Tax Lien?
Tax liens are one of the IRS’s most effective collection methods. In 2015 alone, the IRS filed over of half a million (515,247). Once a tax lien is filed, the IRS has a primary claim on all the taxpayer’s current and future property. This gives the IRS powers that no other creditors have.
Regular creditors must invest time and money in suing a debtor in court to obtain a tax lien. The IRS doesn’t have to receive a judgment to attach a lien on a debtor’s property. In fact, 53% of tax liens are filed automatically by computers without the involvement of an IRS agent. Once a tax lien is filed the IRS can start procedures to garnish wages, auction property, and levy bank accounts to collect back taxes.
Are Tax Liens Affected by a Bankruptcy’s Automatic Stay?
A tax lien is affected by a bankruptcy’s automatic stay if the tax lien is for taxes that can be discharged (removed) in bankruptcy. If the taxes that triggered the tax lien are not dischargeable in bankruptcy, the tax lien sails through the automatic stay undisturbed.
Here are four requirements a tax debt must meet to qualify for discharge in bankruptcy.
- The taxes must be income-based. Tax liens on other types of taxes, such as property taxes, employment taxes, or taxes meant to pay for Medicare are generally impervious to bankruptcies.
- The three-year rule. Only tax liens on taxes that were due at least three years before you filed for bankruptcy are halted by bankruptcy.
- No fraud or tax evasion. If the IRS proves you filed a fraudulent tax return or willfully tried to evade taxes.
- The 240-day rule. The taxing authority must have assessed the tax debt at least 240 days before you file for bankruptcy. This time limit may be extended in certain cases, such as when you file for an installment agreement, an offer in compromise, or if you’re considered a serial bankruptcy filer.
The Benefits of the Automatic Stay
If your tax lien meets the above requirements, bankruptcy law prohibits the IRS (or any other taxing authority) from:
- Sending balance due notices on pre-bankruptcy taxes
- Starting a proceeding to collect pre-bankruptcy tax debt
- Enforcing a judgment that was obtained before the bankruptcy
- Taking possession (auctioning, selling, or garnishing) property in the estate under bankruptcy
- Filing a tax lien against your property
The automatic stay offers these protections until the bankruptcy is closed, the case is dismissed, or a tax discharge is granted or denied.
However, there are things the IRS can still do even when there is an automatic stay on a lien:
- The IRS can commence a criminal action against the debtor
- It can report the case to the police
- Start an audit to determine tax liability
- Demand a missing tax return
- Use tax refund to pay off past-due support obligations
The Difference Between an Automatic Stay and a Discharge
Bankruptcy can remove your tax liability but, as long as a tax lien was properly filed, it cannot remove the tax lien. Of course, this is only an issue if you come out of the bankruptcy with substantial assets. If you no longer own any of the property attached to the tax lien, the tax lien is pretty pointless. However, the tax lien notice will continue to hurt your credit as long as it is on your credit report, which is usually seven years since it was filed. You can request the IRS to remove the notice from your credit report, but that is unlikely to happen if you don’t pay the back taxes on the tax lien.
The Importance of Tax Attorneys
By now you can see why it is crucial to hire a tax attorney with experience in bankruptcies before filing for a Chapter 7 or Chapter 13 bankruptcy. Bankruptcy law includes mind-bogglingly complex laws and exceptions. You need someone who has years of experience to stand a chance. As mentioned above, bankruptcy does not clear you from criminal charges. A qualified tax attorney can help you decide whether filing for bankruptcy is a smart choice in your case.
Before spending thousands of dollars on legal representation, find out what your options are. Complete this short survey and receive a free consultation with a senior tax professional. The IRS has tax relief programs that can reduce or even wipe out your tax liability. Filing for bankruptcy may still be the best option, which can be helpful to have a tax relief company on your side. The best tax relief companies have tax lawyers and enrolled agents on staff, provide a money-back guarantee and charge competitive rates.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.