Federal Tax Liens (FTLs) play a critical role in the IRS’s ability to secure unpaid tax debts. Despite their significance, there is often confusion among taxpayers and practitioners about their implications and the options available to mitigate their impact. Understanding the mechanics of a federal tax lien, the legal framework under IRC § 6321, and strategies to address them can help practitioners guide clients effectively.
What is a Federal Tax Lien?
A Federal Tax Lien arises when a taxpayer fails to pay a tax debt after the IRS demands payment. Under IRC § 6321, the lien automatically attaches to all of the taxpayer’s property and rights to property, including real estate, personal property, and financial assets.
The lien serves as the government’s legal claim against the taxpayer’s property to secure payment of the tax debt. While it does not necessarily lead to immediate seizure of assets, it can significantly affect a taxpayer’s financial standing by limiting their ability to sell or borrow against property.
Notice of Federal Tax Lien (NFTL)
Although the lien itself arises automatically, the IRS may file a Notice of Federal Tax Lien (NFTL) in the public records to inform creditors of its interest in the taxpayer’s property. The NFTL:
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- Protects the IRS’s claim by establishing priority over other creditors.
- Alerts lenders and potential buyers of the encumbrance on the taxpayer’s assets.
As of 2018, the three major credit bureaus—Experian, TransUnion, and Equifax—ceased including NFTLs in consumer credit reports. This change means that NFTLs no longer directly impact credit scores. However, since NFTLs are public records, they can still be discovered through other means, such as public records searches, and may influence decisions by lenders or other entities reviewing an individual’s financial background.
The IRS is required to notify the taxpayer of the NFTL filing within five business days, as outlined in IRC § 6320(a). The taxpayer then has 30 days to request a Collection Due Process (CDP) hearing to challenge the lien or propose alternative resolutions.
Options to Address a Federal Tax Lien
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- Full Payment of the Tax Debt: The simplest way to resolve a lien is to pay the full amount owed. Once the IRS receives full payment, it releases the lien within 30 days, as required by IRC § 6325(a).
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- Discharge of Property: A taxpayer may apply for a discharge to remove the lien from specific property, such as real estate being sold. This process is governed by IRC § 6325(b) and allows the property to be sold free of the lien while the IRS retains its claim on the remaining assets.
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- Subordination: In some cases, the IRS may agree to subordinate its lien, allowing other creditors to take precedence. This option is commonly used to enable refinancing or obtaining new loans. Subordination is addressed under IRC § 6325(d).
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- Withdrawal: A taxpayer can request the withdrawal of the NFTL if certain conditions are met, such as entering into a direct debit installment agreement or showing that the withdrawal is in the government’s interest. Withdrawal removes the public notice of the lien but does not eliminate the lien itself.
Misconceptions About Federal Tax Liens
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- Automatic Lien vs. NFTL
Many taxpayers believe a lien only exists if the IRS files an NFTL. In reality, the lien arises automatically under IRC § 6321 once the taxpayer fails to pay their tax debt after notice and demand. The NFTL is simply the public notification of that lien.
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- Credit Impact
Some taxpayers assume that an NFTL directly impacts their credit score. However, since 2018, the three major credit bureaus have ceased including NFTLs on credit reports. While this means NFTLs no longer affect credit scores directly, they remain public records and may be discovered by lenders or other parties through public records searches, influencing financial decisions.
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- Bankruptcy and Liens
Filing for bankruptcy does not automatically eliminate federal tax liens. While bankruptcy can discharge certain tax debts, liens on property typically survive unless specifically addressed in bankruptcy proceedings.
Relevance for Tax Practitioners
Federal Tax Liens represent a significant challenge for taxpayers, and tax practitioners play a crucial role in mitigating their impact. Understanding the nuances of IRC § 6321 and related provisions allows practitioners to advise clients on preventative measures, such as staying current on tax obligations and addressing debts promptly. When liens arise, practitioners can guide clients through resolution strategies, including installment agreements, offers in compromise, or lien subordination and withdrawal. Effective representation during CDP hearings or negotiations with the IRS ensures the best possible outcomes, helping clients manage their tax liabilities while minimizing long-term financial consequences.