Beating a Recorded Income Tax Lien on Your Home

 Posted on May 25, 2016 in Income Taxes

Once an income tax lien is recorded, Chapter 13 gives you a tool that may enable you to pay no more and yet get a release of that tax lien.

Our last blog post was about using bankruptcy to prevent the IRS or state income tax authority from recording a tax lien on your home. But what if a tax lien has already been recorded?

The Challenge of a Tax Lien

In our last blog we also focused on how bad it is for you if the IRS/state records a tax lien 1) on an income tax debt that could otherwise be discharged (legally written off) 2) against a home that has equity against which that tax lien can attach. Then the problem is that the tax can no longer be discharged since it’s now secured by your home.

But what if the home has no present equity for the tax lien to attach to?

Dealing with a Tax Lien with No Home Equity to Attach

Maybe the IRS/state didn’t know that there was no equity when it recorded the tax lien, or maybe it just didn’t care. A recorded tax lien is a matter of public record. It hurts your credit record and your ability to sell and refinance the home. It puts you under pressure to pay the underlying tax debt. The IRS and state know this and that lien hurts you regardless that your home may have no present equity.

Filing a Chapter 7 “straight bankruptcy” usually doesn’t help because an income tax lien is not affected by it. The tax lien continues to attach to your home. And within just 3-4 months after the case is filed it’s finished and the IRS/state can resume enforcing the lien.

Determining that a Tax is Unsecured in Spite of the Tax Lien

But filing a Chapter 13 “adjustment of debts” bankruptcy instead DOES help. That’s because it comes with a truly unique tool, the ability to get a legal determination that the home has no equity attachable by the tax lien. You simply establish that as of the time the case was filed the liens that come ahead of the tax lien eat up all of your home’s equity, leaving none for the tax lien. (See Section 506(a) of the U.S. Bankruptcy Code.)

As a result the tax debt is treated as a “general unsecured” debt. It is put into the pool of all your other “general unsecured” debts—which include medical bills, most credit cards, and all other debts that are not treated special by the bankruptcy laws. You would pay into that pool, including on that tax debt, only as much as you could afford to pay during the life of your 3-to-5-year Chapter 13 plan, if at all.

Indeed in many situations you would pay little or nothing because you would first be required to pay other higher-priority debts. Again, you would only pay “general unsecured” debts, including the tax debt in issue, to the extent you could afford to do so with any money left over within the length of time that your Chapter 13 plan is required to last.

And in most cases when you do pay some percentage of those “general unsecured” debts, the addition of your tax debt to that pool of your “general unsecured” debts usually doesn’t increase the amount you must pay. That’s because most of the time you pay a fixed amount of money into that pool of debts. So adding the tax debt simply reduces what the other “general unsecured” creditors receive without you paying any more.

Forcing the Release of a Tax Lien When It Does Not Attach to Any Equity

Then at the end of the Chapter 13 case, any portion of the tax debt that hasn’t been paid is discharged, legally written off forever. Then, the IRS/state—regardless how much it’s been paid or not paid—must release its tax lien.

Lack of Equity Fixed As of Date of Filing

The lack of any value in the tax lien is fixed as of the beginning of the Chapter 13 case. So the home’s ongoing appreciation in value (and increase in equity as you pay down mortgage and other debt) is put beyond the reach of the tax lien. The IRS/state does not benefit from the tax lien during the course of the case while you are protected from all collection activity. Then at the end of the case the tax debt is discharged and the tax lien is release.

Under these facts, this is an excellent way to beat a tax lien.