Preventing an Income Tax Lien on Your Home

 Posted on May 23, 2016 in Income Taxes

The recording of an income tax lien turns your home into collateral on the tax you owe. Stop the IRS/state from getting that huge advantage.

Assume you owe an income tax debt of $20,000. Assume also that if you filed a bankruptcy case today that $20,000 would be “discharged”—legally written off—in bankruptcy since that tax meets the conditions for discharge. You would not have to pay a dime of this $20,000. Ever.

But now instead assume that you didn’t file bankruptcy today. Then tomorrow the IRS or state tax authority records a tax lien against your home on this $20,000 tax debt. This could mean that after that you could not discharge that debt at all but instead would have to pay it in full. Plus penalties and interest.

So, bankruptcy doesn’t just write off income taxes under the right circumstances. It prevents a debt that could be written off turning into one that can’t. And protects your home in the process.

A Bad Combination of Circumstances

So the recording of an income tax lien can turn a debt that can be discharged into one that has to be paid in full. This doesn’t always happen. It happens when you have a combination of 2 circumstances. But this combination of circumstances is a common one if you owe taxes:

• First, the income tax you owe meets the conditions for it to be discharged in bankruptcy. A tax can generally be discharged if 1) more than 3 years have passed since the tax return for that tax was due, and 2) more than 2 years have passed since the tax return was actually submitted to the IRS/state.
• Second, your home has equity to which a tax lien could attach.

Tax Liens Often Are Recorded Against Dischargeable Debts

The IRS and the state tax authorities don’t tend to record tax liens early in the collection process. Whether or not they do depends on the amount of the tax due and other factors. But they are often not quick on recording tax liens. They tend to go through other collection procedures first, especially if you cooperate with them (although again it depends on their individual procedures and how they exercise their discretion in each case).

Often the result is that by the time they would be recording a tax lien, enough time would have passed to meet the above 2-year and 3-year conditions for discharging that tax. So when a tax lien is recorded against you, that recording often turns a tax that could have been easily discharged into one that no longer can be.

A Tax Lien Attaches to ALL Present and to FUTURE Home Equity

Whether or not you own a home is a matter of public record. The IRS and state know if you own a home. They can determine, at least roughly, how much you owe on it. And so they know whether you have any equity in it and about how much. These facts can affect whether and when they would record a tax lien against your home.

You may think that you have little or no equity in your home. But consider the following:

• First, you may have learned that you are entitled to a “homestead exemption” that protects the equity in your home from your creditors. You may have even learned that all of the equity that you have in your home is more than covered by that homestead exemption. Doesn’t matter. The homestead exemption does not have the power to stop a tax lien from attaching to your home equity.
• Second, a tax lien attaches not just to your present equity but also to future equity. Your home equity increases as you pay down your mortgage and as the value of the home increases. If you are behind on property taxes, homeowners’ association dues, or other debts against your home, catching up on these builds equity all the more quickly. Tax liens can last a long time and so can attach to your home’s future equity. An IRS tax lien, for example, lasts the 10 years that it can collect on a tax (and can be extended in certain situations).
• Third, even if you have little or no equity in your home and the equity won’t significantly increase in the future, a tax lien gives the IRS/state leverage to force you to pay them in order to get rid of the tax lien. Tax liens are quite damaging on your credit record. They can prevent you from selling or refinancing your home. The IRS/state will use all this to make you pay to get a release of its lien, even if the amount you are forced to pay is more than the amount of equity that the tax lien actually attaches to.

Preventing All This

Stop the IRS and state tax authorities from gaining all these damaging advantages. Do so simply by filing bankruptcy before they record a tax lien.

If you file either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts” before a tax lien is recorded against you and your home, the IRS and/or state are stopped from recording one. Then, the IRS/state cannot record a tax lien during your bankruptcy case. And if the income tax(es) you owe meet(s) the conditions for discharge, towards the end of your Chapter 7 or 13 case the tax will be discharged. After that the IRS/state cannot take any action to collect the debt, including to record a tax lien.

So, especially if you owe income taxes that meet the conditions for discharge, filing bankruptcy before a tax lien is recorded can make a tremendous difference. The difference can be between paying NOTHING on a discharged tax debt and paying ALL of that tax because the lien attached to present and future equity in your home.