When the IRS Will Use a Tax Lien on a Taxpayer

IRS Tax Liens

The IRS can use a lien against the property of any individual taxpayer who fails to pay taxes he or she owes to the IRS. The lien gives the government an interest in the taxpayer’s property to ensure that the government receives the amount of taxes that the taxpayer owes but has not yet paid.

How an IRS Lien Works

If a taxpayer, after filing a return, owes money to the IRS, the IRS will send a Notice and Demand for payment of this. The IRS will typically send at least two such letters. If the taxpayer fails to pay the amount demanded, the IRS may begin a collection action against the taxpayer. A lien against the taxpayer’s property is one type of collection action.

To impose a lien, the IRS files a "Notice of Federal Tax Lien" to put creditors on notice that the government has a legal right to the taxpayer's property. A lien can "attach" to (meaning, give the government an interest in) any of the taxpayer’s assets, including real estate, personal property, vehicles, bank accounts, and securities. It also attaches to the taxpayer’s business property, including accounts receivable.

IRS Tax Liens

An IRS lien is a public record. When the IRS files a lien, it becomes a creditor of the highest priority, meaning that it is paid first when the taxpayer’s assets are sold. Consequently, the lien will almost certainly affect the taxpayer’s credit. If the taxpayer files for bankruptcy, the lien may continue after the bankruptcy.

The lien typically stays in place for as long as long as the IRS can enforce an action against the taxpayer (usually 10 years) or until the taxpayer pays the tax debt or settles it with the IRS. If a taxpayer pays the tax debt after an IRS lien attaches, the IRS will release the lien within 30 days.

In some cases, the IRS can mitigate the effect of a lien. The IRS, if it chooses, can discharge property; that is, it can remove the lien from specific assets. Alternatively, the IRS can subordinate the lien, which keeps the lien in place but allows other creditors of the taxpayer to move ahead of the IRS in the order of priority. As a third alternative, the IRS can withdraw the lien, in which case the taxpayer is still liable for the tax debt but the Notice of Federal Tax Lien is removed and the IRS no longer has an interest in the taxpayer’s property.

How Levy Differs from a Lien

A lien does not mean that the government has seized the taxpayer’s property. However, if the taxpayer continues to do nothing about the tax debt and the lien, the IRS may eventually seize the taxpayer’s assets and use them to satisfy the tax debt. The government’s seizure of property to cover a tax debt is called a levy.

Quiz: Bankruptcy and Your Taxes

Sometimes our financial situations can take a devastating turn and make filing for bankruptcy inevitable. Bankruptcy can have a ripple effect on your taxes, depending on what the terms were for your proceedings and which debts were settled. There are also several stringent rules that must be met concerning filing your taxes before, during, and after bankruptcy proceedings. See how you rank on this quiz about bankruptcy and taxes.

If you file for bankruptcy, what can happen to your tax refund? Answer

A. You can receive it as usual
B. It can be applied to the bankruptcy estate
C. It can be applied to past due taxes
D. Your state’s courts can freeze the funds

B. If you receive a refund check before filing for bankruptcy, you can spend it down. If you are due a tax refund after filing for bankruptcy, it is considered part of your bankruptcy estate and typically goes directly to the trustee.

True or False: You may have to file two different tax returns after declaring bankruptcy. Answer
True. A majority of individuals file for Chapter 13 bankruptcy, where the trustee files a Form 1041 for the bankruptcy estate, and you file your individual 1040 as usual. For Chapter 7 bankruptcies, you need to file both the 1040 and 1041 on your own.

You receive a 1099-C form for a cancellation of debt. How is this income treated on your tax return? Answer

A. You owe taxes on the full amount
B. It is always reported, but not taxed
C. You owe taxes on the amount less your bankruptcy petition expenses
D. You can exclude part of the amount because you filed for bankruptcy

D. Cancellation of debt income is taxable by default, but has exceptions for insolvency (having a negative net worth at the time the debt was forgiven) as well as debts discharged in the bankruptcy.

After filing for Chapter 13 bankruptcy, how many years must you ensure that you file by the tax deadline? Answer

A. 2 years
B. 3 years
C. 4 years
D. 5 years

C. One of the terms of Chapter 13 bankruptcy is that you need to file tax returns by the deadline (plus any applicable extensions) for four years after the proceedings are complete.

True or False: You can discharge income tax-related debts in bankruptcy. Answer
True. Taxpayers can have certain tax debt called off in bankruptcy proceedings. There are certain conditions that must be met, namely, that you can’t have committed any wrongdoing, the tax debt is at least three years old prior to filing for bankruptcy, your tax returns were filed on time, and the IRS has a formal assessment at least 240 days old.

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