What Are Tax Liens and How Do They Affect My Credit?
There are few things in life more loathed than that of federal and state taxes. This isn’t because of their important use in society (although some may argue that it is), but simply because messing up your taxes — even slightly — can result in a major burden on your life: the IRS.
The Internal Revenue Service (IRS) is known to be ruthless in its enforcement and pursuit of tax revenue. They have targeted big time celebrities with audits and lawsuits when their tax returns seemed to be off. They will call you relentlessly when they think you owe them money, and they will find any and every way to get that money from you.
But the IRS is not entirely a nightmare. Many people are simply afraid because they do not understand how all the pieces fit together. Luckily, learning about all the fine details can help you relax knowing the IRS isn’t as big and scary as they are often perceived to be. Yes, they will find any legal way to get the money you owe them, but they are also not the “Big Brother” enigma that you might have previously thought.
Tax liens are one of the many pieces to the IRS puzzle that can cause serious stress to anyone who owes money. What are tax liens, and how do they work? What is their purpose, and how long do they last? If you have one, what can it do to your credit score, and what should you do to appease the IRS?
Let us dive into the ins and outs of tax liens and try to relieve some of that pent up stress.
What Are Tax Liens?
Tax liens are a legal form of secured interest or payment that normally takes the form of property or items that equal the amount owed on taxes. In other words, if you owe the IRS more than you paid in taxes, a lien gives the IRS a claim against your physical property in order to make up that lost or missing revenue. Liens only become active after the amount owed (your tax bill) has remained unpaid following a legal, written demand from the IRS.
For example: if you own a car worth $12,000 and you owe about $12,000 to the IRS in taxes, a tax lien may result in the IRS taking your car as a form of “payment” for the money owed.
According to the Internal Revenue Code (section 6321): LIEN FOR TAXES —
“If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belong to such person.”
The sole purpose of a tax lien is for the IRS to secure the payment of taxes that are owed. It can result from the failure to pay taxes (income or otherwise) and tax liens can expire after a certain number of years. This is known as “a lapse in time” and generally takes ten years. However, there are some circumstances where that period of time can be extended, or where debts can be excused (typically in the case of wrongful charges or when the debtor informs the IRS that they do not have any assets available due to bankruptcy or financial hardship).
There are plenty of other tidbits surrounding the legal repercussions of tax liens, but getting into all the details would be its own 5,000 word essay. Instead, let’s focus on the most important aspects of tax liens: how they can affect your personal finances and credit score.
Tax Liens And Your Credit Score
For many people who have had tax liens in the past or who currently owe tax liens to the IRS, one of the biggest concerns is how this will affect their finances in the long-term. Will tax liens be similar to having an account in collections? If the tax lien lapses, will it disappear from a credit report altogether?
As it turns out, tax liens have a very similar effect on your credit report as bankruptcy. The credit bureaus will see a tax lien as a delinquent account, and will treat it as such even following payment of the lien. (The only exception is if the IRS has withdrawn the lien from the public record due to an error or some other special circumstances.)
Liens are governed by the Fair Credit Reporting Act, which states that a tax lien is not to be removed from a credit report until seven years from the date the lien is paid and released. Once it passes that seven year benchmark, it will disappear from your credit report altogether. However, if the account goes unpaid and the lien lapses past the ten year limitation, that lien can remain on your credit score for up to ten years, according to Experian.
However, there is also the possibility that the lien can be either withdrawn or released. When a tax lien is withdrawn, it has the ability to be taken off of your credit report immediately. The catch is that the lien has to be paid in full and you have to be sure you’ve complied with all tax filings within the past three years. Withdrawals can also happen if you have entered into a direct debit installment agreement with the IRS.
To have a lien withdrawn under a direct debit installment agreement, you must make three consecutive payments in a row (to be able to apply), have the total debt be less than $25,000, and must pay off the debt within 60 months (or before the lien expires, whichever is first). Additionally, any past or current debit installments must not have been defaulted on, as the IRS will take your history of past accounts into consideration.
A release simply means that the IRS acknowledges you have paid off the outstanding tax bill, and no longer reports the debt as delinquent. However, this is different from a withdrawal, in that the lien is still recorded on your credit history for up to ten years. A release just shows that you fulfilled your obligation to pay, and that the IRS no longer has any active claim against your property.
How to Navigate Tax Liens
Because tax liens can be so devastating to your credit report, it’s important to take care of them as soon as possible. Unfortunately, tax liens can be filed by the IRS within 10 days of them sending you a written notice that you owe money for your taxes. That means you’ll have very little time to workout a repayment plan or settle the debt.
If the IRS does file a tax lien on you for a past delinquency, try to pay it off as soon as possible. If you have a tax lien from a few years ago that you are trying to pay off, avoid contacting the IRS directly, and instead contact a professional to help you navigate the situation. Once you are back on the IRS’s radar, they can be ruthless yet again, so it’s best to approach the situation with caution to ensure you have everything sorted out and all your bases covered.
The most important thing to keep in mind with tax liens is that they do have a significant impact on your personal finances and credit score, and it’s vital that you pay them off as soon as possible. The sooner you can get the IRS off your back, the sooner you can get back to enjoying your freedom and building your credit.
What else can affect your credit? Find out at the Fiscal Tiger credit score resource and learning center.
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Katie McBeth is a researcher and writer out of Boise, ID, with experience in marketing for small businesses and management. Her favorite subject of study is millennials, and she has been featured on Fortune Magazine and the Quiet Revolution. She researches SEO strategies during the day, and freelances at night. You can follow her writing adventures on Instagram or Twitter: @ktmcbeth
This post was updated February 28, 2019. It was originally published August 14, 2017.