By Stephen J. Dunn
A Federal tax lien is not a piece of paper. It is a legal claim to a taxpayer’s property. It arises by operation of law when Federal tax is assessed against the taxpayer’s property, and remains unpaid after demand for payment by the United States. A Federal tax lien attaches all property and interests in property owned by the taxpayer at the time it arises, or acquired by the taxpayer during the ensuing ten years.
A Federal tax lien is a “secret” lien, known only to the Internal Revenue Service and the taxpayer. The Internal Revenue Service it is forbidden by law from saying anything about the lien to any person other than the taxpayer, with two exceptions. First, it can bring a judicial proceeding to foreclose the Federal tax lien.
Second, unless the balance is de minimis, the Internal Revenue Service issues a notice of Federal tax lien (“NFTL”) against the taxpayer, and records it in the register of deeds’ office in the county of the taxpayer’s residence. The Internal Revenue Service records NFTLs as a matter of practice, to prevent third parties who purchase property from the taxpayer, or lend money to the taxpayer taking a security interest in the taxpayer’s property, from acquiring an interest in the taxpayer’s property superior to the Federal tax lien.
The three major credit reporting agencies include NFTLs in the taxpayers’ credit reports, affecting the taxpayer’s credit standing. Employers are increasingly checking candidates’ credit before hiring them. A recorded NFTL can affect the taxpayer’s employability in certain industries, such as financial services, or tax administration.
Despite claims commonly made in advertisements for tax resolution services, a tax lien is not something you can just make go away. It continues in existence until the tax is paid in full or becomes uncollectible by the passage of time.
But a taxpayer is not without weapons in dealing with a tax lien. First and foremost, the taxpayer should make sure that the tax lien is in the correct amount. If the assessment is adjusted, the tax lien will adjust with it. The taxpayer’s representative should pull the taxpayer’s account transcripts from the Internal Revenue Service. An account transcript reveals whether the tax was assessed on a tax return or a substitute for return. A tax return is prepared by or for the taxpayer, and presumably takes advantage of all available exemptions, deductions, and credits. A substitute for return is prepared by the Internal Revenue Service, which does not know of deductions that may be available to the taxpayer, and resolves all doubts against the taxpayer. A substitute for return does not start the statute of limitations on assessment or collection running. If account transcripts reveal that substitute for returns have been filed for the taxpayer, the taxpayer should have actual returns prepared and filed as soon as possible. Once the actual returns are filed and processed, the Internal Revenue Service will adjust the assessments to the actual amounts per the actual returns.
Account transcripts will also show whether penalties have been assessed against the taxpayer. Many penalties apply at a percentage of the tax not reported or paid on time. Reduction in tax also reduces such penalties. The Internal Revenue Service will completely abate penalties upon a showing of reasonable cause for the noncompliance. The taxpayer’s representative thus should find out the reason(s) for the penalties, and prepare an appropriate request for relief from the penalties, and submit it to the Internal Revenue Service. The result may be appealed to the Internal Revenue Service Appeals Office, and thence litigated in United States Tax Court.
If, after the above action, an unpaid assessment remains, the lien for it will also remain, until the assessment is paid in full, or it becomes uncollectible by passage of time. The collection statute of limitations is ten years from the time the tax was assessed. While the lien remains extant, the Internal Revenue Service will periodically levy (seize) the taxpayer’s wages, bank accounts, or other property to protect it, unless the taxpayer resolves the account balance. Resolution may include paying the account balance in full, entering into an installment agreement with the Internal Revenue Service, or persuading the Internal Revenue Service to post the account as currently not collectible (“CNC”).
Once a Federal tax lien attaches to property, it remains notwithstanding discharge of the taxpayer in bankruptcy. This is one of several reasons why bankruptcy rarely if ever is an effective means of dealing with tax liabilities. Indeed, there is no reason to attempt to discharge taxes in bankruptcy. If a taxpayer is unable to pay a Federal tax assessment, the Internal Revenue Service will enter into an installment agreement with the taxpayer for a monthly payment he can afford or, if he cannot afford a payment, post the account as CNC.
The Internal Revenue Service does not attempt to seize property of a taxpayer posted as CNC, though it will make sure that a NFTL remains of record as to the taxpayer. Every 18-24 months, the Internal Revenue Service will review current financial information of a taxpayer posted as CNC, and determine whether the taxpayer should remain in that status.
The Internal Revenue Service will release specific property from a Federal tax lien, allowing taxpayer to sell the property, provided the net proceeds of sale are paid to the Internal Revenue Service to the extent of the Federal tax lien.