Bankruptcy gives you power over the IRS in getting rid of a tax lien. Chapter 13 in particular empowers you to value and pay off a lien.
Federal and State Income Tax Liens
A tax lien is the government’s forced legal claim against your property, designed to ensure that you pay the tax debt which resulted in the lien. When the IRS or state record a tax lien against your home—usually at your county’s recording office—you usually cannot sell or refinance your home without paying off the tax. (A tax lien can attach to your other property and possessions, depending on how the lien is recorded, but today we focus on your home.)
A tax lien is different from a tax levy. A lien secures the IRS’s or state’s right to payment of a tax debt against the title of your home. A tax levy is an actual seizing and selling of your property or possessions by the government to pay the tax. Tax levies can happen after the IRS/state records a tax lien.
Tax Liens Outside of Bankruptcy
If you don’t file bankruptcy, you usually have to pay off the tax debt in full to get a release of the tax lien. The IRS’s website itself states that “[p]aying your tax debt—in full—is the best way to get rid of a federal tax lien.” That’s not very helpful if you simply don’t have the money to pay it.
The IRS website also says: “If you file for bankruptcy, your tax debt, lien, and [recorded] Tax Lien may continue after the bankruptcy.”
What the IRS is not telling you is that when done right, a tax lien can be gotten rid of through bankruptcy. Here’s how it really works.
Tax Liens under Chapter 7
The first thing the IRS isn’t telling you directly is that sometimes your tax debt doesn’t “continue after bankruptcy” because that tax debt is forever written off (“discharged”) in bankruptcy. As discussed earlier in this series of blog posts, older tax debts are routinely discharged in either a Chapter 7 “straight bankruptcy” case or a Chapter 13 “adjustment of debts” one.
Also, when you discharge a tax debt, after that the IRS/state can never file a tax lien against you or your home on that tax. However, if a tax lien has already been recorded against you by the time you file a Chapter 7 case, that lien can cause problems. That’s because—as strange as it may sound—even though the tax debt that caused the tax lien is discharged, the tax lien against your home does indeed survive.
What then happens depends on whether you have equity in your home (or in any other property and possessions that the tax lien attaches to). If you are way “under water” on your home—you owe lots more than it is worth—then the lien in effect has no value. It has no equity to attach to. The IRS/state then might be persuaded to release its lien. Or the lien may simply eventually expire and do so before there’s any equity in the property.
On the other hand, if you do have some equity in your home after the tax debt is discharged in a Chapter 7 case, the tax lien attaches to this equity. And your homestead exemption does NOT protect against tax liens, so the tax lien attaches to ANY equity in your home. Then you have the odd and very unsatisfactory situation that if you then sell or refinance your home, you’d have to pay some or all of a tax debt that has already been discharged in bankruptcy.
Tax Liens under Chapter 13
There’s a much better solution under Chapter 13, with the result turning on how much equity you have in your home at the time your case is filed.
If you have no equity, then your dischargeable tax debt is treated as an unsecured debt, lumped together with all your other ordinary “general unsecured” debts—credit cards, medical debts, and such. The practical result is often that you pay nothing more to your creditors in your Chapter 13 plan than you would if you did not owe that tax debt at all. That is, either you pay 0% of those debts, including the taxes, or you pay some percentage of those “general unsecured” debts but the same number of dollars as you would have had you not owed that tax. (That’s because that fixed amount being paid to your “general unsecured” debts is all that your budget allows you to pay during the required term of the payment plan.)
In this situation, at the end of your Chapter 13 case the IRS/state MUST release its tax lien. That’s because at the beginning of the case the bankruptcy court had determined that the lien had no value to attach to, and you would have fulfilled your obligations under the case.
On the other hand, if you do have some equity in your home at the time your Chapter 13 case is filed, but less than the amount of the tax you owe on the tax lien, that’s where Chapter 13 really helps you out. During the course of your case you pay the secured portion of the tax—based on the amount of equity in your home—while the unsecured portion is lumped together with all your other ordinary “general unsecured” debts. That unsecured portion is paid little or nothing, as discussed in the above paragraph.
This is a very good way of taking care of the tax lien for a lot of reasons:
- YOU propose the amount of equity and thus the secured portion of the debt, which is generally the amount the bankruptcy court approves as long as it is reasonable. The IRS/state has to formally object or else the amount stands.
- Either way you have a convenient and inexpensive legal forum to determine the value of the lien against your home. You and your home are not at the mercy of the IRS/state.
- That secured amount is fixed at the beginning of the case, so future property value increases are usually protected.
- The IRS/state cannot take any further collection action against you during the entire repayment period—no levies seizing your personal or business assets, no garnishment of your paycheck or bank accounts, no phone calls or collection letters.
- At the end of your Chapter 13 case the IRS/state MUST release its tax lien, because you’ve fulfilled your limited obligations under the lien, as fixed under your Chapter 13 plan.
So in these situations, where the tax at issue meets the conditions for discharge, and there is some equity securing the tax, Chapter 13 enables you to discharge the tax debt and pay the appropriate portion to satisfy the tax lien, resulting in no more tax debt and no more tax lien.