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Ocean Consulting Services LLC provides tax, accounting, and payroll services to an array of business and individual clients. OCS specializes in IRS Representation - from tax audits to collection issues. Brad Simmons is the founder and managing member of OCS. He has over 35 years of experience in the business including assisting clients in obtaining six figure tax debt reductions.

02. IRS Tax Liens – What Are They? (3/25/22)

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I just received a letter from the IRS – they say they filed a lien against my house – does that mean they are planning to take it – help!

The short answer is no – filing the lien does not mean they intend to take your house. In this post we’ll describe how the IRS uses liens in connection with collecting back taxes.

Before we talk about liens lets back up a bit. In the US we have what is referred to as a “voluntary” tax system – the IRS relies on taxpayers to file tax returns and make payments.

After filing a tax return the IRS “assesses” the tax reflected on the return (basically they record the tax debt in their records). The assessment date is not the date you file a return or the date received by the IRS – it is the date the tax liability is recorded. Typically this happens shortly after the return is received by the IRS.

The assessment date begins a ten year period where the IRS can pursue collection of any unpaid taxes (referred to as the “statute of limitations”). If no return is prepared by the taxpayer the IRS can prepare a return on behalf of the taxpayer – a “substitute for return”. This action triggers an assessment and begins the ten year period.

Once a return has been filed a payment may be due (where the tax amount exceeds tax withholding and estimated tax payments). The IRS is required to notify the taxpayer of the unpaid assessed amount and demand payment. If the taxpayer fails to make full payment a lien is automatically created against all assets owned by the taxpayer. The assessment date is the date the lien becomes effective.

Let’s pause here – what does this mean. First – what does it not mean? It does not mean that the IRS can swoop in and seize your assets or levy your income. There are a number of steps that need to be taken in order for them to take these actions. What it does mean is that the IRS has a “lien” – in other words a right to – any and all assets that the taxpayer has or obtains until the assessed tax (and related interest and penalties) is satisfied.

Consider a few scenarios.

  1. You purchase your home in 2019 for $300,000. You use $60,000 cash and borrow $240,000 in order to make the purchase.You file your 2020 tax returns on April 11, 2021. The return reflects a balance due of $10,000. The IRS records the tax liability on April 14, 2021 -i.e. the tax is assessed.No payment is made so the IRS demands payment on April 24, 2021. The IRS now automatically obtains a lien on all your assets. This is referred to as a “silent lien” since it arises by operation of law – no action is required by the IRS. The lien date is April 14, 2021.

    Upon reviewing your situation the IRS discovers the home. It then files a formal notice of lien with your local registrar of deeds. This lien becomes part of the legal ownership documents associated with the property. In other words it puts the world on notice that you have a debt to the IRS and it has a right with respect to the property.

    Assume the property has a current value of $350,000 and the current mortgage obligation is $230,000. Does the IRS have a right to $350,000? No they do not. The IRS “steps into the shoes” of the taxpayer. It only obtains rights that the taxpayer has in property. In this example if you were to sell the property for $350,000 you would be required to pay $230,000 to the lender (who holds a security interest in the property). Absent the tax debt you would be entitled to the balance – $120,000. This net equity is what the IRS has a right to – the amount that you could realize on a sale of the property after satisfying the secured debt. The lien that the bank has on the property is ahead of the IRS – since the bank debt arose before the debt to the IRS.

    The IRS is not entitled to the entire equity balance – they are entitled to the outstanding tax balance (original tax due plus interest and penalties). You are entitled to any excess amount.

  2. You purchase an RV for $30,000 in 2019. You use $5,000 as a down payment and borrow $25,000. The lender records a lien against the RV on the title maintained by the local registry of motor vehicles.Assume the same tax situation as above – you have a debt to the IRS in the amount of $10,000. In this example the RV is currently worth $25,000 and the outstanding debt is $22,000.If the RV is sold there exists $3,000 in net equity ($25,000 value less $22,000 debt). Since you would otherwise be entitled to the equity the IRS “steps into your shoes” – it becomes entitled to the equity. In this situation since the equity is less than the tax debt the IRS is entitled to all the equity and there remains a tax obligation / liens against your other assets.
  3. You set up an IRA account and have been making yearly contributions to the plan. The account has a current balance of $15,000. You are younger than age 59.5. Due to your age you would be subject to a 10% penalty on any distributed amounts.In this situation the IRS has a lien against the entire value of the IRA. Not withstanding the potential penalty you have a legal right to distributions from the plan. Accordingly the IRS steps into your shoes and obtains a lien against the balance of the IRA account.
  4. Your employer maintains a defined benefit plan for employees. Under the plan provisions no amounts may be paid to individuals until they reach age 59.5. If you are not yet age 59.5 you have no right to plan distributions – notwithstanding the fact that you have a future right to benefits under the plan.In this situation the IRS has no current rights with respect to your interest in the plan – since legally you have no right to plan distributions. If you later become entitled to distributions, while your tax debt remains unpaid, the IRS will obtain rights – stepping into your shoes.
  5. Your mother owns a parcel of vacant land. It’s worth $50,000. She transfers ownership of the property to you – as a gift. Under the step into the shoes rules the IRS obtains a lien against the property once you obtain legal ownership of the property.

As previously discussed the lien against your property arises automatically. But at the point it arises only you and the IRS are aware of the lien. In order to provide public notice of the lien the IRS files what is known as a “Notice of Federal Tax Lien”. This is a public document that provides notice of the tax debt and the IRS lien against your assets. This filing may impact your credit rating, may affect your ability to obtain credit, and may impact your ability to sell assets.

In our next blog post we’ll discuss several methods available to release a federal tax lien.

As always feel free to contact us if you need assistance.

 

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