This article will help you understand when the federal tax lien arises, what effect the filing of a Notice of Federal Tax Lien - Form 668(Y) - has, and how you can get rid of the Notice of Federal Tax Lien.
What is a federal tax lien?
The first thing that you must understand is that the Notice of Federal Tax Lien is not the federal tax lien itself. Rather, it puts the world (most importantly, creditors) on notice that the IRS has a tax lien that may attach to your property.
The federal tax lien is a serious and important tool in the IRS's shed of collection mechanisms. It protects the federal government when a taxpayer does not pay his or her taxes. The federal tax lien attaches to all of the property of the taxpayer.
What must happen before a federal tax lien arises?
Section 6321 of the Internal Revenue Code provides that a tax lien arises when any person liable for tax neglects or refuses to pay after demand. It provides that the amount of the lien is equal to the unpaid tax, interest, additional amounts, additions to tax, assessable penalties, along with any costs.
Three things must occur before a tax lien arises:
- The first step to IRS collection is an assessment. An assessment is the process of the IRS recording tax that you owe in its computer system. Assessments may be based on income tax returns that you filed (self-filed returns), IRS audits, Tax Court decisions, or an IRS determination that you made a math error.
- Notice and demand. Once the IRS makes an assessment, it must issue "notice and demand." I.R.C. § 6303. Although notice and demand is tax lingo, it is, for all practical purposes, simply a bill. The notice and demand informs taxpayers of the assessed taxes, and demands payment of the tax liability within 10 days to avoid interest. There is no particular form required for notice and demand. The IRS generally satisfies this requirement with one of its many form letters. The IRS must either leave the notice and demand at the taxpayer's residence or usual place of business, or mail it to the taxpayer at his or her last known address. I.R.C. § 6303 says that the IRS must send notice and demand as soon as practicable, and within 60 days. If the IRS fails to send notice within 60 days, however, taxpayers are unlikely to escape the wrath of the tax liability. The Treasury Regulation provides that the IRS's failure to provide notice and demand within the 60-day period does not invalidate the notice. Treas. Reg. §301.6303-1(a). The Treasury Regulation has been upheld by courts. See United States v. Friedman, 739 F.2d 252 (7th Cir. 1984).
- Failure to Pay. After the IRS makes an assessment, and sends notice and demand, the taxpayer must fail to pay the entire amount of tax due.
When does the federal tax lien arise?
Although the three steps mentioned above (assessment, notice and demand, failure to pay) must happen before the federal tax lien arises, only of those dates matters for purposes of determining when the lien arises
The assessment date is the date that the lien arises. I.R.C. § 6322 tells us that the lien relates back to the date of assessment.
What is the effect of the federal tax lien?
A federal tax lien attaches to “all property and rights to property, whether real or personal, belonging to” the taxpayer. I.R.C. § 6321. The existence of a federal tax lien does not deprive the taxpayer of the use of his or her property. If a federal tax lien attaches to property, it will follow the property, even if the taxpayer transfers it to a third party, unless the taxpayer obtains a release. Once the federal tax lien attaches to property, the government may seek to claim its interest in the property through a levy, seizure, or foreclosure suit.
How is value of the federal tax lien determined?
The federal tax lien is not limited to the value of the property when it attaches. If the property appreciates, then the IRS's lien position appreciates as well. See Han v. United States, 944 F.2d 526 (9th Cir. 1991).
For example, consider a taxpayer that has a tax liability of $200,000, and a home worth $100,000. Assume that the federal tax lien attaches to property when it is worth $100,000, but the value of the property increases to $200,000. The IRS may seek to foreclose on the property and capture the $200,000 from the property even though it was only worth $100,000 when the lien attached.
How long does the federal tax lien last?
The federal tax lien remains in effect until one of the following occurs
- Payment of the tax liability will end the lien because the liability will no longer exist. I.R.C. § 6322.
- The IRS has a 10-year collection statute under I.R.C. § 6502. Once the 10-year collection statute lapses, the lien is extinguished. However, there are many exceptions that will suspend the 10-year collection statute, including a pending installment agreement, Collection Due Process (CDP) hearing request, pending Offer in Compromise, bankruptcy where an automatic stay is imposed, during an innocent spouse request, when the taxpayer is outside the United States for a continuous period of at least 6 months.
Although the 10-year collection statute may pass, the IRS still has another tool to collect on a tax liability. The IRS will, in certain situations, file a suit to reduce a tax liability to judgment when a tax lien is about to expire. Generally, the IRS will only file suit to reduce a tax liability when it has reason to believe that the taxpayer will have future collection potential, or when the IRS initiated another suit, like a suit to foreclose on a personal residence.
If the IRS reduces a liability to judgment, the tax lien will continue to exist until the judgment is satisfied. I.R.C. § 6322, 6502(a). The tax lien, and the judgment, continue to exist independently. United States v. Overman, 424 F.2d 1142, 1147 (9th Cir. 1970). The suit to reduce a liability to judgment must occur within the 10-year collection statute. I.R.C. § 6502(a)(1).
What is the effect of the Notice of Federal Tax Lien?
The Notice of Federal Tax Lien is often confused with the federal tax lien. A federal tax lien may have arisen after assessment, notice and demand, and refusal to pay, but the IRS may not actually file a Notice of Federal Tax Lien. In most cases, the IRS will not file a Notice of Federal Tax Lien if the unpaid tax liability is less than $10,000.
The federal tax lien is a secret lien—meaning creditors cannot find out about it—until the IRS files a Notice of Federal Tax Lien. When the IRS files a Notice of Federal Tax Lien, it puts creditors and everyone else on notice that the IRS has, or may have, a federal tax lien. I will talk more about why the Notice of Federal Tax Lien may not mean that there is a current unpaid liability when I introduce you to the self-releasing notice in the next section.
The real importance of the Notice of Federal Tax Lien is its effect on the priority of the federal tax lien. Until a Notice of Federal Tax Lien is filed, the federal tax lien is not valid against a purchaser, security interest holder, mechanic's lienor, or judgment lien creditor. Once a notice is filed, the general priority rule is easy to remember: first in time, first in right. There are exceptions to the general rule: purchase money security interests, superpriorities, and equitable subrogation. Those exceptions, however, are beyond the scope of this article.
How do I get the Notice of Federal Tax Lien released once I satisfy the liability?
The IRS must issue a certificate of release within 30 days after the liability is satisfied or no longer enforceable, or when a bond payment is accepted. I.R.C. § 6325(a).
The IRS created the “self-releasing” lien notice starting in 1982 to comply with the 30-day requirement of I.R.C. § 6325(a). This means that most liens include a notice operating as a certificate of release. Notices of liens filed on Form 668-F do not include the self-releasing language.
Although the lien notice is self-releasing, it will still appear where it is filed. If you want creditors to know that the lien has been released, you may request a withdrawal or removal of the notice.
How do I get the Notice of Federal Tax Lien withdrawn?
Although a lien may have self-released, that does not mean that the Notice of Federal Tax Lien disappears. The process to remove the Notice of Federal Tax Lien is called withdrawal.
I.R.C. § 6323(j) gives the IRS authority to withdraw a Notice of Federal Tax Lien under certain circumstances, and to provide notice of the withdrawal to credit agencies. A lien withdrawal can have a drastic impact on a taxpayer's credit score.
There are many reasons that the IRS will permit withdrawal, including that it is in the best interest of the United States, it will facilitate collection, or the taxpayer has entered into an installment agreement.
Requests for withdrawal of the Notice of Federal Tax Lien must be in writing. The IRS prefers that taxpayers use Form 12277, Application for Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien, but any written request that contains the necessary information will be accepted.
The request must include the following information:
- Taxpayer's name
- Current address
- Taxpayer's identification number
- A copy of the Notice of Federal Tax Lien, or details about it
- A statement explaining the basis for the withdrawal request
- Authorization for disclosure of information to creditors, credit reporting agencies, and financial institutions
Notice of Federal Tax Lien withdrawal requests must be signed by the taxpayer, or someone with a valid power of attorney, like a tax attorney.
If the IRS denies your request, you have a wright to discuss the denial with the denying official's immediate supervisor, and you may have Collection Appeal rights.
Will the IRS discharge a lien from certain property even if I have not satisfied the liability?
The IRS will discharge a lien from certain property in the following circumstances:
- Property worth double value. Property may be discharged from the federal tax lien if the fair market value of the taxpayer's remaining property subject to the lien is at least double the sum of the tax liability and all other liens with priority over the tax lien. I.R.C. § 6325(b)(1).
- IRS paid value. Property may be discharged from the federal tax lien if the taxpayer pays to the IRS the value of the government's interest in the property, or the value of the interest that is to be discharged if less than the full property. I.R.C. § 6325(b)(2)(A).
- IRS's interest has no value. Property may be discharged from the federal tax lien if the IRS determines that the government's interest in the property has no value. The IRS may consider the forced sale value of the property, not just fair market value. Treas. Reg. § 301.6325-1(b)(6). The IRS will allow normal selling expenses.
- Property sold and proceeds subject to the federal tax lien. Property may be discharged from the federal tax lien where property is sold if the sale proceeds are to be held subject to the federal tax lien. I.R.C. § 6325(b)(3).
- Right of substitution of value. Where a third party that is not the taxpayer owns property subject to a tax lien, the third party may deposit money equal to the value of the government's interest in the lien, or furnish a bond, and then file suit under I.R.C. § 7426(a)(4) to challenge the IRS's determination of the value of the government's interest in the property.
- Estate or gift tax liens. If the IRS finds that estate or gift tax liabilities have been fully satisfied or provided for, the IRS may issue a certificate of discharge for certain property. I.R.C. § 6325(c).
- Subordination of lien. The IRS may subordinate the federal tax lien if the IRS receives an amount equal to the amount of the lien or interest to which subordination relates, and the IRS believes that the value of its interest will increase through the facilitation of the subordination, or the IRS determines that its interest will be adequately secured after subordination. I.R.C. § 6325(d).
- The IRS may issue a certificate of nonattachment to indicate that a federal tax lien does not attach to a person's property. Generally, the IRS issues this when there is a confusion of names. I.R.C. § 6325(e).
Navigating through the IRS's lien discharge procedures can be challenging. It is important that you determine the government's interest in the property as part of these procedures, which includes looking at how state law defines property interests. For example, joint tenants in Arizona may argue that they are entitled to recoup expenses that they paid on behalf of another joint tenant. Call Brandon Keim at (602) 892-1500 for a free consultation to learn how he can help you deal with an IRS federal tax lien.