The federal government takes it very seriously when you fail to pay your taxes. And it can be bad for your credit reports and credit scores as well. Not paying Uncle Sam his due could also result in a tax lien being placed on your assets, such as property, security and vehicles. A lien also applies to all business property and to all rights to business property, according to the Internal Revenue Service. In this article, we’ll focus on defining what a tax lien is, how it impacts your credit and how you can avoid it.
What Is a Tax Lien?
A federal tax lien is the U.S. government’s legal claim against your property when you fail to pay a tax debt. “The lien protects the government’s interest in all your property, including real estate, personal property and financial assets,” the IRS explains on its site. Once you fail or neglect to pay a tax liability on time, the IRS assesses your liability and sends you a bill explaining how much you owe, known as a Notice and Demand for Payment. The IRS will also file a public document called the Notice of Federal Tax Lien “to alert creditors that the government has a legal right to your property,” the IRS says.
Do Tax Liens Affect Your Credit Scores?
Tax liens can have a major impact on your credit, appearing as a negative account on your credit report. (To see how an unpaid tax bill may be affecting your credit, you can view two of your credit scores, updated every 14 days, for free on Credit.com. Checking your credit scores will not affect them in any way.)
Consumers with no other negative items who have a tax lien appear on their credit reports could see their credit scores plummet by 100 points or more. Also, a tax lien stays on your credit report for seven years from the date it is paid. A tax lien could also impact your credit for even longer if you wait to resolve your tax liability and make it difficult for you to get credit.
How Can You Remove a Tax Lien?
Now that you know the toll a tax lien can take on your credit, you probably want to know how to remove it. In general, paying your tax debt in full is the best route to take, as the IRS will release your lien within 30 days after you’ve made your payment. The IRS also made some changes to its policies concerning tax liens in early 2011, including:
- Increasing the dollar threshold when liens are generally issued to $10,000.
- Making it easier for taxpayers to obtain lien withdrawals after paying a tax bill.
- Withdrawing liens in most cases where a taxpayer enters into a Direct Debit Installment Agreement.
These changes mean it is possible to get a tax lien removed from your credit reports if you’ve paid it before the normal seven-year reporting period is up or while you still owe taxes if you are paying them back through an installment agreement with the IRS.
To have a tax lien withdrawn, you must file Form 12277, requesting the lien be withdrawn. If your request is accepted, the IRS will file a notice of the withdrawal and send you a copy. Do note you will still be liable for the amount that is due.
You also may request in writing that the IRS notify credit reporting agencies, creditors and your financial institutions about the tax lien withdrawal. (You can send the notice of withdrawal from the IRS to the credit reporting agencies yourself.)
Depending on your situation, you may qualify for additional options. As the IRS notes on its site, a “discharge” removes a lien from a specific property while “subordination” works differently, allowing creditors to move ahead of the IRS so a consumer can take out a loan or apply for a mortgage.
How to Avoid a Tax Lien
The best way to avoid a federal tax lien is to be a good taxpayer: File all your taxes in full and on time, as the IRS recommends. “If you can’t file or pay on time, don’t ignore the letters or correspondence you get from the IRS,” the bureau advises. There are payment options available to help you settle your tax debt on time. If you have questions regarding a tax lien, it may be worth it to speak with an IRS representative by phone or to contact a centralized lien operation, among other resources. The latter can help you handle basic and routine lien issues, such as verifying the payoff amount. You can find a number of resources on the IRS’ website, and you can visit Credit.com to learn more about handling old tax liens on your credit report.