It's bad enough when borrowers can't pay off amounts owed to commercial creditors such as banks and other financial institutions. But people can find themselves in really hot water if they owe the IRS money.

What could happen? The IRS can establish a legal claim to a person's property, including a house or car, as security for payment of a tax debt. However, an IRS lien can only be filed after the following three steps have occurred:

How a Levy Compares With a Lien

A Notice of Levy is another method the IRS may use to collect taxes that are not paid voluntarily. This means the IRS can legally confiscate money or assets to satisfy a tax debt. This could include a person's wages, bank accounts, Social Security benefits, and retirement income. If a tax liability remains unpaid, the IRS may also levy assets such as a car, boat, or real estate.

In addition, when a person has an outstanding tax liability, any future federal tax refunds that are due will be taken to offset by the amount owed. Any state income tax refunds due may also be levied, and the proceeds applied to the liability.

The law requires the IRS to notify a taxpayer in writing not more than 5 business days after the filing of a lien. The IRS may give this notice in person, leave it at the taxpayer's home or usual place of business, or send it by certified or registered mail to the last known address.

1. The IRS assesses a tax liability.

2. The IRS notifies the person of the deficiency and sends a demand for payment stipulating the amount owed.

3. The person does not pay the debt within ten days of being notified.

Once these steps have been completed, a lien is created. By filing notice of the lien, the IRS effectively "warns" other creditors about its interest in the person's property. The notice is used by courts to prioritize claims in certain situations. The lien remains a matter of public record until the tax debt is paid off in full.

However a filed notice of tax lien might be withdrawn if:

  • The notice was filed too soon, or not according to IRS procedures.
  • The taxpayer entered into an installment agreement to pay the debt (unless the agreement provides otherwise).
  • The withdrawal will speed up collection of the tax.
  • The withdrawal would be in the taxpayer's best interest (as determined by the IRS Taxpayer Advocate), and in the best interest of the government.

Key point: Despite a common misconception, an IRS lien does not always take precedence over other creditor claims. Under the process known as "subordination," a federal tax lien can be made secondary to another lien. Your tax adviser can provide more details upon request.

Lesson to be learned: An IRS lien is a serious matter. Once filed, a person's credit rating is generally harmed. In one report, the U.S. General Accounting Office noted that it is crucial for the IRS to release liens in a timely fashion because:

  • Businesses may be unable to obtain necessary credit because lenders 
    may assume they are bad credit risks.
  • Individuals may miss an opportunity to buy a home or an automobile 
    because they are unable to obtain financing.
  • Individuals may be unable to sell their homes because of the presence 
    of tax liens on their properties.

Do not hesitate to obtain assistance from your tax attorney if you, or someone close to you, is in this kind of tax trouble.

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