A federal tax lien affects not only your credit score but also your cash flow. So, preventing and dealing with a lien must be high priority.
In this article:
- Understand What an IRS Tax Lien Is
- What to Do When You Receive a Notice of Federal Tax Lien
- Steps to Preventing and Removing a Tax Lien
Best Practices to Prevent and Complete the Federal Tax Lien Process
Tax lien: it is a last resort legal claim by the government on a delinquent taxpayer’s properties and assets to ensure and secure payment after several warnings.
Understand What an IRS Tax Lien Is
The federal tax lien is how the IRS ensures a late taxpayer prioritizes paying off the debt. The IRS attaches the lien to all of the assets, not just to a specific property.
Generally, the IRS will not place a lien if the unpaid taxes amount to less than $10,000. However, if there is a bankruptcy proceeding, the IRS may join the legal proceeding. The IRS can still levy a lien even if the unpaid amount is lesser than $10,000.
For a more in-depth resource, head over to the IRS resource page about levies and liens.
There is a process for an IRS tax lien to start. First, the late taxpayer must receive five notices for collection from the IRS.
Once the taxpayer receives the five notices, the IRS can file the lien in your local courthouse. By doing so, the IRS makes the unpaid tax a public record and enforceable.
Getting the first notice of collection only reminds you of your future taxes. Of course, the notice informs you of possible late fees, like the failure to file and failure to pay penalties.
Also, note that the IRS also levies interest on the unpaid taxes on top of the fees. Usually, the interest is higher than most bank loans, as the rate is at 3% plus the federal short-term interest rate.
What to Do When You Receive a Notice of Federal Tax Lien
First off, you only get the Notice of Federal Tax Lien (NFTL) after five notices.
The most important issue is clarifying information. The next step should focus on paying the taxes.
A good practice is to call the IRS at 1-800-829-1040 to confirm your status. You may also ask for an extension for paying your taxes.
Sometimes, the mail can take up weeks to arrive, and in some cases even months. By asking about your status, the IRS can recognize your gesture as an intention to fulfill your obligation as an American citizen.
If you already received the Notice of Federal Tax Lien, then you need to plan how to pay the unpaid taxes as fast as possible.
Removing tax lien goes faster the earlier you pay off the taxes. A tax lien can take some time before the courts order its removal.
Usually, the tax lien by the IRS can take up to 30 days for removal. Liens can affect not only your finances and credit score but also your schedule, resources, and energy.
Steps to Preventing and Removing a Tax Lien
Preventing a federal tax lien is simpler than removing an IRS tax lien.
Steps 1 to 4 deal with how you can avoid a tax lien. Steps 5 to 7 deal with how to remove the said lien.
The best tax lien prevention is a healthy financial profile. Strategic tax relief planning can help mitigate the financial burden.
Having a punctual record of paying and filing taxes improves not only your financial planning but also lessens the risk of the IRS zooming in on you for an audit.
Step 1: Pay the Unpaid Taxes in Full or in Part
Pay the bills as early as you can. The fastest method is the IRS direct pay.
Do note, though, the IRS direct pay can only process at most two payments in a 24-hour cycle. Direct pay also does not have any attached fees.
For those who want the more traditional route of mailing, you can fill out the Form 1040 from the IRS.
Reporting your taxes as accurate and as early as possible is a great way to stay on top of your finances.
You do not need to pay the full amount if you cannot afford to. The important thing is to pay as much as possible at the earliest possible time.
Step 2: If Paying in Full or on Time Is Not Feasible, Structure a Payment Plan Agreement
There are two payment plans available for those who cannot pay a substantial part of their taxes on time.
The first plan requires the total payment of the total unpaid amount within 120 days.
The second plan allows the taxpayer to fulfill the unpaid taxes for an extended period. Payment period may differ depending on the case but is usually around 72 months.
The second plan also has 2 further processes. The payment plan can either be automatic or not.
Do note that the second payment plan is more expensive. There are setup fees, ranging from $31 to $149, due to the risks of default.
Step 3: Offer a Compromise or File for Financial Hardship
The IRS can accommodate people who are encountering financial hardships. However, before you file for an offer or for financial hardship status, make sure that you qualify.
A simple way to know if you qualify is to take the pre-qualifying quiz from the IRS offer in compromise page online.
The IRS looks at four factors to decide if a taxpayer qualifies for a compromise or for financial hardship status.
These four factors are the ability to pay, expenses, asset equity, and income.
A compromise usually gives the taxpayer a lower tax amount to pay. On the other hand, a financial hardship status can give a taxpayer both more time and a lower amount.
However, the IRS can still attach a federal tax lien, but this situation is not common.
Step 4: Avoid Unnecessary Late Fees
There are two main penalties levied by the IRS to late taxpayers. These are the failure to file penalty and the failure to pay.
Failure to file penalty levies 5% on the monthly unpaid taxes to penalize late taxpayers.
On the other hand, the failure to pay rate is at .5% of unpaid taxes.
It is better just to file your taxes early, even if you are struggling financially. Doing so will lessen the financial impact any penalty might cause.
Lowering the unpaid taxes and fees lessens the risk of the IRS attaching a tax lien on all your properties.
Step 5: If a Tax Lien Is Unavoidable, Prioritize Paying off the Debt
The long-term payment plan from the IRS can take quite some time. The IRS has 72 months or 6 years of monthly payments.
You can ask the IRS to recalculate and change the payment plan. However, the IRS qualifies late taxpayers on a case-to-case basis.
The short-term payment plan is 120 days, and there is no minimum payout amount. As long as you settle the debt within 120 days, then the IRS sees no problem.
Also remember that the IRS still levies interest on the unpaid taxes, which increases the unpaid amount. The lesser the unpaid amount, the lower the taxes.
Step 6: Get a Tax Lien Investor to Help
Sometimes, you just have to let your creative juices flow to reach your goals. Rather than have a federal tax lien, have a private investor loan you money with a property as collateral.
By going the private route, your credit score may not change as the IRS will not attach a lien. Removing a tax lien from credit report reflects negatively on you.
You can use this to your advantage by showing your credit trustworthiness. If you are on time and the creditor is an institution, your credit score may even go up.
Having your property as collateral is better than an IRS lien. Having debt to a bank and paying it off increases your credit score while owing the IRS can decrease it.
Step 7: Once the Debt Is Fully Settled, Fill out the IRS Lien Release Form
Form 12277 is what you fill out to remove a tax lien from your records.
Of course, you can use this form only if you have satisfied the whole unpaid debt from the IRS. Again, the IRS can take around 30 days for the removal of the tax lien.
A credit score also changes whenever entities report your credit transactions. Due to the logistics of how information moves from the government to the banks, it may take some time before your credit score updates.
Dealing with a federal tax lien is simple but can prove difficult. Theoretically, all you need to do to prevent a tax lien is to pay on time.
However, a tragedy or unaccounted expense can change your finances overnight. By dealing with this issue through the steps listed above, you can avoid or deal with federal taxes efficiently.
Do you have other useful tips on how to deal with and avoid federal tax liens? What are your experiences not just with federal tax liens, but with liens in general? Let us discuss in the comments section below!