What You Need to Know About Tax Liens and Bankruptcy

In bankruptcy court, the IRS is a creditor like any other, with a few key differences that make it a bit more difficult to wipe out tax debts compared to the debts of credit card companies and other unsecured creditors.  Tax debt is, at first, unsecured, meaning that the IRS cannot yet seize your assets to pay down your debt. But a major difference between the IRS and other creditors is that the IRS does not have to sue you to file a Notice of Federal Tax Lien (NFTL) in your home county.  A Federal Tax Lien is a lien on ALL your property, not just your real property. This means the IRS can potentially seize any asset you have and sell it to satisfy your back taxes.

Fortunately, bankruptcy will wipe out income taxes where 1) the return was due at least three years ago, 2) that were assessed more than 240 days ago, 3) where the tax return was filed more than two years ago, 4) and where there was no determination that fraud or willful evasion occurred.

If your income taxes can be discharged, the IRS cannot come after you personally for the debt; however, if they have filed a tax lien, they can come after any property the lien attached to pre-petition.

Chapter 7 and Federal Tax Liens

Chapter 7 will wipe out a debtor’s personal tax liability if they meet the qualifying conditions. But tax liens survive bankruptcy, and they survive as an attachment to the debtor’s equity in property he had prior to filing bankruptcy.  This means that if the debt is discharged, the IRS cannot garnish your wages after bankruptcy, but they can seize your house if it had significant equity prior to filing.

The good news is that the IRS lien does not attach to property you acquire after bankruptcy, and any equity you gain in your house or vehicles post-bankruptcy is not subject to the tax lien either.  You have three choices to treat a tax lien after receiving a Chapter 7 discharge.

1. file a Chapter 13 immediately after receiving your Chapter 7 discharge (sometimes called a “Chapter 20”) and pay the lien off over a 3 to 5 year period of time.

2. negotiate a settlement with the IRS to pay off the value of the tax lien as it existed pre-petition.  For example, if you had $25,000 in equity in your house before filing bankruptcy, the IRS tax lien will attach to that equity after receiving your discharge. You can contact the IRS and offer to pay them the full or partial amount to release the tax lien.

3. do nothing and hope that the IRS never enforces its lien.

Chapter 13 and Federal Tax Liens

If the IRS has not recorded its tax lien before you file Chapter 13, they cannot file one during the 3 to 5 year period of your Chapter 13 case. This is the reason why its always best to get in front of your problems by filing a Chapter 13 before the IRS files its tax lien.  If the IRS has already filed its tax lien before you file a Chapter 13, you will be required to pay off that lien as a secured claim over the life of your plan.

But the good news is that you will only be required to pay off the tax lien to the extent it attaches to your pre-petition assets. The IRS effectively crams down its own debt for you by filing a proof of claim as “secured” to match the value of your assets in your bankruptcy schedules, without consideration for any exemptions taken.

For instance, if you list $20,000 worth of assets on your bankruptcy schedules and you owe $50,000 of dischargeable tax debts to the IRS secured by a tax lien, the IRS will file a proof of claim listing $20,000 as secured and $30,000 as unsecured.  You will have to pay off the entire $20,000 portion of the secured tax claim, but the remaining $30,000 will simply be lumped into the general unsecured creditors’ pool and paid whatever is left over from your plan payments.  Anything not paid at the end of the plan is wiped out, just like other creditors’ claims.

You may be aware that you are allowed to shield certain assets from the reach of creditors and the trustee by taking exemptions in that property. For example, under Georgia’s exemption statute, you can exempt up to $21,500.00 in the value of your home.  But unlike a judicial lien, you CANNOT avoid an IRS tax lien. This means that you will have to pay the IRS the full value of your assets without consideration for any exemptions you can take against other creditors.

Chapter 13 is still one of the best ways to treat a secured tax lien. And if you have a steady income, significant assets, and the tax lien is present before you file bankruptcy, Chapter 13 offers significant advantages over a Chapter 7.