Prevent Future Income Tax Liens

Bankruptcy can prevent future income tax lien recordings against your home. The result: paying nothing on the tax vs. paying it in full.

Income Tax Liens Are Dangerous

Our last two blog posts were about judgment liens. First was about how filing bankruptcy can sometimes remove, or “avoid,” a judgment lien from your home. Second was about preventing a judgment lien from hitting your home’s title in the first place.

Income tax liens have some similarities to judgment liens and some differences. An important difference is that there is no mechanism for removing a tax lien once it hits your home’s title. This is especially bad and impactful if the income tax debt at issue was one that bankruptcy could otherwise have written off (“discharged”) for you. The recording of the tax lien turns a debt that you could have written off and paid nothing on into a debt you usually have to pay in full.

So, as with judgment liens, it’s much better to prevent the recording of a tax lien by filing bankruptcy beforehand. It’s even more important because you can’t get them off your home’s title, under just about any circumstances. You usually have to pay the tax in full, instead of potentially paying nothing.

How Bankruptcy Stops a Tax Lien Recording

How could filing bankruptcy be so powerful that it stops the IRS/state from recording a tax lien on your home?

It’s the law. Federal law is crystal clear that filing bankruptcy stops and prevents “any act to create, perfect, or enforce any lien” against your property. Section 362(a)(4 and 5) of the U.S. Bankruptcy Code. The IRS and the state tax agencies do not dispute this. They cannot record a tax lien against your home or anything you own once you file bankruptcy.

How Long Does This Protection Last?

Under the right circumstances this prevention of a tax lien lasts forever. It’s permanent.

We referred above to income taxes that can be discharged—permanently written off—through bankruptcy. Some can, some can’t. Mostly it depends on how long it’s been since the relevant tax return was due, and was actually submitted. See our earlier blog titled “Bankruptcy Writes Off (Some) Income Taxes.”)

Assume for today that the tax that you’re worried a tax lien will be recorded on qualifies for discharge.

In that case your bankruptcy should in fact discharge that tax debt. So it will be legally gone after your bankruptcy case is finished. With the tax debt gone there is nothing upon which to record a tax lien.

The Huge Difference

Assume, for example, that you owe $10,000 for a couple years of income taxes to the IRS and your state. These taxes qualify for discharge (mostly by being old enough). Your home has a bit of equity but no more than is generally protected by the homestead exemption. Assume the IRS and state have not recorded any tax liens. If you file a consumer bankruptcy (Chapter 7 or Chapter 13) you would very likely no longer owe any of that $10,000 at the completion of your case.

However, now assume the IRS/state record tax liens on that $10,000 in income tax debt before you file bankruptcy. Those liens attach to the equity in your house. Filing bankruptcy does not affect those tax liens. There is no mechanism for removing the tax liens (as there is for qualifying judgment liens). The liens continue to encumber your title and eat into your equity. If you have less than $10,000 in equity the liens encumber your future equity. The IRS/state will almost for sure require you to pay off the lien in order to release it. They’ll get their $10,000 out of you. And they’ll do so simply because they recorded the tax liens before you filed your bankruptcy case.

Chapter 7 vs. Chapter 13

Which of these is better for you if owe income taxes and are trying to stop the recording of a tax lien? We’ll address this in our next blog post (to be posted early next week). If you need to talk with a bankruptcy lawyer before then about this or anything else, please call us.