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Dealing with a Recorded Income Tax Lien and Preventing Future Ones

Chapter 7 sometimes doesn’t give much help with tax liens. But Chapter 13 hugely helps with tax liens already recorded, and stops new liens.


Today we cover the 5th of the 10 ways that Chapter 13 helps you keep your home, which we listed in a recent blog post. Here’s how we had introduced this one:

5. Protection from Both Previously Recorded and Future Income Tax Liens

Chapter 7 usually does nothing to address income tax liens that have already been recorded on your home. It also doesn’t prevent future tax liens on income taxes you continue to owe after the bankruptcy case is completed. In contrast, Chapter 13 provides an efficient and effective procedure for valuing, paying off, and securing release of tax liens. Plus, the IRS/state cannot record a tax lien on income taxes during the years while the Chapter 13 case is active.

Let’s show how this works in practice.

The Example

Assume that you own a home worth $215,000 with a mortgage loan balance of $210,000. The home value has been increasing modestly each year.

You tried to start a business at the beginning of 2012 which you couldn’t really get off the ground so you closed it down at the end of 2013. You worked part-time during those two years to have some income, and the business made some money. But the combined income was not nearly enough. As a result you didn’t have the money to pay estimated self-employment or withholding income taxes during those two years. And before, during and after that two-year period you racked up a bunch of credit card and other debt.

As a result you owe $8,000 in income taxes to the IRS for 2012 and $6,000 for 2013. You’ve filed all tax returns on time, don’t owe anything for 2014 and 2015, nor expect to for 2016. Your credit card and other non-mortgage debts now total $68,000.

You just received a notice that the IRS recorded a tax lien against your home on the $8,000 2012 tax debt. You are strapped, have used up all sources of credit and have fallen behind on some credit card payments. You can’t afford to pay anything to the IRS, and don’t know what to do.

Chapter 7 “Straight Bankruptcy” Not Sufficiently Helpful

At first it looks like a Chapter 7 case would solve many of your financial problems. The question is whether it would solve them adequately.

A Chapter 7 case would likely forever “discharge”—legally write off—all or most of the $68,000 in credit card and other miscellaneous debts. That would no doubt free up a fair amount of cash flow.

The 2012 income tax debt would have met the conditions for discharge (essentially, more than 2 years since the tax return was filed and more than 3 years since that tax return was due). But the new tax lien now recorded against and attached to your home would survive a Chapter 7 bankruptcy.

That means that the IRS can still force you to pay that $8,000 tax debt by sitting on the tax lien and maybe threatening to foreclose on your home. There’s currently only $5,000 in equity in the home ($215,000 value minus $210,000 mortgage), less than the amount of the tax lien. But that equity will likely increase as the home’s value increases and you pay down the mortgage. You will eventually have to pay the tax. In the meantime the tax lien will continue significantly hurting your credit.

On top of that, the $5,000 tax debt for 2013 would not yet meet the conditions for discharge. It’s not yet been 3 years since its April 2014 tax return due date. So you would continue owing that entire $5,000 tax debt. Plus the interest and penalties would just keep accruing. Then just as soon as your Chapter 7 case is completed the IRS would be able to use all of its usual collection powers. That includes recording a tax lien on this 2013 tax debt as well.

So a few month after your Chapter 7 case would be finished you would likely have two tax liens of $8,000 and $5,000 on your home, and have to figure out how to pay them off.

Chapter 13 Often Much Better

As we stated at the beginning, “Chapter 13 provides an efficient and effective procedure for valuing, paying off, and securing release of tax liens.” Here’s how that works.

In the example provided, you and your bankruptcy lawywer would propose a Chapter 13 payment plan that treats the 2012 tax debt as partially secured against your home and partially not secured. That $8,000 tax debt is secured to the extent of $5,000 (again, the $215,000 value minus $210,000 mortgage). The remaining $3,000 of that $8,000 would be declared by the court to be unsecured. That portion would be paid if, and only to the extent, that there was any leftover money to pay it during the course of the Chapter 13 case.

As for the $5,000 in 2013 income taxes, your Chapter 13 payment plan would have to earmark enough to pay that in full as an unsecured “priority” debt. But the interest and penalties would stop accruing, effectively reducing the amount that you’d have to pay. And you’d have a great deal of flexibility when and how it was paid. The payments would be based on your budget and worked around other important debts. And, in contrast to Chapter 7, and very importantly, the IRS would not be able to record a tax lien against your home during the course of your case.

At the successful completion of your case you would have paid off the secured port of the 2012 tax. And so that tax lien would be released. Whatever portion of the unsecured part of that tax would not have been paid would be discharged, along with any unpaid portion of the other $68,000 in debts. The 2013 priority debt would be paid in full. You’d owe no taxes. And other than the mortgage, you’d be altogether debt-free.


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