A tax lien fully encumbered by the equity in your home is dangerous. Chapter 13 may be your best option.
Today we finish a short series of blog posts on income tax liens recorded against your home. Last time we explained how to use Chapter 13 “adjustment of debts” to get the release of a tax lien when there is SOME equity in your home to secure the tax debt. The time before we got into what happens when there’s NO equity in your home to which the tax lien can attach. Today is about tax liens that secure the entire tax debt because the amount of home equity is enough to cover the ENTIRE tax.
To make better sense of this, here are three scenarios to illustrate the three above situations.
All of them involve a homeowner who owns a home worth $190,000 while owing an income tax debt of $20,000. Assume that this tax debt meets the conditions for “discharge”—legal write-off in bankruptcy. That usually just means that the tax return for that income tax debt was due more than 3 years ago and the tax return was submitted to the IRS/state more than 2 year ago.
- In the first scenario, assume that the mortgage(s) and any other prior liens (such as for property taxes) against this $190,000 home total $180,000. So the home has $10,000 in equity. If the IRS or state tax agency recorded a tax lien against the home on the $20,000 tax, that tax would be partially secured, to the extent of $10,000. See our last blog post for how best to deal with this partially secured situation.
- In the second scenario, assume that the mortgage(s) and any other prior liens against this $190,000 home total $195,000. Then of course the home has no equity at all. If a tax lien was then recorded on the $20,000 tax debt against the home, it has no home equity to which to attach. So in spite of the tax lien, the tax debt would still be effectively unsecured, at least unless and until equity built up on the home by an increase in its value or pay-down of the prior liens. See two blog posts ago about how best to deal with this completely unsecured situation.
- In the third scenario, assume that the mortgage(s) and any other prior liens for the $190,000 total only $170,000. Now when a tax lien is recorded against the $20,000 tax debt, there is enough equity in the house to cover that full amount. The tax lien makes the tax debt fully secured. This is what we cover now.
You Must Pay the Tax to Keep the Home
If your home has enough equity to cover the amount of the tax on which the tax lien is recorded, you have to pay the tax. With the recording of the tax lien, your home involuntarily became collateral on the tax debt.
This is true even if that tax would otherwise meets the conditions for being legally discharged—completely written off (by meeting the 2-year and 3-year conditions, and occasionally another condition or two, mentioned above).
A recorded income tax lien—similar to a home mortgage—continues in effect after your bankruptcy case. So if you want to keep the home, again you have to pay the tax.
Because of this drastic effect of a tax lien, as we emphasized in a blog post a week ago, if at all possible try to file bankruptcy before a tax lien is recorded. This is especially true if you qualify for discharge of the tax debt AND there is equity in your home that would be encumbered by a tax lien.
Chapter 7 “Straight Bankruptcy” Might Help
Filing Chapter 7 case my help by:
- discharging (writing-off) all or most of your other debts so that you could afford to make payments on the income tax debt until it was paid in full, including ongoing interest and penalties, and the tax lien was released from your home’s title.
- discharging other income taxes that qualify for discharge and don’t yet have a recorded tax lien
But That Often Doesn’t Work
In practice Chapter 7 often isn’t the best option because even after discharging your other debts, you may not qualify for or be able to afford to pay what the IRS/state requires in a monthly installment tax payoff plan.
This would especially be true if you have other special debts to pay that Chapter 7 does not discharge and would have to be paid as well. Examples are student loans and child support arrearage.
Or if you are behind on a vehicle loan, and/or the home’s mortgage, property taxes, or homeowner association dues, you would have to pay these to hang onto the vehicle and/or the home.
Other obligations like these would likely make it hard to make the required installment payments on the income tax secured against your home by the tax lien.
Chapter 13 Can Be Much Better
Filing a Chapter 13 “adjustment of debts” case can protects you from the tax debt and its tax lien as follows:
- The IRS/state is stopped from enforcing the tax lien through foreclosure of the lien, or any other collection methods. The protection that in a Chapter 7 case usually lasts only about 4 months, under Chapter 13 lasts throughout your 3-to-5-year payment plan.
- Your payments on the tax debt at issue can be delayed or reduced while you pay other even more time-pressing debts (such as child support, home mortgage, or vehicle arrearage mentioned above).
- If your circumstances change during your Chapter 13 payment plan, you can usually adjust your plan payments, including the payments being paid on the income tax debt. Instead of just hoping that the IRS/state would be willing to accept delayed or lower payments, Chapter 13 would very likely give you more flexibility and protection.
When you meet with your bankruptcy lawyer, together look very carefully into whether getting rid of your other debts through Chapter 7 would really free up enough of your cash flow so that you could enter into a reasonable monthly payment plan with the IRS/state.
If not, or if you have other special debts that need the other benefits that Chapter 13 provides, discuss with your attorney if that is the best way for you to go.