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How Bankruptcy Handles . . . a Recorded Income Tax Lien that Is Partially Secured by Your Assets

A tax lien may attach to something you own, worth less than the amount of the tax you owe. How can you get rid of that tax lien?


Our last 2 blog posts discussed what happens if the IRS or state tax entity records a tax lien before you file bankruptcy. First, if that tax lien attaches to nothing of value—such as a home without any equity—bankruptcy provides a way to get that lien released. Second, if a tax lien attaches to something worth more than the tax that the lien is enforcing, bankruptcy provides a way to protect what you own, pay off the tax, and then get the lien released.

But what if whatever you own that the tax lien attaches to is worth less than the tax debt at issue? In our two earlier examples the tax debt was either fully unsecured in spite of the tax lien or fully secured because of the tax lien. But what if the tax debt is partially secured and partially unsecured?

A Tax Lien Usually Gives the IRS/State Tremendous Leverage

For a host of reasons a tax lien can be very dangerous. It’s terrible on your credit record. Even worse, as a matter of public record anybody can find out that you haven’t paid your taxes, and how much you owe. The tax lien can prevent you for selling or refinancing whatever the lien attaches to, such as your home or vehicle, unless you pay all the sale or refinance proceeds to the tax owed. And tax liens can lead to the IRS/state seizing, selling, and paying itself out of the proceeds of the sale of your assets.

The Special Problems of a Partially Secured Tax Debt

Since a recorded tax lien gives the IRS/state so much leverage against you, it tries to exploit that leverage even if the assets that the lien attaches to are not worth as much as the tax.

For example, assume you have a home with little equity—say, only about $5,000—against a tax debt of $20,000. The IRS/state wants the $20,000 tax paid, and will be reluctant to release its tax lien without being paid in full, or at least paid as much as it can force out of you. The IRS/state could challenge and disrupt a sale of the home on grounds that the home is not being sold for enough money, resulting in less money for it.

A Partially Secured Tax Debt in a Chapter 7 Case

A Chapter 7 “straight bankruptcy” often does not help you much in defeating the leverage of a tax lien.

Even if the tax debt otherwise meets the conditions for being “discharged”—legally written-off—the tax lien survives a Chapter 7 bankruptcy. As a result the IRS/state will use that tax lien to get paid as much as it can. It will likely drive a hard bargain, trying to get more than the value of whatever the lien attaches to.

In the above example, the tax authority would try to make you pay more than $5,000 to get a release of the lien on your home, even if that is the amount of equity in your home. The IRS/state knows that the property’s value may increase, potentially giving it more money. So time is mostly on its side.

The tax authority also recognizes that you probably have intangible reasons—such as the desire to improve your credit record, or the intent to sell or refinance the asset at issue—for getting rid of the tax lien, driving you to be willing to pay a premium to get it done.

The problem is that Chapter 7 does not provide a way to determine the value of and pay off a tax lien, particularly one which attaches to assets worth less that the tax. So the IRS/state can often exploit this ambiguity to extract more from you in return for releasing the tax lien.

A Partially Secured Tax Debt in a Chapter 13 Case

In contrast, the Chapter 13 “adjustment of debts” includes within its arsenal a mechanism for determining the precise value of an IRS/state tax lien, and arranges for that value to be paid (and no more), and for the tax lien to be released. This mechanism takes away much of the leverage of the IRS/state, because the issues are reduced to the black-and-white tangibles: the value (or equity) of whatever the tax lien attaches determines the value of the lien.

If you have a tax that meets the conditions for discharge but has a recorded tax lien, the portion of the tax that is covered by the value of whatever the lien attaches to is considered secured and has to be paid. But the rest of the tax is “general unsecured” and only has to be paid to the extent (if at all) that you have money left over after paying legally more important debts in full.

To use the above example of a $20,000 tax debt and a tax lien against a house with only $5,000 of equity, under Chapter 13 $5,000 of that $20,000 would be considered secured and the rest unsecured. That $5,000 would have to be paid, but the remaining $15,000 would not have to be except to the extent that there would be money to spare for that. The $5,000 could be paid over the length of a 3-to-5-year payment plan, under very flexible payment terms, and while under protection from the IRS/state. Then at the end of the Chapter 13 case, the rest of the tax would be discharged and the tax lien released.


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