The Extraordinary Tools of Bankruptcy: Taking the Bite Out of an Income Tax Lien

Bankruptcy can prevent a tax lien from being recorded. But even if one IS recorded before you file, Chapter 13 can particularly benefit you.             

Secured and Unsecured Debts

The power that a debt has over you turns a lot on whether or not that debt is secured by anything your own. For example, if a debt is secured by your vehicle or your home, that vehicle or home is collateral on that debt. In most situations you have to either pay the debt or you will lose the vehicle or home.

The Effect of an IRS or State Tax Lien

If you can’t pay an income tax, the resulting debt is an unsecured one. The IRS and state taxing authorities have various special collection techniques at their disposal, but they cannot summarily “repossess” anything of yours because the debt is not secured by anything.

That changes when a tax lien is recorded. That recording converts the unsecured tax debt into a debt secured by your property. Exactly which items of property becomes security on that particular tax debt depends on the details of your state’s property laws. But generally an IRS/state tax lien can turn everything you own into security on that tax debt. That means that if you don’t pay the tax, the IRS/state can take your property in payment of the tax debt.

Unsecured Older Income Tax Debts in Bankruptcy

Most unsecured debts can be legally discharged (forever written off) in bankruptcy.

Even many older unsecured income tax debts can be discharged. This can happen in a Chapter 7 “straight bankruptcy” within just 3 or 4 months after filing the case. And in a Chapter 13 “adjustment of debts” case these taxes are only paid if and to the extent you have money to spare to do so during the 3 to 5 year payment plan. Such debts often receiving little or nothing under Chapter 13.

But if an income tax lien was recorded on an older income tax debt, that debt is then (usually) immediately secured by everything you own. How bankruptcy deals with it then depends on whether you file a Chapter 7 or Chapter 13 case.

Today’s blog post is about older taxes—basically, income taxes for which the tax return was due more than 3 years before your bankruptcy case is filed and also the tax return was in fact filed more than 2 years before bankruptcy. The next blog post will be about newer taxes, those that don’t meet those 2 conditions, and how income tax liens on those taxes are handled under Chapter 7 and Chapter 13.

An Older Income Tax Debt with a Tax Lien Under Chapter 7

You can discharge an older income tax debt through Chapter 7, but the IRS/state would still have a lien on all your property after the bankruptcy case was completed.

You and your assets would be protected from the IRS/state during the course of the case, but that’s usually only for about 3 or 4 months. Just before the end of the case the tax debt itself would be discharged—written off—but the tax lien would survive.

So just as soon as that tax debt and most or all of your other debts were discharged and your Chapter 7 case completed, the IRS/state would be able to exert its rights under the lien to take and sell whatever property the lien applied to (usually all your personal property or real estate, or both). To prevent this, you would usually be able to negotiate with the IRS/state about the value of the equity you have in your property subject to the lien, and then arrange to pay that amount.

But throughout this negotiating process you are at a substantial negotiating disadvantage because you have the threat of seizure of your property hanging over your head. You may well end up paying more than the fair market value of your property, perhaps even the full amount of the discharged tax debt, just to get out from under the threat of seizure.

An Older Income Tax Debt with a Tax Lien Under Chapter 13

This situation is often much more to your advantage in a Chapter 13 case.

Instead of being at a negotiating disadvantage in fixing the value of the property covered by the tax lien because of the threat of seizure of your property, under Chapter 13 you are under continuous protection from such seizure throughout the time that this value is negotiated and paid. This protection from seizure negates this negotiating disadvantage.

And very importantly, instead of being largely at the IRS’s/state’s mercy under Chapter 13 you have a very convenient, fair, and independent forum—the bankruptcy court—for quickly settling the value of the lien. Instead of you paying whatever the IRS/state require to get them off your back, the burden effectively shifts to them to dispute whatever value you believe is fair and accurate.

Because of these differences, you can usually pay off a lien on an otherwise dischargeable tax debt for significantly less through a Chapter 13 case.

Related posts:

Tax Season: The Benefits of Filing a Chapter 13 Case Before the Recording of a Tax Lien Tax Season: The Benefits of Filing a Chapter 7 Case Before the Recording of a Tax Lien The Extraordinary Tools of Bankruptcy: Avoid Hurting Your Favorite Creditor The Extraordinary Tools of Bankruptcy: Avoid Hurting Your Favorite Creditor The Extraordinary Tools of Bankruptcy: Preventing Resumed Garnishments