It’s that time of the year again – tax season. If you were unable to pay taxes you owe in past years, you might run into trouble when you file this year. The Internal Revenue Service (IRS) might inflict penalties, late fees, and interest payments on what you owe from the past, on top of new taxes you might owe after filling your latest return.
If you continue not to pay your taxes in full, the government might solve the problem by imposing a tax lien on your property. A lien isn’t the same as a property seizure, but it’s still a serious matter. Here’s what you need to know about tax liens, and whether you’ll see a tax lien on a credit report.
What to Know About Tax Liens
A tax lien is a form of adverse, or involuntary, lien. An adverse lien describes one person or entity’s (the creditor) right to possess someone else’s (the debtor) property, until the debtor can pay off a debt he/she owes to the creditor. If the federal government places a tax lien on your property, the government will have possession of this property until you can pay off your tax debt. This means you cannot sell or discharge the property until you satisfy your debt. If you do choose to sell, money from the proceeds will go to the IRS to repay your debt. When you pay off your tax debt, the county will release the lien.
You will still have the right to use your property with a lien against it, but the government will technically hold the property and property rights. The government can place a tax lien on your wages, bank accounts, accounts receivable, vehicle, home, business, valuables, and other types of property. In Texas, the IRS (or any other party) can place a lien on your primary residence, but it cannot seize this type of property. Texas codes protect primary residence seizures. If the IRS places a tax lien on your homestead and you sell this property, you have six months to put the proceeds from the sale into a new primary residence. If you fail to do so by the deadline, the government can use the proceeds to satisfy your tax debt.
It can be very difficult to sell your property while there is a lien against it, as well as to refinance your home and qualify for loans. Tax liens automatically become part of public record, where potential creditors can see the lien and make loan decisions. Should you stop paying off your tax debt to the IRS while it has a lien on your property, the government can potentially possess, or seize, your property. Wage garnishment is an example of a creditor seizing property (your wages) as payment for a debt. Again, this is the case unless the lien is against your primary residence in Texas. Tax liens can attach to property you currently own as well as properties you might possess in the future.
How a Tax Lien Can Affect Your Life
As a taxpayer with a tax lien from the IRS or the local government, you could experience property losses outside of your control. The government might decide to seize your property as payment if you continue to fail to pay your back taxes. You might receive a notice of intent to seize, or the action might happen without warning. If your tax case went through the IRS’ automated collection system (ACS), the IRS might begin to seize your property without notice, as soon as a government agent gets your case at random from the pool.
You might discover that suddenly the IRS is taking a portion of your wages or collecting money from your bank accounts. Note that local governments are historically more likely to take actions such as wage garnishment compared to the IRS. The IRS generally moves slower to act against tax debtors. Some cases that go through the ACS can go for months or even years without contacting the debtor. This does not, however, mean you should ignore your unpaid taxes until you hear from the IRS. Acting to avoid tax liens in the first place can safeguard you from adverse consequences – including potential effects on your credit score.
About Your Credit Score
Your credit score is the three-digit number that sums up how likely you are to repay debts you owe. Your credit score can be a major contender in whether banks, lenders, and creditors approve you for loans, financing, and credit cards. Three main credit bureaus, Experian, Equifax, and TransUnion, create credit scores based on models such as FICO or VantageScore to come up with a number, typically between 300 (bad credit score) to 850 (excellent credit score). Bureaus base credit scores off many factors, including:
- Payment history
- How many years you’ve had credit
- Types of credit you hold
- Credit limits
- Percentage of your credit limit you’re using
- Total amount of debt
- Credit report inquiries
- Late payments
To creditors, unpaid debts are bad news. Creditors assess potential clients for their creditworthiness before deciding whether to take them on as new credit card holders, loan recipients, account holders, renters, etc. Since liens become part of public record, a creditor will have access to this information when you apply for something such as a home mortgage or vehicle financing. If a creditor sees that the government has placed a tax lien against you for failure to pay the taxes you owe, this could indicate that you’re a potential risk as a borrower. A lower credit score could also signify a risk.
Tax Liens and Credit Scores
The IRS or local government will never report a tax lien directly to credit bureaus. Instead, bureaus learn of this information through public record. If a credit report registers a tax lien, it can plummet your score by 100 points or more. It can take a great deal of time to pay off your tax debts and eventually improve your credit score. Even paid liens can stay on your credit score for up to seven years. You must petition the IRS to withdraw a lien once you finish paying your debt, at which time the lien will leave your credit report.
Tax liens can be red flags for creditors, but thanks to a 2017 credit bureau initiative, you might not see a tax lien on a credit report. Starting in July 2017, the three major credit bureaus started excluding unpaid tax debts, tax liens, and court judgments from credit score reports. The bureaus agreed to remove and exclude many types of liens and civil judgments – including tax liens – from consumer credit reports. Now taxpayers might not have to worry as much about tax liens hurting otherwise positive credit scores.
If your tax lien does not include your name, address, and Social Security number and/or date of birth, the tax bureau will leave the lien off your credit report. It will be as if the lien never happened in terms of your credit score. The new rule will cover both existing and new tax liens. If a tax lien still reaches your credit score, the impact can vary depending on your financial history. Paying what you owe in tax debt and petitioning the IRS for withdrawal is your best chance at removing a lien from your credit history. Otherwise, speak to a tax or financial professional about a tax lien on your credit report.