This article has been reviewed by tax expert Erica Gellerman, CPA.
What Is a Tax Lien?
A tax lien is a government’s legal claim to your property after you’ve failed to pay taxes. Should the government enforce the lien, they can seize your real estate, financial accounts, or other property that you own. Tax liens can be levied against an individual’s personal assets or against a company’s assets.
If you’re like most Americans, then you probably shudder at the thought of receiving any type of notice from the Internal Revenue Service (IRS) or other tax authority. If you’re responsible for your business’s accounting, facing a tax lien may make you fear losing your business.
The IRS (or a state or local tax agency) can file a tax lien against you for failure to pay personal taxes or against your company for failure to pay small business taxes. Fortunately, people are usually able to resolve tax liens by paying back the overdue amount or going on a payment plan. Tax liens rarely turn into a matter of criminal prosecution.
If you’re concerned about having a tax lien and its consequences, it might help to understand more about what it actually is and how it could affect your business operations. We’ll also show you how to have the lien removed and get back on track.
How a Tax Lien Works
With small business tax rates being pretty high across the U.S., many entrepreneurs aren’t prepared pay their tax bill. A tax lien is the government’s legal claim against your property when you fail to pay taxes. They can enforce the lien and seize your property to satisfy the unpaid debt.
Here are the steps involved in the government’s issuance of a lien:
- Notice and Demand for Payment – When your taxes become overdue, the IRS will first send you a Notice and Demand for Payment outlining the amount of money that you owe. This amount will include any penalties and interest that the IRS assessed on the original amount.
- Explore Payment Arrangements – The taxpayer can explore different options to pay the debt, such as installment payments or a settlement.
- Notice of Tax Lien – The IRS will automatically file a tax lien against you, called a Notice of Federal Tax Lien, if they don’t receive payment within 10 days after they send the Notice and Demand for Payment.
- Notice of Levy – Should the tax continue to go unpaid, the IRS can levy (seize) assets, such as your wages, bank accounts, retirement income, real estate, and more. They might also offset a pending or future tax refund to satisfy the debt.
The steps might be a little different if a local or state tax agency files a lien, rather than the IRS. But the end result is that the tax agency has rights to your property that take precedence over that of any other creditor.
Photo credit: IRS.gov
Tax Liens Can Be Filed Against Personal or Business Assets
The government can file a tax lien against your personal or business assets, depending on how you’ve structured your business and what types of taxes remain unpaid. If you are a sole proprietor or a general partner in a partnership, then the IRS will file a lien against your personal property. This applies to your car, retirement accounts, social security benefits, and other personal assets.
If you have a registered business entity, such as a corporation or limited liability company (LLC), then the government is limited to filing a lien against your company’s assets. The lien covers physical assets such as inventory and supplies, as well as intangible assets such as intellectual property.
How Tax Liens Affect You and Your Business
Prior to April 16, 2018, an unpaid tax lien would appear on your personal credit report for up to 10 years. Liens would show up on your report for up to seven years, even after you paid off the debt. Fortunately, tax liens no longer appear on personal credit reports. However, having a tax lien can still have a negative impact on your finances.
A business tax lien can show up on your business credit report and affect your business credit score. Not to mention, tax liens are part of the public record. When you apply for business financing or for trade credit with a new vendor, they can look up your business in public lien records, which are available through a county clerk or recorder’s office. If a lender sees that you have an existing tax lien, they’re much less likely to extend you a business loan until you’ve paid off the tax debt.
Photo credit: IRS.gov
How to Minimize the Effect of a Tax Lien
To minimize the effect of a tax lien, you should use all the tools and options available at your disposal. The IRS has several options that make it easier for people to pay their overdue taxes and get past a tax lien:
- Installment Agreement – You can sign up online or by phone to pay your debt in monthly installments. There’s a user fee for an installment agreement. The fee is lower for direct debit agreements, in which payments are automatically deducted from your bank account each month.
- Offer in Compromise – If you can’t afford to pay your entire tax debt, you can offer to settle your debt with the IRS for a percentage of what’s owed. The IRS will consider your offer based on your income and tax return history.
- Delay Collection – If you need more time to pay your debt, you can ask the IRS to delay filing a lien by showing proof of your financial status. However, interest and penalties will continue to accrue until you can pay back your debt.
Remember, even if you can’t pay the full tax debt, you should send in as much as you can afford. The earlier you send your payment, the lower the penalties and interest will be.
As a business owner, you also want to be proactive at the first sign of financial trouble. If you think you’ll come up short at tax time, try to trim operating expenses now. This might be difficult, but your actions could save you thousands of dollars in IRS penalties and fees down the line.
Could My Tax Lien Be Cause for Criminal Prosecution?
A tax lien does not spontaneously transform into a crime. According to Allie Petrova, the managing partner of Petrova Law, “For a civil federal tax matter to go criminal, the IRS must refer the case internally—to its Criminal Investigation division.” Only if the IRS believes a business owner intentionally evaded taxes through fraudulent activities, the criminal investigation begins.
A person or business can face criminal prosecution only if the IRS can prove, beyond a reasonable doubt, that failure to pay or file tax returns was the result of a deliberate act to violate the IRS tax code.
Examples of fraudulent activity include:
- Filing false tax returns
- Hiding income
- Falsifying deductions
- Operating with cash and not reporting the receipts
- Creating fake invoices to create bogus deductions
In order for the IRS to prove that you’ve committed a tax crime, they’ll have to prove that you knowingly attempted to defraud them. Though many businesses are familiar with the rules around good tax practices, some may be engaging in these practices unintentionally.
Though intention is the delineator here, it’s best to correct any practices that could be mistaken for criminal intent down the line.
How to Have a Tax Lien Removed
There are four main options to have a tax lien removed:
- Full Removal – The easiest way to rid your business of a tax lien is to pay your tax obligation in full. The IRS will remove the lien within 30 days after you’ve made the payment.
- Withdrawal – In this case, you’re still liable for the amount of taxes that are due, but the IRS removes the Notice of Lien from the public record.
- Subordination – Subordination doesn’t release the lien, but gives other creditors preference to your assets ahead of the IRS. This might make it easier for you to get financing.
- Discharge – If you paid some of your outstanding debt, the IRS might remove the tax lien from a specific piece of property. This makes it easier to get other types of financing.
If there’s a lien against your assets, the best practice is to be in regular communication with the IRS. Even if you don’t have the money that you owe right now, the IRS has options to help you handle your tax issues and remove your lien.
The key to smartly addressing a tax lien is to remain responsive and communicate with the IRS regularly. One of the biggest mistakes that small business owners make is ignoring IRS notices or not responding to calls from IRS representatives.
The sooner you respond, the more likely the government is to work with you on paying back your overdue debt. If your case ever ends up in court, you’ll want to retain a tax attorney. Before that, work with a certified public accountant or other tax expert to get further help on your business tax lien.
- IRS.gov. “Topic No. 201 The Collection Process“