IRS Tax Debt and Tax Liens

The Internal Revenue Service (IRS) has enhanced tools to collect income taxes from delinquent taxpayers. Federal law imposes a federal tax lien on all of a debtor taxpayer’s assets. The tax lien tax takes precedence over exemptions from execution that would protect assets from normal civil judgment creditors. Asset protection against the IRS’s collection of tax debt is very difficult.

How Does IRS Collection Work?

Tax law provides that the amount of any income taxes owed, plus interest and penalties, shall be a lien upon all the taxpayer’s property or rights to property. The federal tax lien continues until the tax liability is paid or until the expiration of the IRS’s maximum collection period, which is ten years from the date of the tax assessment.

A tax lien arises automatically upon the non-payment of tax liability after the IRS has sent the taxpayer a timely notice and demand for payment. The tax lien is retroactive to the date the IRS assesses tax liability even though the lien does not exist until after proper notice to the taxpayer with demand for payment.

IRS Tax Levy and Lien

Although the IRS has the legal right to apply a tax lient to all property, including a home, the IRS will not usually levy upon a taxpayer’s home.

The IRS does not typically levy upon income-producing assets such as business equipment or rental property to the extent the seizure would diminish the taxpayer’s ability to pay the tax debt.

An IRS lien does not defeat prior recorded security interests in the taxpayer’s property, such as a mortgage on real property. The IRS may file a Notice of Federal Tax Lien (“NFTL”) to perfect the lien against subsequent security interests filed by competing secured creditors. It is important to understand that the tax lien exists without the NFTL and attaches to the taxpayer’s property at the time the IRS assessed tax liability. It is already too late to transfer assets when the IRS reveals its tax lien through the NFTL.

The strength of the federal tax lien is its scope covering “property and rights to property.” Not only does the lien attach to property titled in whole or in part in the name of the taxpayer, but the tax lien enables the IRS to “step into the shoes” of the taxpayer and enforce any property rights the taxpayer may have under state law presently or in the future.

Tax liens supersede property exemptions created by state law. Here is a list of property subject to IRS tax liens but otherwise exempt from creditors under Florida law:

  • Homestead: a federal tax lien becomes a lien on a Florida homestead. The IRS will not foreclose the lien and force the sale of the taxpayer’s home, but the tax lien must be paid like any other mortgage lien if the taxpayer sells or refinances the house.
  • Salary and wages: the IRS can garnish 15% of a taxpayer’s otherwise exempt salary and wages on a continuous basis. This means that the IRS may get a continuous garnishment order against the salary and wages of a Florida taxpayer who is head of household even though these wages cannot be garnished by an ordinary judgment creditor in Florida.
  • IRA and retirement plans: the IRS has the right to levy upon a taxpayer’s IRA and 401k retirement plan. However, the revenue agent will not take this action without the written authorization of an IRS manager. The IRS can get no greater right to compel retirement distributions than the taxpayer has under the plan documents.
  • Social security: the IRS may garnish 15% of a taxpayer’s monthly social security check.
  • Tenants by entireties property: tenants by entireties assets are not exempt from IRS levy when spouses have not filed a joint return and only one of the spouses is liable for taxes. The spouse not liable for taxes may get funds released that they can prove they contributed individually to the joint account.
  • Disability benefits: the IRS may garnish disability payments otherwise exempt under Florida law.
  • Beneficial interest in a spendthrift trust: a trust set up by a third party for the benefit of a taxpayer is exempt from judgment creditors if the trust agreement contains a “spendthrift provision” that prohibits the beneficiary taxpayer from assigning their right to receive trust distributions. However, because tax liens apply to property rights as well as property title, the tax lien can be enforced against a taxpayer’s rights to receive trust distributions from a spendthrift trust. The lien attaches to a beneficiary’s present rights to distributions at some future time even though distributions may be contingent upon a future event. The IRS may levy upon the beneficiary’s trust interest and order the trustee to make all future distributions to the IRS instead of the taxpayer.
  • Discretionary trust: a taxpayer’s beneficial interest in a trust may be protected from IRS liens if trust distributions are entirely in the discretion of a third-party trustee. The trustee must have absolute and unconditional control over trust distributions to the taxpayer. If the taxpayer has any legal basis to compel a trustee to distribute money then the IRS could assert its tax lien against the beneficiary’s legal right and power to get trust money.

A taxpayer may carve out assets from the tax lien if the IRS levy would create an unreasonable hardship in the taxpayer or their family. Taxpayers can get hardship relief by contacting the IRS taxpayer advocate service.

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Does Bankruptcy Eliminate Taxes?

Bankruptcy will eliminate, or discharge, some types of tax debts. The Chapter 7 bankruptcy discharge rules are best understood as “negative rules.” Chapter 7 bankruptcy will eliminate tax debts eligible for bankruptcy discharge except the following:

  1. Taxes for which a tax return was due to be filed within three years (plus extensions) prior to the date of filing bankruptcy. For example, the tax return for 2014 income taxes was due to be filed on April 15, 2015, (plus any extensions) , and therefore, these income taxes cannot not be discharged by filing bankruptcy filed on or before April 15, 2018 (plus the time of extensions); OR
  2. Taxes assessed by the IRS within 240 days before the filing of bankruptcy. Assessment date is the date that tax liability is entered on IRS records; OR
  3. Taxes not yet assess but still assessable; OR
  4. Taxes for which a tax return was filed late and filed within two years prior to filing bankruptcy ( however, some courts have held that a late filed return prevents discharge of income tax);
  5. Taxes of a debtor who committed fraud related to a tax return or willfully attempted to evade or defeat taxes sought to be discharged.
  6. Substitute tax returns cannot be discharged- those returns the IRS files on behalf of the taxpayer

In other words, eligible tax debt that does not fail any of the above five tests may be wiped out in a Chapter 7 or a Chapter 13 bankruptcy. These taxes are “dischargeable.”

The income tax dischargeability test is different in Chapter 13 bankruptcy. A Chapter 13 bankruptcy a debtor can discharge:

  1. Taxes for which tax returns were filed late but within the two years preceding the bankruptcy, provided tax assessments have either not been made or have been made more than 240 days prior to the bankruptcy filing; AND
  2. Taxes related to fraudulent returns or taxes the debtor willfully attempted to evade or defeat.

If a bankruptcy debtor’s income taxes meet the requirements to be discharged, then any accumulated interest will also be subject to discharge.

Gideon Alper

About the Author

I’m an attorney who specializes in asset protection planning. I graduated with honors from Emory University Law School and have been practicing law for almost 15 years.

I have helped thousands of clients protect their assets from creditors. Before private practice, I represented the federal government while working for the IRS Office of Chief Counsel.