When the IRS is owed more than $10,000.00, it will record a notice of federal tax lien in the County in which you or your real property are situated. It will do this unless you've arranged a streamlined installment agreement, or you file a bankruptcy case before the recording occurs.
The recorded document puts the world on notice that the IRS has a lien on your stuff and makes it impossible to sell your home without obtaining the Government's “permission”.
We've reviewed IRS liens and the options that exist to deal with them several times inside this blog. Start here to read more about how liens are dealt with outside of bankruptcy.
When a bankruptcy case is filed, and the Filer has equity in a home and/or other substantial assets, another layer of complexity is added to the mix. There are 3 problems IRS liens create if a bankruptcy case is filed after the lien notice has been recorded
IRS LIENS POST-DISCHARGE – CHAPTER 7
If the IRS has recorded it's lien prior to filing the chapter 7 bankruptcy case, and the underlying obligation to pay the debt is removed, the lien itself isn't removed. Bankruptcy exemption laws don't apply to IRS Liens.
If the bankruptcy filer has equity in a home or other assets that were subject to the lien prior to the bankruptcy filing, those same assets will be subject to the lien after the bankruptcy case is over.
In certain situations this isn't a terrible thing. Where the equity value in the assets is low, the IRS will sometimes just release the lien or agree to release the lien just because you asked. Sometimes an amount offered that is less than the value of the asset(s) is paid in exchange for a release.
Even when the equity is large, it will make sense in certain situations to file the chapter 7. As an example:
Mr. F owed the IRS $250,000.00 and his home had an equity value of $75,000.00 at the time of filing. That equity was exempt in bankruptcy and safe from creditors, but not the IRS' lien. He also owed other creditors $50,000.00. He wasn't a great candidate for an offer in compromise but he did qualify to file a chapter 7 and was able to discharge his tax obligation and credit card debt. Post bankruptcy, the equity in the home had climbed to $85,000.00 making the lien more valuable. The IRS approached him and he agreed to pay them $50,000.00 in exchange for a release of the lien.
BANKRUPTCY TRUSTEE AND SECTION 724(b) OF THE BANKRUPTCY CODE – CHAPTER 7
I mentioned above that the exemption law that might protect home equity during a bankruptcy, doesn't protect that home's equity from a tax lien. This problem shows up post bankruptcy when the IRS tries to collect on the assets as described above.
That same lien however does something that would surprise most bankruptcy filers. It gives the Bankruptcy Trustee the ability to snatch the equity in the home under Bankruptcy Code Section 724(b).
The Bankruptcy Trustee rarely uses this power because it tends only to benefit the IRS and the IRS can collect it's own equity post bankruptcy.
What needs to be understood though, is that many people file bankruptcy to discharge IRS debt and they understand that the lien will survive. They're taking the calculated risk that the IRS won't try to collect the assets subject to the lien before the 10 year statute runs on collection post bankruptcy discharge.
Section 724(b) adds another layer of complexity to that decision, because the Trustee can use the lien to take the home, the filer has to assume the additional risk that the home equity may be grabbed before the bankruptcy case ever ends.
PAYING LIEN VALUE IN CHAPTER 13 BANKRUPTCY
A chapter 13 bankruptcy isn't a “liquidation” case like a chapter 7 bankruptcy. Nobody is taking anything in a chapter 13 unless you ask them to. The trade-off is that certain debts have to be paid over time to the Trustee for distribution to creditors in order to obtain a confirmed plan and an eventual discharge. Most secured debts have to paid to the Trustee through the plan.
If the IRS has recorded it's lien and you have equity in assets, the IRS is a secured creditor as well. In order to receive a confirmed plan and eventual discharge in the bankruptcy case, that lien's value as of the filing date, has to be paid to the IRS with interest during the plan period.
Despite the fact that this sounds awful, it's often the case that the overall situation lends itself to a chapter 13 filing. Chapter 13 Bankruptcy and it's potential value has to be viewed with the big picture in mind.
If you have a large IRS debt and assets that would normally be exempt or safe in bankruptcy AND the IRS debt would potentially be discharged in bankruptcy, you will want to file a bankruptcy before the IRS records it's lien notice if you were going to file a bankruptcy at all. This would remove all 3 of the above problems.
Talking to an attorney who is experienced in bankruptcy and IRS debt sooner rather than later is absolutely necessary.