The obligation to pay Personal Income Tax Debt can be “discharged” or wiped away in bankruptcy. Many people use bankruptcy to do this and it actually works if the tax debt meets certain “criteria”. My Office has used this legal method many times to help our clients get rid of millions in tax debt obligations.
One of the first questions I ask a client when I think Bankruptcy may make sense is whether they own Real Property and whether that property has any equity. If so, the second question we must answer is whether the IRS has filed a tax lien in the County where the property sits.
We ask these questions because when you file for bankruptcy and the underlying debt obligation is discharged, the story doesn't end if you own a home with equity and there is a properly filed tax lien.
The reason is that even though the tax debt obligation may have been terminated, the Lien has made the debt “In Rem” (Latin for “against the property”)
The tax lien is still attached to the property's equity and the IRS can use the lien to enforce the debt…at least in theory.
An example to help make this clear:
Jim and Nancy owe the IRS income tax debt in the amount of $130,000.00. The tax debt meets the criteria for “discharge” and Jim and Nancy otherwise meet the requirements to file a chapter 7 Bankruptcy. The home they own has $100,000.00 in equity i.e. it is worth $200,000.00 and they owe the bank $100,000.00.
One year before they decide to file the Bankruptcy Case the IRS recorded a “Notice of Lien” in the County in which Jim and Nancy live.
They file the Bankruptcy case anyway. At the end of the case, the obligation to the IRS is wiped away… Jim and Nancy don't owe the IRS anymore. 6 months later they try and sell the home. The title agency informs them that when the home is sold they will need to pay the IRS the $100,000.00 equity leftover after the mortgage is paid.
Filing for bankruptcy may not have made much sense in the above scenario. Underlying debt obligation is gone, but the home and the IRS are still attached at the hip for almost the entire amount of the debt.
What if Jim and Nancy's Mortgage were the same amount as the Home's value when they filed for bankruptcy? In other words what if the dischargeable tax debt were $100,000.00 and the equity in the home were $0.00.
Would filing make more sense?
Yes, the Lien is worthless. On the date of filing there was no equity in the home, so even though the lien survives the Bankruptcy case, it isn't worth anything. If the IRS tried to use the Lien to collect the debt it would end up with nothing. They couldn't do it as a result. In this scenario, the IRS will typically agree to remove the lien, as it is not collectible.
If you have assets with value, a large tax debt and are considering bankruptcy, get some help to determine whether you should be concerned about a tax lien.