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Bankruptcy: Before an Income Tax Lien

The Advantages of Filing Bankruptcy BEFORE You Get Hit with an Income Tax Lien

Adam M. Weiner Bankruptcy Layer, Attorney, Tax LienBankruptcy treats creditors with collateral much better than those without.  This is especially true if one of your creditors is the IRS or the Oregon Department of Revenue.  The difference is that with them YOU have some control about whether these taxing authorities have collateral or don’t.

Let’s start with some crucial information:

  • You can discharge (legally write off) some income tax debt, depending on a number of factors mostly related to how old the tax is.
  • What happens to a tax is affected by whether or not that tax is secured by a lien on your real estate or any other possessions.
  • The taxing authorities do NOT have an enforceable lien on your real estate or your possessions unless and until they take the formal step of filing a tax lien (which is called a “distraint warrant” by the Oregon Department of Revenue).
  • The taxing authority’s filing of a tax lien in the county real estate recording office creates a lien, in the amount of the unpaid income tax, on any real estate that you own in that county.  Similarly a lien is placed on all your personal property (anything that isn’t real estate) when the taxing authority files a tax lien at the Oregon Secretary of State’s office.
  • The IRS and Department of Revenue have procedures and practices about how old a tax debt has to be, and what other factors they will consider before filing a tax lien.  But ultimately they have discretion about when they will do so, and so for practical purposes it is very difficult to predict when they will file for a lien.
  • Property exemptions—which protect your homestead, most retirement funds, and certain other assets from your conventional creditors inside and outside of bankruptcy—do NOT apply to tax liens.  So, for example, a tax lien attaches to any equity you have in your home regardless of your homestead exemption, or to most retirement funds, even though they are usually exempt from collection by other creditors.
  • If you file a bankruptcy—either Chapter 7 or 13—BEFORE a tax lien is filed against you, the IRS and Department of Revenue are stopped from filing them, usually for as long as your bankruptcy case is active.
  • IF your bankruptcy case discharges the tax, the taxing authority cannot file a tax lien or distraint warrant AFTER the bankruptcy case is over.  But if the tax is NOT discharged in the bankruptcy case, then it can pursue the debt with its usual means, including filing a tax lien.
  • Bankruptcy can discharge debts but it can’t get rid of most liens on your home or possessions—except in rare cases that don’t apply to income taxes.

The upshot of all this is that if you have a tax debt that would have been discharged in bankruptcy, but the taxing authority files a tax lien before you file your bankruptcy case, that lien stays attached to your asset(s) AFTER your bankruptcy case is completed.  The IRS or Department of Revenue can then enforce its lien, possibly by foreclosing on your home or seizing your possessions.

If you have no equity at all in your home, or your possessions have essentially no marketable value, sometimes the taxing authority will voluntarily release its lien after the bankruptcy is over.  But it’s not required to and can just sit on it, for example to see if your home value will rise to create equity worth grabbing later.

How long can the IRS or state keep their lien? The statute of limitations for collection of debts owed to the IRS is 10 years, but can be extended by various events, including your filing of bankruptcy.  There is no statute of limitations at all for state taxes so the Oregon Department of Revenue can apparently chase your assets forever.

And all this can be avoided by simply filing the bankruptcy before the tax lien attaches.

So, in situations where you have an income tax debt that is dischargeable, filing the bankruptcy case BEFORE the taxing authority files a tax lien can make all the difference.  The difference can be between paying NOTHING on a tax debt because that debt is discharged in full, and paying ALL of that tax because the lien attached to equity in your home or in your retirement account. With this in mind, if you have any significant tax debt you should see an attorney about your bankruptcy options just as soon as possible.

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