What’s a tax lien — and what does it mean for your small business?
A tax lien can harm your personal and business finances, damage your business’s credit, and put your personal and business assets in jeopardy. A tax lien can have a financial impact comparable to declaring bankruptcy and lead to the government seizing and selling your property.
Tax liens stem from failure to pay business taxes in full and on time. The IRS issues about 1 million liens each year. If you’re at risk of failing to pay your business taxes, it’s important you understand your options.
We’ve gathered all of the information you need to know about tax liens and how they can affect your small business.
What is a tax lien?
A Notice of Federal Tax Lien is a public document filed by the Internal Revenue Service (IRS) that tells creditors and lenders that the government has put a lien on your property. The government files a lien when you’re overdue on taxes.
A lien means that the government has the first legal claim to your property, which it can seize and sell to pay off your tax debt. If you have an incorporated business or an LLC, the government can only file a lien on your business property. The business property the lien encompasses can be physical property like equipment, inventory, and buildings, but also intellectual property like patents, trademarks, and copyrights.
But for sole proprietors or business partners who are overdue on taxes, the government can also file a lien on personal assets. This can include your home, car, investments, and even property you acquire while the lien is in place.
The IRS only files a tax lien against you if you’ve failed to pay your business taxes in full and on time. Small business owners have a lot on their plates, so it’s understandable that you might miss a tax filing deadline or underestimate your tax bill. If this happens, you’ll receive a Notice and Demand for Payment from the IRS. At this point, you have 10 days to pay your tax debt in full, including any and all late penalties, interest, and fees. If you don’t pay, the IRS can file a tax lien against you.
Note: Like the IRS, state and local governments can also file tax liens if you don’t pay state or local taxes on time and in full.
The good news
Although it may not seem like there could be anything positive about tax liens, there is some good news.
The tax lien gives the government the right to seize your assets to pay off the tax debt, yes. But because the process of obtaining a court judgment to seize property and inventorying, evaluating, and auctioning your assets and accounts is a hassle for the IRS, they would probably much rather resolve the debt with direct payment.
Another piece of good news is that tax liens no longer appear on consumer credit reports. Starting in April of 2018 credit reporting bureaus stopped including tax lien data on consumer credit reports. That doesn’t mean that lenders and creditors can’t find out about your tax lien, but it does mean that a tax lien won’t harm your personal credit score. Your business credit score, however, can still take a hit if you have a tax lien.
One more thing working in your favor: When you do pay your business taxes, the government can easily remove the tax lien from your record. If you’re able to pay off your tax debt in full, the IRS will release the lien within 30 days of receiving payment.
The bad news
If you’re unable to pay off your tax debt in full, things get a bit more challenging.
The purpose of a tax lien is to guarantee that the government receives the taxes you owe before any other creditor or lender. The lien can hurt your chances of securing a business loan because every lender wants assurance they’ll get their money back. If the government already has a claim to your property, that puts other lenders at the back of the line.
A tax lien also severely impacts your business’s credit rating, similar to if you declared bankruptcy. As you can imagine, this makes it much more difficult for you to not only secure a business loan, but also to refinance an existing loan, sell your business, or even transfer any of your business assets.
To make matters worse, a tax lien against your business could even affect your spouse’s financial standing. While your tax lien will not directly damage your spouse’s credit rating, it can make it difficult for you to apply for credit together, as you might want to do if you were buying a home together, or the lien against your business might attach to property you and your spouse own together.
While this may all sound a bit bleak, if you do find yourself in the unfortunate situation of the federal government filing a tax lien against your business, there are steps you can take to handle the lien and get your finances back in order.
Your options for getting past a tax lien
There are three options for minimizing the effect of a federal tax lien:
1. Discharge of property
This option removes the lien from a specific piece of property. The IRS might discharge the lien on a certain piece of property as long as they have a lien on enough other property to satisfy the tax debt.
Removing the lien from a specific piece of property can make it easier to get an equipment loan, real estate loan, or other asset-backed loan. The situations that apply to discharge of property can be found on this IRS form.
This option doesn’t remove the lien, but allows other creditors or lenders to move ahead of the IRS in line to be paid, which can make it easier for you to secure a business loan.
The IRS will allow subordination in some cases to help you pay off the tax debt faster. For example, let’s say you have an expensive short-term loan that’s eating into your business’s cash flow. You might want to refinance the debt to a lower-interest-rate loan. Refinancing will allow you to pay off the tax debt more quickly. To learn more eligibility details, see this IRS form.
This option removes the public Notice of Federal Tax Lien and ensures other creditors that the IRS is not competing with them for your property. However, you still must pay the full amount of tax debt due. Withdrawing a tax lien basically treats the lien as if it never existed.
There are two primary situations where the IRS would withdraw a tax lien. Either the IRS must have filed the lien incorrectly to begin with, or you must be on an installment plan and owe less than $25,000 in taxes.
For eligibility, refer to this IRS form.
States and local governments will have their own procedures for removing a lien, so make sure you contact the appropriate tax agency to find out your options.
Avoiding a tax lien with a payment plan
As always, the best way to prevent the financial complications and stress that come along with a tax lien is to avoid one in the first place.
If you receive a Notice and Demand for Payment from the IRS, that means the government is just a few steps away from filing a tax lien against you. At this stage, you can avoid the tax lien by enrolling in a payment plan.
You might be able to work out an installment payment plan with the IRS if you can’t pay back the debt all at once. The government might even settle the debt for less than the amount you owe if you can prove you’re unable to pay the full amount (for example, because your revenue dropped, you were forced to close your business, etc.).
Paying taxes should be a business priority, no matter what
This may sound overly simplistic, but small business owners who juggle so much to keep their businesses going may sometimes need a reminder that federal, state, and local tax payments should always be at the top of the financial priority list.
Always pay close attention to notices from the IRS and your state or local tax board, and if you find yourself falling behind on tax payments, contact the government agency immediately to set up a payment plan to help get your business back on track.
Avalara Returns for Small Business provides an affordable option for smaller businesses to file returns quickly and accurately.
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