Under certain circumstances federal income taxes owed can be discharged in a Chapter 7 bankruptcy filing (see corresponding legal guide), however a federal tax lien that has been properly recorded by the IRS will survive the bankruptcy and is not discharged even if the underlying tax is discharged.
1. What is a Federal Tax Lien
To establish a lien, the IRS will file a Notice of Federal Tax Lien in the county the debtor or the debtor’s property resides, which acts as a security interest against the debtor’s pre-petition personal and real property. This effectively converts the IRS to a secured creditor, even if the tax debt itself could be discharged.
2. Consequences of Federal Tax Lien
A pre-petition federal tax lien can create a variety of consequences in relation to a bankruptcy filing. First, it would be beneficial to file a bankruptcy prior to perfection of the lien. However, the timing considerations for determining the dischargeability of the underlying tax must also be evaluated. If the tax is determined non dischargeable, the bankruptcy filing might not be the best option (depending on other circumstances). If the lien has already been filed, it will attach to all of the debtor’s pre-petition property, even if that property could otherwise be exempted in a bankruptcy filing. Thus, even if the personal liability to pay the tax is discharged, the lien will survive the bankruptcy and allow to IRS to collect the tax against the debtor’s pre-petition property post-bankruptcy.
3. Options to Resolve a Federal Tax Lien
1) Pay the lien in full; 2) Negotiate a payment plan to release the lien; 3) File Chapter 13 bankruptcy in order to pay the secured value of the lien over time; or 4) With nominal property, consider doing nothing and risk that the IRS will not collect against the lien, especially if the underlying personal liability to the tax was discharged in a Chapter 7 bankruptcy. Regardless, consulting an experienced bankruptcy attorney when dealing with the IRS is highly recommended due to the complex nature of tax debts in bankruptcy.