What’s the difference between a tax lien and a tax levy?

When dealing with unpaid taxes, understanding the potential consequences is crucial. The Internal Revenue Service (IRS) and other tax authorities have several enforcement tools at their disposal, with tax liens and tax levies being among the most severe. These terms are often used interchangeably, but they represent distinct processes with different implications for the taxpayer. Knowing the difference between a tax lien and a tax levy can help you better manage your tax obligations and protect your assets.

What Is a Tax Lien?

A tax lien is a legal claim by the government against your property when you fail to pay a tax debt. It acts as a public notice to creditors that the government has a right to your property because of unpaid taxes. A tax lien is a way for the IRS or state tax authority to secure its interest in your assets until the debt is resolved. The lien applies to all of your property, including your home, cars, financial accounts, and even future assets you might acquire.

How Does a Tax Lien Work?

When you have unpaid taxes, the IRS or other tax authority may file a tax lien to protect their ability to collect the debt. Here’s how the process works:

1. Assessment of Tax Debt: The tax authority determines that you owe taxes after either failing to pay your taxes or underreporting your income.
2. Notice and Demand for Payment: Before filing a lien, the IRS will send you a “Notice and Demand for Payment,” informing you of the amount owed and requesting immediate payment.
3. Failure to Pay: If you do not pay the tax debt by the due date, the IRS may file a lien to protect its interest.
4. Notice of Federal Tax Lien (NFTL): The IRS files a Notice of Federal Tax Lien with local authorities, notifying creditors and the public that the government has a legal claim against your property.
5. Lien Attachment: Once the lien is in place, it attaches to all your assets, including real estate, vehicles, financial accounts, and even intangible assets like patents.

Impact of a Tax Lien

A tax lien can have severe financial consequences, even though it doesn’t result in immediate asset seizure. Key impacts include:

• Credit Damage: While tax liens no longer appear on consumer credit reports, they can still impact your ability to get loans, mortgages, or other forms of credit since lenders often check public records.
• Difficulty Selling or Refinancing Property: A lien remains attached to your property, making it difficult to sell or refinance until the debt is paid or the lien is removed.
• Priority Over Other Creditors: In the event of bankruptcy or liquidation, the government’s lien takes priority over many other creditors, meaning the IRS is first in line to receive payment from your assets.

Types of Property Affected by a Tax Lien

A tax lien is comprehensive and affects various types of property:

• Real Property: Your home, land, or any other real estate you own.
• Personal Property: Vehicles, jewelry, equipment, and other valuable possessions.
• Financial Assets: Bank accounts, brokerage accounts, and other investments.
• Future Property: The lien also attaches to assets you acquire after the lien is filed, meaning any future income or property is also subject to the lien.

How to Remove a Tax Lien

Removing a tax lien is possible but requires taking specific steps:

1. Full Payment of Debt: The most straightforward way to remove a lien is to pay the full amount of your tax debt. Once paid, the IRS will release the lien within 30 days.
2. Lien Withdrawal: If the lien was filed in error or if it meets certain criteria, you can request a withdrawal. Unlike a lien release, a withdrawal removes the public record of the lien.
3. Discharge of Property: You can apply for a discharge of property, which removes the lien from a specific property, allowing you to sell or refinance it.
4. Subordination: Subordination doesn’t remove the lien but allows other creditors to move ahead of the IRS, which can make it easier to obtain a mortgage or loan.
5. Offer in Compromise: You may be able to settle your debt for less than the amount owed, leading to a release of the lien once the terms are satisfied.

What Is a Tax Levy?

A tax levy is the actual process by which the IRS or another tax authority seizes your property to satisfy a tax debt. While a lien is merely a claim on your property, a levy involves the legal taking of your assets to pay off the debt. This is a much more aggressive enforcement tool and typically comes after multiple warnings and failed attempts to collect payment.

How Does a Tax Levy Work?

A tax levy is usually the last step in the collection process and involves several stages:

1. Notice and Demand for Payment: Just like with a lien, the IRS sends a notice demanding payment of the tax debt.
2. Final Notice of Intent to Levy: If you do not pay the debt, the IRS will issue a “Final Notice of Intent to Levy and Notice of Your Right to a Hearing” at least 30 days before the levy action. This gives you a final opportunity to resolve the debt.
3. No Response or Resolution: If you do not respond, settle the debt, or arrange an alternative payment plan, the IRS will proceed with the levy.
4. Seizure of Assets: The IRS can then seize your assets, which may include bank accounts, wages, Social Security benefits, real estate, and personal property.

Types of Property That Can Be Levied

The IRS can levy a wide range of assets, depending on the nature and value of the debt:

• Bank Accounts: The IRS can freeze and take money from your bank accounts. Once frozen, you typically have 21 days before the funds are transferred to the IRS.
• Wage Garnishment: A wage levy directs your employer to send a portion of your paycheck to the IRS until the debt is paid off.
• Social Security Benefits: The IRS can take a portion of your Social Security benefits, although they are limited in the percentage they can claim.
• Real Property: Homes, land, and other real estate can be seized and sold to pay the debt.
• Personal Property: Vehicles, jewelry, and other valuables may be taken and sold at auction.
• Accounts Receivable: If you own a business, the IRS can seize payments owed to you by clients or customers.

How to Stop a Tax Levy

Stopping a tax levy is critical to avoid losing your property. Here are some strategies to prevent or stop a levy:

1. Pay the Debt in Full: The simplest way to avoid a levy is to pay the full amount owed.
2. Enter Into an Installment Agreement: You can negotiate a payment plan with the IRS. Once an agreement is in place, the levy is generally lifted.
3. File for an Offer in Compromise: If you qualify, you can settle your debt for less than the full amount, which can prevent or stop a levy.
4. Prove Financial Hardship: If you can demonstrate that the levy would cause significant financial hardship, the IRS may release the levy.
5. Request a Collection Due Process (CDP) Hearing: If you receive a Final Notice of Intent to Levy, you have 30 days to request a CDP hearing, which can delay the levy and provide an opportunity to negotiate.

What Happens if a Levy Is Enforced?

If the IRS successfully levies your property, the consequences can be severe:

• Immediate Financial Strain: A bank levy or wage garnishment can leave you with limited access to funds for basic living expenses.
• Loss of Property: Real estate and personal property may be sold at auction, often at prices below market value.
• Business Disruption: Levies on accounts receivable or business assets can severely impact your business operations.

Key Differences Between a Tax Lien and a Tax Levy

While both tax liens and levies are serious, they serve different purposes and have different impacts:

Nature of the Action:

• Tax Lien: A claim against your property that secures the government’s interest in your assets until the debt is paid.
• Tax Levy: The actual seizure and sale of your property to satisfy the debt.

Impact on Credit and Assets:

• Tax Lien: Primarily affects your creditworthiness and ability to sell or refinance property.
• Tax Levy: Directly impacts your cash flow and assets, leading to loss of property and income.

Timing and Process:

• Tax Lien: Filed early in the collection process as a way to secure the debt.
• Tax Levy: Enforced later in the process when other collection efforts have failed.

Property Involvement:

• Tax Lien: Affects all of your property, but doesn’t immediately take anything away.
• Tax Levy: Targets specific assets for immediate seizure and sale.

Resolution Options:

• Tax Lien: Can be removed through payment, discharge, subordination, or withdrawal.
• Tax Levy: Can be stopped by paying the debt, negotiating a payment plan, or proving financial hardship.

Conclusion

Understanding the difference between a tax lien and a tax levy is critical when managing unpaid taxes. A lien is a warning sign that the government is securing its interest in your property, while a levy is the actual enforcement action that can lead to losing your assets. If you find yourself facing either situation, it’s vital to take immediate action, whether that means settling the debt, negotiating with the IRS, or seeking professional assistance. By addressing the issue early, you can avoid the devastating financial and legal consequences that come with tax enforcement measures.