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Credit Scores and the Federal Tax Lien

Posted on Aug. 12, 2016

A recent article suggests that credit agencies are preparing to reduce the hit on a credit score that the notice of federal tax lien (NFTL) creates. You can find other articles here and here.   I have written about withdrawal of the notice of federal tax lien previously.

This is good news for taxpayers where the IRS has filed the notice of federal tax lien.  I do not know if the change will have much impact on the value of the lien to the IRS in bringing in revenue.  The change seems unlikely to impact revenue to the IRS and may simply represent a great consumer victory for taxpayers.  Another possible outcome is that because the NFTL no longer hurts taxpayers as much, the IRS may feel it can return to its preFresh Start days and file the NFTL at lower dollar levels.    I think that would be a mistake for reasons I discussed in an article several years ago and am not suggesting that the IRS contemplates doing that, but one of the reasons for pulling back on the number of lien filings, among many others, was the damage to taxpayer’s credit ratings and balance between that and the benefit to the IRS.

The issue that has long puzzled me regarding the NFTL and the credit reporting agencies concerns their willingness to boost a credit score when the taxpayer gets the lien withdrawn but not when the taxpayer gets the lien released.  The National Taxpayer Advocate has written on this subject several times (see here, here, and here), as have others (see here and here), and the NTA has worked hard to get the IRS to be more generous in withdrawing the NFTL.  Local taxpayer advocates regularly work with taxpayers to obtain lien withdrawals.  I understand why removing the notice of federal tax lien through withdrawal provides some boost to a taxpayer which could or should get reflected in their credit score but having the NFTL released provides a far more positive outcome to the taxpayer generally since it reflects the end of the federal tax lien.  Yet, credit agencies have not embraced the release as a trigger point for upgrading someone’s credit score.

Withdrawal of the NFTL simply removes the notice of the lien and the benefits to the IRS provided by defeating the four parties enumerated in IRC § 6323(a) but it does not eliminate the lien itself.  The taxpayer still owes the money.  The unfiled federal tax lien continues to attach to all of their property and rights to property.  The fact that the NFTL was on file still provides creditors notice that the taxpayer has outstanding tax debts and should make creditor wary.  The IRS can still levy or offset or file suit.  All withdrawal does is remove the debt from the public eye, but credit agencies embraced it as a reason for improving the taxpayer’s credit score.

Until lien withdrawal went into the Code 20 years ago, the IRS had no way to pull back an NFTL once it was filed.  There can be many good reasons to pull back the NFTL and the statute provides flexibility to the IRS to deal with those situations.  The withdrawal provision received more attention than I thought it deserved because of the credit reporting agencies decision to boost scores upon lien withdrawal.  That decision, which seems to make little sense, caused the National Taxpayer Advocate and others to push for lien withdrawals in many cases not contemplated by Congress when the withdrawal provision came into existence.  I applaud the NTA and others for helping taxpayers but it always seemed to me that the action was driven by a misguided view of the benefits of withdrawal on the part of the credit reporting agencies.

Congress has also passed sections requiring the IRS to release the NFTL quickly and provided some minor remedies when it does not do so.  One aspect of lien release that may cause credit agencies to ignore it as an important event may stem from the way release occurs.  Starting in the ealy 1980s, the IRS began filing self releasing liens.  Almost all, if not all, NFTLs contain this self releasing feature.  That can make it difficult to know when the release has actually occurred since you must read the NFTL to know when it releases.  Unlike mortgages which get formally released with the filing of a document or a margin release clearly indicating the release of the mortgage, NFTLs that release because of the passage of time have nothing that clearly signals the release has occurred.  Credit reporting agencies may avoid making decisions on releases because it requires a little bit of work to discover when it occurs as opposed to lien obligations terminated with a specific document.

I like to focus more on release because that is where the taxpayer receives a tangible benefit.  The release signals the end of the liability.  That is something to celebrate and something that deserves attention from the credit reporting agencies.  I hope that as the credit reporting agencies pay attention to the NFTL and how it should impact a credit score, they will focus on the importance of release and recognize that importance with a credit boost at that point.  Their old rules caused taxpayers and their representatives to spend a fair amount of time chasing the goal of a withdrawal rather than keeping their eyes on the real prize of release.  Focusing on how to obtain a release, rather than a withdrawal, would benefit taxpayers more and deserves more recognition.

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