It's one of the worst things that can appear on your credit report - a federal tax lien can take between 50 to 200 points off your credit score. This can increase your borrowing costs and have a long term impact.
If you owe a significant tax bill, you have between nine months and a year to resolve it before the IRS will file a Notice of Federal Tax Lien - NFTL in IRS jargon, tax lien in plain English. The numbers of NFTLs have been decreasing since the IRS increased the threshold from $5,000 to $10,000. But more than 515,000 were still filed in 2015, according to the IRS data book.
In this blog, we will answer some basic questions about the impact a tax lien has on your credit score. Then we will discuss several solutions to avoid the issue or resolve it.
Credit reporting bureaus can easily see public tax liens
The highest credit score possible is an 850 and the other extreme is a 300. To qualify for the best interest rates, you need somewhere around a 760. On average, most Americans have a credit score somewhere between 670 and 740.
Investopedia offers an example of how a credit score can affect the total cost of a 30-year mortgage. Assume one borrower has a score of 760 and the other a 620. When taking out a $200,000 fixed rate mortgage, the borrower with the lower score may have to pay a 1.6 percent higher premium. Over the life of the loan, this adds $68,000.
A tax lien could make the difference. What steps are available to avoid the tax lien in the first place and keep that hard earned credit score?
IRS tax liens are generated through one of three systems that are automated. In this situation, it is important to take action as soon as you learn of a tax deficiency.
The IRS Fresh Start Initiative may provide an option if you are struggling to pay a significant and unexpected tax bill. In other circumstances, an installment agreement may resolve the issue by spreading payments out over a period of time. When little chance exists that you would ever be able to pay the full outstanding balance an offer in compromise might be an option.
When a tax lien has already been filed
Whether the tax lien is open or has been released, Form 12277 allows you to request removal of the lien. The form will help in the following situations:
- The tax lien was filed improperly - maybe the IRS did follow the proper procedure in mailing the notice
- You have entered a direct debit installment agreement
- Withdrawal will help with collection efforts or it is in both your and the government's best interest
The form then allows you to make the best case to support your request. This is when the involvement of an experienced tax attorney can make the difference. Proactively dealing with a tax problem can save money in the long term by avoiding dings to your credit score.