Release or Withdrawal of Federal Tax Lien – Which Is Better?

April 2, 2010

The IRS Office of Chief Counsel has announced that the IRS is not legally prohibited from withdrawing a federal tax lien after it has been released. This will greatly benefit taxpayers who pay the tax they owe after the IRS has filed a Notice of Federal Tax Lien (NFTL) against them.

One of the many tools the IRS has for collecting taxes is the federal tax lien. When a taxpayer fails to pay taxes due after notice and demand, a lien automatically arises in favor of the United States upon all the property and rights to property of the taxpayer. Unless the IRS “perfects” this lien by recording a NFTL in the public records, other creditors of the taxpayer, such as purchasers and holders of security interests, may obtain priority over the IRS.

A NFTL adversely affects a taxpayer’s credit rating. This can be particularly problematic for taxpayers who own small businesses.

The IRS must release a tax lien, by issuing a certificate of release of lien, not later than 30 days after the underlying liability is fully satisfied through full payment of the tax, or is legally unenforceable (e.g., the statute of limitations for collecting the tax has expired).

The IRS also has the authority, under certain circumstances, to withdraw a NFTL. If a NFTL is withdrawn, the tax laws shall be applied as if the NFTL had not been filed. The circumstances that permit withdrawal are any one of the following:

  • Filing of the NFTL was premature or otherwise not in accordance with the IRS’s administrative procedures.
  • Taxpayer has entered into an installment agreement to satisfy the liability for which the lien was imposed.
  • Withdrawal will facilitate the collection of the tax liability.
  • With the consent of the taxpayer or the National Taxpayer Advocate, the withdrawal of the NFTL would be in the best interests of the taxpayer and the United States.

The distinction between whether a NFTL has been released or has been withdrawn is important because of the manner in which credit reporting agencies treat withdrawals verses releases. When credit reporting agencies receive a notice of the withdrawal of a NFTL, they delete any reference to the tax lien in the taxpayer’s credit history.

In contrast, when the credit reporting agencies receive a release of a lien, while they note the filing of the release in the taxpayer’s credit history, the filing of the release does not operate to remove the references to the tax lien from the taxpayer’s credit history. In fact, typically a released NFTL remains noted in the taxpayer’s credit history for seven years from the date of the release. (The credit reporting agencies are required to remove references to released tax liens after seven years under the Fair Credit Reporting Act.)

As a consequence, even though a taxpayer has fully paid the tax and a certificate of release has been filed, the fact that the NFTL was filed in the first place can adversely affect the taxpayer’s credit history for years after the tax is paid. Anyone checking the taxpayer’s credit history during the seven-year period after the tax was paid will see that a tax lien was filed. In contrast, if the IRS files a withdrawal of the NFTL, from a credit rating standpoint, it is as if the NFTL were never filed.

Several years ago, the IRS Office of Chief Counsel took the position that the IRS did not have the legal authority to withdraw a NFTL once it had been released. Thus, if a taxpayer immediately paid the tax in full after the NFTL was filed and the IRS released the lien, the taxpayer’s credit rating nevertheless would be adversely affected for the next seven years. This could put a small business out of business.

Now, if a taxpayer’s tax liability is paid in full and the IRS releases the lien, the IRS can withdraw the NFTL if it believes that doing so “would be in the best interests of the taxpayer and the United States.” In deciding whether this standard is met, the IRS Office of Chief Counsel concluded: “In the absence of a definition of ‘best interests’ in the Code or regulations, we believe that this term can be broadly defined so as to permit withdrawal where the NFTL has been released but the taxpayer nevertheless needs the NFTL withdrawn to improve his credit. In the general sense, withdrawal can be said to be in the United States’ best interests insofar as the improvement in the taxpayer’s credit history assists him with future tax compliance.”

The National Taxpayer Advocate, in her 2009 Annual Report to Congress, identified the IRS’s position that it could not withdraw a lien once it was released as one of the most serious problems encountered by taxpayers. The change in position by the IRS Office of Chief Counsel appears to be in direct response to the National Taxpayer Advocate’s efforts.

McGuireWoods’ Civil and Criminal Tax Controversy/Litigation Group routinely handles tax controversies and litigation against the IRS, and has broad experience representing clients in IRS examinations and collections matters. If you have any questions, please do not hesitate to contact us at your convenience.