Stop the IRS From Destroying Your Credit: 4 Moves

Last Updated Feb 28, 2011 2:12 PM EST

Having trouble paying taxes? To collect, the Internal Revenue Service uses a pernicious tactic that destroys your credit: It files a lien against your property. Supposedly, that guarantees payment. More likely, it will sink your personal finances, making it twice as hard for you to get back on your feet.

Under new rules announced by the IRS last week, fewer hard-up taxpayers will face this harsh - and unfair - punishment. You'll have a better chance of getting your financial life back in order, not to mention getting the government off your back. (Keep reading for a few other new ways to fight back.)

The changes comes in response to years of needling by Nina Olson, the National Taxpayer Advocate. She has argued, forcefully, that the IRS inflicts needless harm on people who are struggling to find or keep their jobs and pay their debts.

A tax lien - on your house, car, or business - is a claim for money by the IRS. It prevents you from selling the property or borrowing against it until your tax is paid. The IRS even files against people who have no property, or property of little value, Olson says. The lien shows up on your credit report, where it can sit for seven years or more.

A tax lien can wreck a small business that needs access to credit. It can cost you your job, if your employer checks credit reports - something that's not uncommon in the financial industry. It can raise the monthly premiums on your auto insurance. A landlord might refuse to rent you an apartment. Eventually, the IRS can seize your property and sell it, to satisfy an unpaid tax bill.

The new rules are a step - but only a step - toward helping willing taxpayers square their accounts.

Under the rule changes, you should not be hit with a lien unless you owe the IRS more than $10,000 - double the previous threshold. More people will be able to settle their tax problems without ruining the rest of their financial lives.

Raising the threshold makes the lien machine better but still far from fair, Olson says. The IRS is stopping people's access to credit without evaluating whether they can actually afford to pay. Lien filings rose by 14 percent last year and have climbed about 550 percent since 1999, Olson says - "damaging [taxpayers'] records in the midst of the worst economy in several generations."

If that's what it took to collect the tax, you might say, OK. But there's scant evidence that liens bring in many dollars, Olson says - and much evidence that they wreak "financial devastation" on working families. If you come under the new $10,000 lien threshold, the IRS should not file against you. Contact your taxpayer advocate if you think that an IRS agent isn't following the rules.

The new procedures generally aren't retroactive. Old cases won't be opened up. But if you're in discussions now with the IRS, you can ask to be considered as if your case had just begun, IRS Commissioner Doug Shulman said in a telephone press conference. (No guarantees, but you can ask.)

Here are a few other ways you can fight back:

1. You can remove a lien from your credit history, as if it never existed.

Usually, the IRS "releases" the lien, once your tax problems have been resolved. But that doesn't clear your credit history. The blot stays on your record, where it will damage your business and reputation for seven years or more.

Under the new procedures, you can clear the blot by asking the IRS to "withdraw" the lien. That takes it off your credit history. But the IRS won't do this automatically. You have to ask for a certificate of withdrawal, and send copies to the three major credit bureaus yourself, says Alex Clamon, vice president of sales for TaxMasters, a company that resolves taxpayer problems with the IRS. The bureaus are supposed to remove the lien from your record, but you'll have to track your credit history to be sure that happens. You'll also have to clear the lien from your real estate property records at the county clerk's office or from the title to your car. The IRS won't give you any help.

2. You can get a lien withdrawn even if you haven't paid your back tax in full.

You should qualify if you're paying with automatic debits from your bank account, owe $25,000 or less in tax, and haven't skipped out of a payment plan before. There's no guarantee, however: IRS agents have a lot of discretion, and there's no set number of payments you have to make before they'll set your property free.

3. Your small business may be able to qualify for streamlined installment payments of back taxes.

That means less paperwork. Small businesses now qualify for this program with tax debts of $25,000 or less - more double the amount before.

4. You can try for offers-in-compromise, where the IRS accepts less than the full amount you owe.

You have to be able to prove that you don't have the income or assets to pay the full amount, which potentially requires huge piles of paperwork. But the IRS will now simplify the system if your income is $100,000 or less and your tax debt is $50,000 or less. Still, it's up to the individual agents to decide whether to make a deal: In 2010, the IRS accepted fewer than 14,000 offers, while unpaid accounts grew to almost 4.3 million.

Olson hopes for improvement this year. Failing to compromise creates "a category of permanent tax debtors," she says, while throwing away the chance to collect at least something from people who might pay.

The next question is whether tax collectors in field will cooperate with the new rules. Aggressive agents have been ordered to change their behavior in the past, but haven't complied, Clamon says. In his experience, debtors actually want to get back into compliance with the income-tax laws. The IRS just has to give them a break.

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