How Tax Liens Affect Your Credit Score
If you have fallen behind on taxes there is a very good chance that you have had or will have a tax lien filed by the IRS or state because of it. A tax lien is a legal security the IRS or state requires in order to stake a claim in your property and pursue enforced collections such as garnishments, bank levies, and other asset seizures. A tax lien is also bad news for your credit score – though that is about to change a little for the better of the consumer.
Changes to Tax Liens and Credit Reporting
One of the most common questions we get here is how do I remove an IRS tax lien. This is because a tax lien can be a real big problem when trying to get credit or when having your credit report inspected for reasons outside of credit. Finally some good news for consumers. Things are about to get a little better for some people. Starting in 2017, some tax liens and civil judgments will be removed from people’s credit reports. The result will be a boost credit score for millions of consumers – but also an increased risk for lenders.
The three major credit reporting companies: TransUnion, Equifax, and Experian will begin removing tax-lien and civil-judgment data in July. The caveat is that the data will be removed only if the lien or judgment data lacks a complete list of a person’s name, address, as well as a social security number or date of birth.
This is important because often liens and judgments data lack all three or four. This change will apply to new tax lien and civil-judgment data that are added to credit reports, as well as existing data on the reports.
In our experience, however, the IRS is pretty good about filing complete data. Civil judgments are another story. These are often cases in which collection firms take borrowers to court over an unpaid liability. Most of these judgments will be removed and about half of tax liens will be removed because they lack all the data.
Why are the Credit Reporting Agencies Doing This?
It is estimated that one in five people have an error on at least one of the three credit reporting companies.
TransUnion, Equifax, and Experian together chose to make the changes, bowing under pressure from regulatory pressure around credit reports and the role they typically play in lending decisions.
Inaccurate credit report information can hinder a consumer’s ability to get lending or can cost them a much higher interest rate if they can get credit, and can often prevent someone from getting approved for an apartment or even affect a person’s job application.
In 2015 the credit-reporting firms reached a settlement in New York over several practices, including how they handle errors. Thirty-one other states followed New Yorks’s lead, sued, and won. The pressure was mounting as the state settlements required the credit-reporting firms to remove particular negative-data their from reports, including items like library fines, gym memberships, and even traffic tickets!
How Does This Affect You?
Scores are projected to rise by at least 40 points for around 700,000 consumers, according to FICO. This will be a big difference to many people, bumping them up a tier. But for most, especially those with better credit histories, the score increase will be modest: about 11 million people will experience a score improvement of fewer than 20 points.
Such changes will help some borrowers with both credit and also situations where credit is considered, such as job and rental applications. On the flip side, it could potentially increase risks for lenders who might not be able to accurately assess borrowers’ default risk. Lenders are good at making – not losing – money and if they see problems in baskets of loans or credit extensions, they will sniff out another common denominator, such as just changing the credit score required for a particular threshold, and will balance the scales.
According to LexisNexis Risk Solutions, people with liens or judgments are TWICE as likely to default on loan payments. Lenders are not going to just start issuing loans to these people without new checks and balances. Recall the Great Recession and the housing market collapse. A large part of that was caused by credit rating companies giving lenders overly optimistic ratings on loans, hiding the underlying risk. It did not turn out well for anyone. The scrutiny to risk will be much greater this time around and the credit companies will likely find another way to “punish” those with bad credit.
The “unknown” category is how the Trump administration will impact this and related regulatory issues going forward. President Trump has proposed major cuts to the Consumer Protection Agency and other regulatory agencies.
Removing Tax Liens from Your Credit Reports
Below are steps to getting an IRS tax lien removed from credit reports and also the qualifications required to make such requests. Each state has a separate procedure though in general, it’s similar to the IRS process.
Request Copies of Your Credit Reports
All three agencies must give you a free annual credit report. A tax lien will show in the public records section of the report.
Pay the Liability
You must pay the balance or be in an Installment Agreement to pay the balance due for the tax lien. Note: the amount that you owe may differ greatly from the amount of the tax lien.
Pay off Your Balance
Pay the liability, either in full or through the repayment plan you established with the tax office. Make sure you save all documents related to the repayment of the lien. Request a paid-in-full letter from the tax office. You will need to save these documents in order to make a case for removal.
Filing a Dispute
As part of the IRS Fresh Start Program it is easier to have a tax lien withdrawn. In order to qualify for this, you need to be compliant with your current taxes for the last three years. That means all filings and payments on time. Regarding your old tax liability to the IRS from which the tax lien arises, you must not owe more than $25000, be on track to pay your liability within 5 years (or before the statute of collections runs) and have made three payments already. You cannot have defaulted on a previous Installment Agreement.
It is best to have paid your balance in full. Otherwise, you need to be granted a waiver for and must obtain a Release of Federal Tax Lien [Form 668(Z)]. Then file form an Application for Withdrawal of Lien.
If the process to remove the tax lien seems onerous, it can be. It may be much more time-effective to have a tax professional execute the steps for you.
If you have a tax lien you may be in luck as far as your credit report goes. Still, you really must deal with the underlying tax issue. It will not go away. The liability will grow due to compounding interest. The sooner you get your tax situation under control the sooner you will be on the path to a stronger financial future.