Monthly Archives: April 2012

Tax Lien or Tax Levy: Which is Worse?

If you owe the IRS money and arrangements are not made for payment, eventually you are likely to see one or more tax levies and be impacted by the filing of a tax lien.  What is the significance of these two collection activities?  Let’s start with some basic definitions.  A tax levy is the means by which the IRS compels someone (typically a bank) that is in possession of the taxpayer’s property to turn that property over to the IRS.  A tax lien is the means by which the IRS encumbers property owned by the taxpayer (most importantly real property) and establishes its position as a secured creditor in relation to other creditors of the taxpayer.  A tax levy is either mailed or hand delivered to the person/bank that has the taxpayer’s property.  A tax lien (which technically arises automatically when a tax is due) is asserted by the filing of a Notice of Federal Tax Lien in the county clerk’s office where the taxpayer resides.

So which of these collection devices is most significant?  It depends.  In my estimation, the tax levy is the more powerful and disruptive tool as it requires the third party holding the taxpayer’s property to turn that property over to the IRS in rather short order.  But if the third party doesn’t have any property of the taxpayer when the levy is served, then the tax levy has no effect.  One good thing about a tax levy is that it is not a public action.  That is to say, no one other than the third party is ever made aware of the fact that the taxpayer owes money and that collection activity is underway. 

 A notice of federal tax lien, on the other hand, is a very public act.  When a notice of federal tax lien is filed, all the world is now on notice of the unpaid tax debt.  The taxpayer’s credit will immediately be impacted because credit agencies, lenders, and other financing services will see the tax debt when searching the county records where the taxpayer resides.  Notwithstanding these negatives, a tax lien does not require the taxpayer (or anyone else) to do anything with the property encumbered by the lien.  The filing of the tax lien notice simply secures the debt.      

So which is worse?  There is no right answer to that question; both are very powerful tools in the IRS’ arsenal of collection devices.  There are ways to navigate around, or in spite of, a tax lien and tax levy but it is always best to avoid them if possible.  If you are facing collection issues with the IRS, the assistance of an experienced tax practitioner may help you do just that.

An Interesting Change in Strategy Because of Interest Rates

The New York State Department of Taxation and Finance has released their new interest rates for the second quarter of 2012.  Although these rates have not changed from the prior quarter, this announcement is a reminder of the significant interest charges that New York State is now charging when there is an unpaid tax.  The “basic” underpayment rate on most types of unpaid taxes 7.5%.  If that isn’t bad enough, the underpayment rate for sales and use taxes is a whopping 14.5%!  A sliver of good news:  if the State determines that the failure to pay sales tax is due to reasonable cause and not willful neglect, it will use the 7.5%.  Perhaps all of this would be more palatable if the State was as generous when they owed you money.  No such luck.  If you overpay your taxes, the State pays you 2% interest.

Clearly none of these interest rates are tied to current market rates.  What these rates reflect is the State’s determination to increase revenues from delinquent taxpayers.  If these rates were imposed only on those who chronically underpaid their legitimate tax debt, the higher rates could be an effective compliance tool.  But these rates also apply when there is a bona-fide disagreement over whether a tax debt is owed.  In that instance, these exorbitant rates can result in a very costly (dare I say punitive) price to pay to exercise the right to question whether a tax is really owed.

If someone has a dispute over whether a tax is owed, there are still two basic options:  contest the liability without paying anything until all appeal rights are exhausted or, pay the tax and then seek a refund.  Traditionally, no one ever wanted to pay the tax when they didn’t think it is owed, so the first option was almost always taken.  But now with the State’s high interest charges coupled with the fact that your money is not earning much interest sitting in a bank, the economics of how to approach a tax dispute have changed. 

Consider a simple scenario.  If the liability at issue is $20,000 and the dispute goes on for two years, at least $3000 of interest (using the 7.5% rate) could be added to the bill if you are unsuccessful.  (The cost would be $5,800 if sales taxes are involved and the 14.5% rate applied).   Even if the appeal is partially successful and you settled for $10,000, the two-year interest charge of $1,500 is an expensive price to pay to dispute the bill.   If instead you paid the $20,000 and then were unsuccessful on appeal, at least the cost has been held to $20,000.  If you resolved the matter for $10,000 of tax, the State would then refund you $10,000 plus 2% interest for two years (a total of $10,400); thereby reducing the tab from the original $20,000 to $9,600. 

There may still be good reasons not to pay disputed taxes before pursuing a tax appeal, and it is best to understand all of your options, and their implications, when you face a tax problem.  These higher interest rates now add another important consideration in the process.