When facing mounting debt and multiple due payments, the last thing you want is for one debt to supersede and take priority over others – but depending on how your debt is structured, this might end up happening. A subordination agreement allows you to exempt a specific debtor from this structure, so you can pay them first – and have one less thing to worry about, especially if your superseding debt is far more substantial than the debt you are trying to resolve urgently. In the context of tax debt, subordination is potential option taxpayers have when faced with the notice of a federal tax lien.
Understanding a Federal Tax Lien
A tax lien is one of the IRS’ most powerful collection actions against taxpayers with outstanding tax debt. The way it works is quite simple – if a taxpayer is in debt with the IRS, the agency can utilize a federal tax lien to effectively coerce payment by superseding all other debts and locking a taxpayer out of liquidating their assets without paying their tax debt or using their assets to secure other debts.
Federal tax liens are a matter of public notice, meaning the IRS issues a tax lien through the notary rather than simply sending it to you. You do, however, receive ample warning whenever the IRS plans to issue a tax lien and have 30 days to respond before they officially begin the lien. Tax liens are limited in power because they do not allow the IRS to claim your assets or empty your bank accounts physically. That’s part of the next step in the collections process. But a federal tax lien is powerful nonetheless.
In the not-so-distant past, a federal tax lien had nearly the same impact on your credit score as a bankruptcy did, making it potentially lethal for your ability to seek financing for up to seven years. Thankfully, all three major credit reporting agencies have stopped taking liens into account on consumer credit reports. However, that doesn’t mean creditors and lenders can’t see that you’re under a tax lien and will thus refuse to finance you. This can spell disaster for any business venture or investment plan.
But the real trouble lies with existing debts. What happens if you’re behind on payments for your home and the IRS has a tax lien on your account? Do you lose your home? Are you in danger of defaulting? In theory, yes. But that is where lien subordination becomes crucial.
How Lien Subordination Works
To keep things simple, lien subordination changes the order of priority on the creditors vying for your assets. Through a lien subordination agreement, you can effectively name a creditor to supersede the IRS’ claim on all your assets and liquidate a specific property or asset to pay that debt without first paying the IRS.
Lien subordination is similar to how subordination agreements are set up between non-government lenders and creditors. When one debt takes priority over another, the junior creditor (i.e., the debt with less priority) can be moved up the chain of priorities through a subordination agreement made with the creditor at the top of the chain (the senior creditor) by the debtor.
A subordinated debt refers to a debt lower in the chain than senior debt. In this instance, the IRS agrees to have their debt subordinated below a junior creditor. This agreement is not a matter of course. The IRS does not accept any subordination agreement sent their way. You need to present a valid reason for wanting a specific junior creditor to be prioritized above the IRS’ claim for your tax liability.
A reasonable way to look at the situation is this – will subordinating the lien and pulling this debt ahead of the IRS help you pay your debt by keeping a roof over your head or allowing you to secure a loan that you will use to pay your tax debt? Then the IRS may agree to a subordination.
Applying for a Certificate of Subordination of Federal Tax Lien
The Certificate of Subordination of Federal Tax Lien can be reviewed in full through Publication 784. To fill out and send this application, you will need Form 14134, Application for Certificate of Subordination of Federal Tax Lien, and you will need to mail it to the address corresponding to the property you aim to use to secure your loan, as per Publication 4235, Collection Advisory Group Addresses.
Note that you need to submit your application at least 45 days before you aim to secure your loan or complete your transaction with a junior creditor. The IRS requires enough time to process and respond to your application.
In addition to basic taxpayer information, you will need to provide adequate information about the basis for subordination and information about the lender in question, the property in question, the proposed loan agreement, and a copy of your federal tax lien. You will need to explain how subordination is in the best interests of the United States.
It is usually recommended to fill this form out with the help of an experienced tax professional. Not only can they help you navigate all the requirements of the IRS for this task, but they can also help you navigate your tax debt in general.
Lien Subordination vs. Lien Discharge
A lien subordination is not to be confused with a lien discharge. However, the two are similar and have the same core function – to create an exception for an overarching federal tax lien and give you just enough leeway to expedite your debt repayment. Whereas a lien subordination allows a named creditor to supersede the IRS, a lien discharge exempts a specific asset or property from a federal tax lien. Lien discharges are not attached to any given creditor but an asset or property. However, like subordination, the IRS needs a good reason to issue a lien discharge.
Getting Your Lien Withdrawn
Your goal should be to seek lien withdrawal. The IRS withdraws or ends a federal tax lien when taxpayers have either paid their debt or entered a guaranteed or streamlined payment plan. These monthly installment agreements are available to taxpayers who owe less than $50,000 and agree to pay through a direct debit or payroll deduction agreement. If you owe more than $50,000, the IRS usually will not eliminate your federal tax lien until your debt is paid. Defaulting on a payment plan also reinstates the lien.
The IRS can be difficult to deal with, especially if you owe them money. Working with a tax professional helps ensure you have the right representative for the job. Still, it lets you determine your next best course of action during your repayment journey. Even if you are limited in means and can’t repay your debt, working with a tax professional to negotiate a plan with the IRS can help you get your life back on track as soon as possible.