If you don’t pay your taxes in full, you could get hit with a tax lien. Although some tax liens won’t ever show up on your credit report, the ones that do could have a significant impact on your credit score.
Why are tax liens such a big deal? Well, if the government files a tax lien against you, it implies that something has gone wrong with your finances—and that you might be a financial risk. If you fail to pay your taxes, you might also fail to pay off your debts, which makes banks and credit card companies less likely to want to offer you credit. Potential employers might also assume that a tax lien means you’re prone to forgetting or ignoring important obligations.
In July 2017, major credit bureaus began excluding tax liens and civil judgments from consumer credit reports that didn’t include the consumer’s name, address, Social Security Number or date of birth. As Experian explained, this policy helped ensure tax liens were attached to the appropriate credit report – so John Smith in Arizona wouldn’t see his credit score drop because of a tax lien issued against John Smith in Ohio. This is another reason to regularly check your credit report for errors and dispute those errors promptly.
Essentially, if you do end up with a tax lien on your credit report, it’s probably yours—and it’s probably going to hurt your credit score.
How a tax lien affects your credit score
Tax liens are just one of the factors that comprise your credit score. The FICO credit scoring model also takes into account payment history, age of credit, types of credit, how much of your available credit is currently in use and more.
“A tax lien is considered a severe derogatory entry, just like bankruptcies, judgments, collections, charge-offs and repossessions,” says John Ulzheimer, a credit expert who has worked for FICO and Equifax.
How much will your credit score drop if you have a tax lien on your credit report? It’s hard to say. “The impact a tax lien has on a consumer’s credit score depends on the consumer’s unique financial history, as well as the credit score model that’s being used,” said Chris Hobday, a Vice President at Equifax.
How long tax liens remain on your credit report
The first step in removing the negative impact of a tax lien is to pay your outstanding taxes. Tax liens are released 30 days after payment, according to the IRS. Once the credit bureaus receive notice that you’ve paid your taxes, they’ll update your credit reports (typically within a day of notification).
Although, a paid lien can remain on your credit report for up to seven years after it’s been released, and an unpaid lien stays for up to 10 years after it was originally filed. This means banks, creditors and potential employers still have access to your tax lien history.
Paying your credit cards and loans on time and keeping balances low is the best way to minimize credit score damage if you’re hit with a tax lien. However, there is a way to get a tax lien removed from your credit file.
How to remove a tax lien from your credit report
First, find out if you’re eligible to apply to the IRS for a withdrawal, which will remove the public notice of the lien. You may be eligible if the tax lien has been paid, you’ve kept up with filing all tax returns on time for the past three years and you’re current on any estimated tax payments and federal tax deposits. You may also qualify if you’ve agreed to pay off your tax debt in installments, or if the withdrawal would make it easier for you to pay off your tax debt
If you’d like to apply for a withdrawal, complete Form 12277, Application for the Withdrawal of Filed Form 668, Notice of Federal Tax Lien. When you complete your application, be sure to include the names and addresses of any credit bureaus you want notified. “Withdrawn tax liens are removed immediately, as long as you let the credit bureaus know the lien has been withdrawn,” Ulzheimer explains.
There are no benefits to having a tax lien on your credit report, even if the lien has been paid off, so apply for withdrawal as soon as you’ve paid your outstanding tax or set up your installment plan. Check your credit report after the withdrawal is granted to ensure it has been removed. If you find any inaccurate tax lien information—for example, a released or withdrawn lien that isn’t reported as such—file disputes with the credit bureaus.
The best way to prevent a tax lien from hurting your credit score is to pay your taxes on time. If you slip up and receive a tax lien, your credit score should be the least of your worries. Failure to pay what you owe the government could result in penalty fees, interest charges, wage garnishment, asset seizure or even jail time.
So don’t let a single mistake hurt your finances—or your credit—long-term. Set up a plan to pay off your taxes, apply for a tax lien withdrawal and continue to practice responsible financial habits in the future.