On February 24th the IRS announced new policies regarding the collection of unpaid taxes and liens. Specifically, if the tax payer pays their liens “in full” the IRS will “withdraw” them. What does this mean for consumers’ credit reports? Simply put, tax liens are now the only derogatory item on a credit report that will be removed once it has been paid, as long as you play your cards right.
An unpaid tax lien can remain on a credit file indefinitely per the Fair Credit Reporting Act. In the old days, pre February 24th, even when paid the lien remained on file for an additional 7 years and was only shown as “released.” And, a released tax lien is just as bad for your credit as an unpaid tax lien. This new IRS policy suggests that if you pay your liens in full they will be removed from your credit files much sooner, and this was confirmed by all three credit reporting agencies and their trade organization, the Consumer Data Industry Association (CDIA). According to Norm Magnuson, Vice President of Public Affairs for the CDIA, “I’ve confirmed that all three credit reporting agencies remove withdrawn IRS tax liens.”
Tax liens are one of FICO’s “Seven Deadlies” and can severely damage your FICO scores for years. The new IRS policy offers hope to consumers who want to clean up their credit sooner rather than later. However, some don’t agree that this is a good idea. IRS liens, which can remain on a credit report longer than anything else, are now the only derogatory item that could be removed once paid. This “opportunity” doesn’t apply to any other derogatory debts such as collections, foreclosures, repossessions or defaulted credit cards. Ironically, this is the type of “pay for deletion” scenario that is generally frowned upon by the credit reporting industry.
The question some are asking, and it’s a legitimate concern, is whether or not the removal of a tax lien waters down the value of the credit report. If tax liens are indicative of elevated credit risk, and they are, then removing them would mask the consumers true credit risk. Lenders could be duped into granting credit for someone they may have considered too risky if they had seen the lien. Still, “most people with a tax lien have other negative history and that other negative history will continue to weigh down their score”, according to FICO spokesperson Craig Watts.
The new IRS policy doesn’t apply to tax burden settlements. The new IRS rules don’t offer a withdrawal if the lien is only settled, “Full payment” is required, according to the IRS website. So, if you can’t afford to pay off your lien in full you’ll still eventually have a released lien on your credit files for 7 years from the date it was settled.
If the lien is the only negative item on your credit reports, and if the lien is fairly recent, this new IRS policy can result in a monumental change in a consumer’s score. In fact, my estimates show a potential 100 to 200 point increase, under some circumstances. At the very least a consumer’s score should improve. The amount of the improvement will be determined by the age of the lien and what other negative items, if any, are on the consumer’s reports.
Withdrawal of the lien is only at the consumer’s request. This is important as the process to have the lien removed isn’t “autopilot.” In fact, if consumers are unaware of the new IRS policy they might never ask to have the lien listed as “withdrawn”, and thus they’d have 7 more years of credit reporting. The IRS announcement is clear on that matter, “Liens will now be withdrawn once full payment of taxes is made if the taxpayer requests it.” Consumers with withdrawn liens should notify the credit reporting agencies of the new status and ask them to be removed.
Finally, approved payment plans for larger liens will also result in a withdrawal perhaps even before the full payment has been submitted. In these cases the credit reporting could be stopped even before a full lien balance has been exhausted. The IRS was in a good mood yesterday.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry.