The Internal Revenue Service (IRS) will file a lien against your assets if you leave your federal tax debt unpaid. After filing its lien, the IRS notifies you via a Notice of Federal Tax Lien. A federal tax lien attaches to all property that you own and also appears on your credit report. Tax liens negatively impact your credit rating, making it more challenging to get approval for new credit.
Tax Lien Impact
Tax liens show up on your credit report as derogatory public records. While a tax lien will inevitably lower your score, the degree to which your credit rating suffers will vary. The Fair Isaac Corporation -- the organization responsible for calculating credit scores -- keeps the exact credit scoring algorithm a closely guarded secret. Thus, there is no way to estimate exactly how much your credit score will suffer from a federal tax lien. In general, however, the better your credit rating is, the more damage it will incur.
Reporting Period
A tax lien only damages your credit for the amount of time that it appears on your credit report. Unlike other negative credit records, such as collection accounts, bankruptcies and judgments, the Fair Credit Reporting Act does not set a formal reporting period for tax liens. Because of this, an unpaid tax lien can remain on your credit report indefinitely.
Each credit bureau determines how long it will allow a tax lien to appear within your credit files. Experian, for example, removes unpaid tax liens after 15 years. Should you pay off your federal lien, however, the credit bureaus will remove the lien seven years from the date you paid it off.
Negative Effects
A lower credit score makes getting approved for loans, credit cards and housing more difficult. An unpaid tax lien, however, poses an additional risk for lenders other than past evidence of poor debt management. Federal tax liens attach to all property you own even if you get the property after the lien was filed. Thus, a lender may turn down your application for secured debt, such as an auto loan, based on the lien itself rather than a damaged credit rating.
Reducing the Damage
A tax lien negatively affects your credit score, but you can take action to reduce the damage your credit rating suffers. Paying the tax lien not only limits its reporting period to a mere seven years, but it also prevents you from posing a greater risk to future lenders.
While paying off a tax lien restricts its reporting period, the lien itself remains a negative entry within your credit history. Provided you pay your creditors on time and practice good debt management, the tax lien will have less of a negative effect on your credit over time. This is because the FICO scoring formula places less importance on older entries. Thus, you can re-establish a positive credit profile even with a tax lien on your record. Once the reporting period expires and your tax lien disappears, your credit score will improve considerably.
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