Debunked Myth: Tax Liens are Always Filed When a Business Doesn’t Pay Its Taxes Published May 20, 2016

The difference between tax liens and tax liabilities“The failure to pay the collected taxes will frequently, but not always, signal that the business is about to fail.”  Keith Fogg, Professor of Law, Villanova
University School of Law, 30 year employee with the IRS Office of Chief Counsel.

Esteemed law professor T. Keith Fogg presented the quote above in the opening paragraphs of a research paper on IRS enforcement strategies at the IRS Research Conference in 2010.

While the paper goes on to talk about how the IRS can improve on their processes to collect business taxes, this quote strikes at the heart of why commercial underwriters do what they do – gather information, complete a financial analysis, and make an informed decision as to whether or not to extend credit. And when it comes to a borrower’s tax compliance, knowing whether a business has paid its taxes or not could be the difference between a loan that defaults or is successfully repaid.

This powerful premise is backed by the deeper understanding that when a business fails to pay its taxes, it is indicative of a real-time cash flow problem which could ultimately lead to the business’ failure and/or inability to repay the extended credit.  Because of the IRS’ inefficiencies in collecting tax liabilities, many times it’s easier for a business to ignore their IRS obligations in order to pay their suppliers, employees, vendors, etc. Typically, the business’ mindset is that will that they’ll catch up with their tax liabilities in the future before the IRS catches them.

The reality is that some business eventually do get into compliance, but many do not. And as commercial underwriters, it’s your job to find out if your prospects haven’t, because those are the businesses that could fail.

That brings us to the prominent tool in underwriter’s toolkit – public record searches for tax liens.

Why Do Underwriters Search For Federal Tax Liens?

We’ve spoken with thousands of commercial credit underwriters and, generally, they answer that they’re looking to see if there is a tax lien on record for their prospects for two main reasons:

  1. Security – This is to determine if another party has a lawful claim or right against the prospective borrower’s property or funds. This speaks mostly to secured lenders that need to determine if any other creditors hold superior lien positions before extending credit.
  2. Creditworthiness– As mentioned above, underwriters make informed credit decisions, in part, on the basis of whether or not a business is paying its taxes or not. The basis of this creditworthiness analysis is to assess the likelihood that a borrower will or will not default on their debt obligations.

There’s no need to further hash out #1 since it’s an accepted lending standard and necessary to secure collateral for funding. However, reason #2 is an incorrect premise. As long as underwriters continue to extend credit with this flawed assumption, commercial lenders remain at an increased risk because many underwriters have told us that they believe that they are searching for tax liabilities when searching for tax liens.

MYTH: TAX LIENS ARE ALWAYS FILED WHEN A BUSINESS DOESN’T PAY ITS TAXES

According to the U.S. Government Accountability Office, only 40% of all unpaid payroll tax liabilities currently in the IRS’ inventory have a tax lien filed against them.

Translation – if you’re doing a public records search to find out of your borrower is paying their taxes or not, you could be missing their tax liabilities 60% of the time. As underwriters, you need to be right 100% of the time.

Fortunately, this due diligence problem is fixable by shifting your understanding and your due diligence because searching for tax liens is NOT the same as searching for tax liabilities. The more you understand your borrower the better you can measure your risk.

Stay tuned for our upcoming post that will take a deeper dive into the recent IRS data and examine some finding from the hundreds of thousands of Tax Guard Reports that we’ve completed.  By understanding these trends, realities, and truths, you can ensure that you’re using the industry standards for your due diligence when it comes to IRS tax information.

Tax Guard
Posted By: David Bohrman

As the Director of Marketing, David is responsible for driving overall marketing strategy for Tax Guard including brand positioning, go-to-market execution, and lead generation programs. For the past 15 years, David has held senior positions in early growth and mature companies, leading marketing, operations, and business development teams. Prior to Tax Guard, David was the Director of Marketing of one of the largest tax consulting firms in the country. He holds a B.A. in English and Philosophy from the University of Vermont.