Paying off back taxes owed will pay off more quickly on your credit report now. June 15, 2011 By John Ulzheimer, Guest ColumnistEditor's note: Our regular Kip Tips columnist Cameron Huddleston, is taking a deserved vacation but has solicited the help of her favorite personal-finance bloggers to guide Kip Tip readers in her absence. It’s been a long-standing reality that federal tax liens can remain on your credit reports for as long as it takes you to pay them, plus an additional seven years. They can remain that long because the Fair Credit Reporting Act -- the law that defines how long negative items can remain on your credit reports -- clearly allows it. In fact, unpaid tax liens can remain on your credit reports longer than any other negative item, even a bankruptcy. That’s the bad news. The good news is the IRS recently announced a new policy that will result in tax liens being removed from credit reports much sooner than any other negative item. How was this stark reversal achieved? The answer in one word is “withdrawal.” Advertisement Tax lien withdrawals The IRS will now formally withdraw a tax lien if, and only if, the taxpayer pays it in full or enters into an installment program that will eventually result in full payment. Once this has been accomplished the taxpayer must request that a withdrawal be filed, which can be done using IRS Form 12277 (Application for Withdrawal of Filed Form 668(y), Notice of Federal Tax Lien). The response you will get from the IRS will come via IRS form 10916(c) (Withdrawal of Filed Notice of Federal Tax Lien.) That form is your golden ticket. The Consumer Data Industry Association (CDIA), which is the trade association of the credit reporting agencies, has gone on record and confirmed that all three of the major credit reporting agencies (Equifax, Experian and TransUnion) will remove IRS tax liens that have been withdrawn. Consumers can facilitate the removal of the tax lien from their credit reports by contacting the credit reporting agencies, disputing the lien, and providing a copy of the withdrawal form. Once the credit reporting agencies confirm withdrawal, they will delete the lien from your credit reports. There are a few things to keep in mind if you have tax liens on your credit reports. First, liens are considered seriously derogatory by most credit scoring systems, including FICO, so the removal of the lien could result in a significant increase in your credit scores (assuming you don’t have other similarly negative items remaining). Also, the IRS policy doesn’t trickle down to the state level. That means if you have state tax liens on your credit reports, then you’re still subject to their brutal credit reporting rules. Advertisement Settlements The new withdrawal policy does not apply to “offers in compromise,” more commonly referred to as tax settlements. A settlement occurs when you and the IRS cut a deal for less than you actually owe. Because a settlement does not result in full payment to the IRS, the lien will simply be “released” rather than withdrawn. And you guessed it, the credit reporting agencies do not remove released tax liens until seven years has passed from the release date. Retroactive or not? The new IRS tax lien policy doesn’t address whether withdrawals would be granted for liens that had been paid off in the past. However, recent success stories from taxpayers who have been successful getting old tax liens withdrawn by the IRS and removed by the credit reporting agencies suggests that the new policy is retroactive. For example, a consumer in Texas who paid off a federal tax lien in June of 2008, well over two and a half years before the IRS announced their new lien withdrawal policy, was able to have the lien removed from his credit report. Advertisement Collateral impact The IRS doesn’t place tax liens on your credit reports. The credit reporting agencies do using electronic access to court records (the system is called PACER) and by sending public record vendors to courthouses to gather data. And while the credit reporting agencies were not a party to the IRS’s decision to withdraw tax liens, they certainly are affected because of the amount of tax lien information that they will have to remove. The question about whether this is good for lenders still remains. Lenders depend on credit reports and credit scores to approve or deny consumer applications for credit. A tax lien tells a story about a consumer’s credit worthiness, which is why they can have such a negative impact on your credit scores. Removing paid-off liens from credit reports, prevents lenders from seeing a pertinent piece of information that indicates a potentially elevated credit risk. Tax liens are now the only negative item that can be removed because of payment. That flexibility doesn’t exist for collections, repossessions, foreclosures, defaulted credit cards, medical bills, judgments or any other negative debts that appear on credit reports. Regardless, most consumers who are elevated credit risks aren’t going to be able to fool a lender just because they were able to get a tax lien removed from their credit reports. “Most people with a tax lien have other negative (credit) history” according to FICO. What this means is their scores will still be poor because of the remaining negative credit history and the lenders will still treat them accordingly. Advertisement Who wins? The new IRS policy is clearly a win for the IRS because consumers who would have attempted to settle their tax debts may now consider paying them in full because of impact on their credit benefit. And, consumers who have no other negative items on their credit reports win big because their credit scores will likely increase significantly with the deletion of the lien. Follow John Ulzheimer on Twitter. 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 and Equifax, John is the only recognized credit expert who actually comes from the credit industry.