How to Get a Business Loan with Tax Liens
If you are a small business owner who has a tax lien on their record but needs access to capital you might think all hope is lost. Not so. It is possible to get a business loan with tax liens, though you will pay more for the loan. It will not be as easy as applying with a clean record, true, but if you go about the process wisely you will be successful. How to get a business loan with tax liens is not magic, you just need to know what to do and be willing to put in some hard work.
What is a Tax Lien?
A tax lien is a legal action taken by the IRS, or a government or other state agency, to place a claim on your property for non-payment of taxes. It gives them a priority claim on most or all of your assets. Those assets can be sold or seized in order to pay off the debt. Typically, it’s filed with the county clerk or secretary of state.
Often, the lien relates to the reason you owe money. So if you owe parking tickets and other fines, the DMV or local government might place a lien on your car. If you failed to pay your property taxes, the city government would put a lien on your house.
The IRS most frequently places liens against personal property for failure to pay personal taxes, or a business’ property for non-payment of payroll or other business taxes. Business property that the IRS might file tax liens against includes equipment, intellectual property, business bank accounts, accounts receivable or buildings. Personal property could be your house, car, or bank accounts.
If you fail to pay your personal or business or payroll taxes, property taxes, or car registration fees you will incur a tax lien. Tax liens go on the public record, and the government will charge interest, fees, and late penalties on the amount that you owe.
Why are Tax Liens so Bad for Small Business Owners?
A tax lien is bad for small business owners for a number of reasons. The government has a priority claim on those assets. So if you were to sell them off in a bankruptcy, the government is repaid first and then whatever is left is divided among your creditors. Even if a creditor was able to obtain a judgement against you in court, they could not supersede the IRS’ claim. A tax lien on an asset also means that you cannot use it as collateral for a loan.
Tax liens overall are a negative mark on your application because they make you a risky borrower. In fact, without a payment plan in place with the IRS showing you are paying back the money you owe no lender will approve your application. And even if you have a repayment plan with the government, lenders will include that monthly payment in their analysis of your cash flow effectively reducing your borrowing power. Having a tax lien on your credit history makes borrowing much harder in a number of ways so avoid it at all costs if you can.
If It’s Not On My Credit Report, Will a Lender Find It?
As of April 2018, tax liens no longer appear on personal credit reports. It might have caused a bump in your score if a lien dropped off. It’s tempting to think that, now that the lien isn’t on your credit report, a lender won’t find it and you’re safe to apply for a small business loan with a traditional lender. This is not the case.
Business loans pass through a stringent underwriting process before getting approved. Part of that underwriting process includes searching for tax liens. Lenders find tax liens in the following ways;
- Search public records during the business loan underwriting process
- Pay for a third party company to provide them with tax lien data not readily available in standard reports
- Look at your business credit report
A lender will find any tax liens outstanding, and if you lied on your application form your loan will be immediately denied. Be upfront and honest, even if you are sharing negative information.
Before You Apply Consider Doing These Steps
Verify the Accuracy of any Tax Liens
The government can make mistakes. Your payment might have been applied to the wrong account. Or they might report that you owe the wrong amount. A tax lien that you have paid in full might still appear on your public record. It is always a good idea to check your records to see if they are accurate before applying for a bad credit business loan.
If you’ve paid off a lien, it should be released from your record, but the government does not have much incentive to worry about your credit. When you pay off a lien, they will send you a certificate of release. If you find a lien on your public record that you have already paid off, you should contact the government to get it cleared up. It is also a good idea to send a copy of the certificate of release to the assessor’s office, as they might be able to remove it from your record more quickly than if you wait for the IRS to contact them.
Other times, while you may know that you have a tax lien outstanding and that you do owe the money, the details on your public record could be wrong. Before applying for a business loan when you have a tax lien outstanding, double check all of its details. Always verify that you really owe the money. Also make sure that the amount reported on the lien is correct; though make sure to add interest and fees to the amount that you think you owe.
To check on a lien’s status, call your country clerk, recorder, or assessor’s office. They can search lien records using your home or business address to check for any liens on real estate. If you think there might be a government lien on your car, call the DMV. The process varies for other liens.
If you’re having difficulty finding a tax lien and have been rejected for a loan because of one, request that the lender who rejected your application supply you with the information. Under the Equal Credit Opportunity Act they must tell you why you were denied, and that could help you find the lien.
Pay Off the Tax Lien Before Applying for a Small Business Loan
A tax lien makes it very difficult for a small business owner to obtain funding. Lenders see it as a huge red flag. Even if you would already be applying for a bad credit business loan for a lower credit score, it is another black mark against you and it will lead to a higher cost of capital. If it is at all possible, paying off the tax bill will not only make the borrowing process easier, but it will save you significant money over the course of paying back the business loan because you will have better rates and terms.
If you have a business account for emergencies, the time to tap into those funds is now. Or if your business has been generating excess revenues that you’d been planning on using elsewhere, redirect them towards the tax lien until it is paid off.
If your personal financial situation is stronger than your business’ finances, pay off the lien with personal funds. Or take out a personal loan, tap a line of credit on your house, or borrow money from family. Make paying off the tax lien a top priority.
The IRS does accept credit card payments, so settling the debt with a personal or business credit card is an option. However, they charge payment processing fees and credit cards often have higher interest rates than what the interest the IRS would add onto a tax lien. If you use a credit card to pay off the lien, have a plan to pay off the card in short order.
Arrange a Payment Plan
If you do owe the money and cannot settle the whole pay you should still take action immediately. Creditors do not like being ignored. The IRS also charges interest and penalties on the amount you owe. A great option if you cannot pay the entire balance is to enter into an installment plan to pay the money owed. The IRS is often very flexible with payment plans and lenders look favorably upon repayment plans when a tax lien is present.
If your business is cash flow positive and you can provide an alternative lender with proof of a repayment plan, you have a much better chance of being approved for a loan. Lenders do not like uncertainty. If you have no repayment plan in place they do not know the eventual monthly amount you will be required to pay the IRS, or whether your assets could be seized and they would have a subordinated claim, or if you’re in danger of filing bankruptcy because of tax issues.
Without an approved repayment plan even an alternative lender will be reluctant to work with you. If you have resolved all these uncertainties, your odds of being approved greatly improve.
The IRS has three payment plans:
- Installment Plans
- Compromise Plans
- Lower debt and request a withdrawal
If you owe less than 50k, you can arrange for an installment repayment plan. Similar to a loan, you’ll make monthly payments for six years. But, also like a loan, you will pay interest on the total amount you owe. Options exist for monthly repayment plans of larger amounts, but the length of repayment term and rates vary and are negotiated on an individual basis.
Compromise plans settle your tax lien by paying as much as you can afford. It will take some work to be approved for a compromise plan and you are asking the government to settle your tax lien for less than what you owe. The IRS will review your revenues and other sources of income in order to judge your repayment ability. In the negotiation process, they will evaluate your business’ strength and possible longevity if they forgive a portion of your tax lien.
The IRS considers compromise plans because they also benefit the government. There are administrative costs associated with servicing an installment plan and the risk of default in the future should you go out of business. The government, like most lenders, prefers to have its money in-hand and dislikes waiting.
The last option is not so much a payment plan as it is a way to remove the tax lien from your record. The IRS typically only files tax liens if you owe more than ten thousand dollars. Once you have paid your debt down below that amount, you can request it be withdrawn from your record. Given the significant impact that a tax lien has on your credit-worthiness, if your debt is not much higher than ten grand it would be a good idea to borrow money from a family member or pull from your personal resources to lower the debt.
Wait a Few Months After Starting a Payment Plan to Apply
If it’s possible, wait for a few months or longer after you have started your repayment plan before applying for a loan. If the loan is for growth or expansion plans, put them on hold. Alternative lenders want to see that you can and will repay your debts. While having a repayment plan is a good start, proving that you have been sticking to its terms is even better.
Applying for a Business Loan with a Tax Lien
Managing to get a payment plan going for a few months is a great first step if the debt could not be settled or reduced in other ways. You can now apply for a business loan, but your lender options will be limited.
While a traditional lender will not consider lending to you, alternative lenders are often willing to work with borrowers. Alternative lenders work with borrowers that have poor credit, past bankruptcies, judgments, or other issues that make a loan with a bank very unlikely.
Because of the higher level of risk associated with these types of business loans, however, the interest rates and fees will be higher than at a bank, and the repayment periods are typically shorter. Often when you take out a bad credit business loan, the lender requires daily or weekly payments through direct withdrawals from your bank account.
Before approaching an alternative lender keep in mind that you must be enrolled in a payment plan with the IRS even if you are applying for bad credit business loans. Additionally, when you have a negative mark such as a tax lien on your credit report it is important to try to make other parts of your application look as good as possible. Get your business banking in order, try to pay off any smaller debts that just add to your lower credit score and derogatory information, and make as many payments to your government payment plan. These very small adjustments will help improve your chances when a tax lien is looming.
Improving Your Chances of Approval
Apply for Subordination
One of the biggest reasons that lenders dislike tax liens more than any other kind of debt is that the government comes first. If a lender obtains a judgement against you, the government gets paid first. If you declare bankruptcy, the government has first claim on all your assets. Which is why, to improve your chances of being approved for loan, you should apply for subordination.
When you fill out Form 14134 with the IRS, you are requesting that the government willingly subordinate its position on yours assets to lenders. Instead of going first should you file bankruptcy or default on a loan and a creditor has to liquidate your assets, the IRS allows other lenders to take priority.
Obviously, you will have to present compelling reasons to approve a subordination. Remember, the IRS or whichever agency filed the tax lien wants to be repaid. If your business’ future is in doubt unless you can get more capital, the IRS might agree to a subordination rather than let you go out of business. A strong business reason, combined with a business plan that demonstrates that they will eventually be repaid, increases the likelihood they will agree.
If you are applying for a loan to pay off the tax lien, the IRS will most likely approve the subordination. Your lender, attorney, and possibly accountant will have to be involved in the application process. If you can prove that subordinating the debt will guarantee the IRS repayment of the lien and all interest and taxes, they will consider your case. Instructions on how to apply for subordination can be found on the IRS’s website.
If approved, you’ll receive a certificate of subordination which you can include in your loan application to reassure your lender that, should you default, they will not be waiting for repayment behind the IRS.
Make your Application as Strong as Possible
In general, put together as strong a loan application as possible. Because tax liens no longer appear on personal credit scores, you might still have a decent score. If it is low, investigate how you could bring it higher. This can be done by paying down the balances on revolving lines of credit and making all payments on-time. Your personal credit score is an important part of any loan application.
Tax liens do appear on your business credit history, though. To minimize a tax liens’ damage, go several months with on-time payments and no overdrafts in your business accounts before applying for a small business loan. Evaluate assets with no tax liens on them for their value as collateral.
Finally, your business will need to be cash flow positive in order to qualify for a business loan with a tax lien. This helps prove to any potential lender that you can repay the loan. Alternative lenders who specialize in bad credit business loans know how to evaluate your tax lien within the context of your business’ annual revenue and cash flows. If your payments are less than 7-10% of annual revenue, you are more likely to be approved.
Debt Ratio and Total Debt
Another aspect of your loan application which you could improve is the total amount of your debt and your debt ratio. While financial planners often advise to pay off the highest interest rate debt first, if your goal is to be approved for a small business loan, you might want to prioritize your debt differently.
Your debt ratio is the total amount you owe divided by the total amount of credit available to you. It is a ratio which expresses how well you manage credit. For example, if you owe 15k and have a credit limit of $30k, your debt ratio is 50%. A lower debt ratio will be viewed more favorably.
Because of this, you might want to direct any excess cash to paying down debt on credit cards or loans if it will improve your debt ratio. Lenders do not just look at the tax lien, they take into account every fixed monthly payment for which your business is responsible. This is why a repayment plan is not a guarantee that you will be approved for a loan, particularly if it raises your monthly debt payments to a level which worries a lender about your ability to repay.
Getting a business loan with a tax lien is hard, but it can be done. Some simple steps like enrolling in a payment plan with the IRS and making small improvements to your credit history and business banking accounts can help make obtaining a business loan with a tax lien a reality.