It's your prerogative, as a lender, to learn as much as you can about a potential borrower's finances before you offer terms and finalize a loan. You get this information through due diligence, which involves searching for claims on the person or business's property. If you're going to become their creditor, you want to make sure your interest takes priority. If there are liens on a borrower's real or personal property, including federal and state tax liens, you might not be the first party to get paid in the event they default or file for bankruptcy.
Due diligence best practices involve a four-part search: a UCC lien search, a federal tax lien search, a state tax lien search, and a judgment lien search. Finding a recorded UCC-1 financing statement is relatively straightforward: you query the Secretary of State (SOS) where the property is located, or the borrower incorporated.
Searching for tax liens, however, comes with a few stumbling blocks. Creditors record state tax liens differently from one jurisdiction to the next. It's to your advantage to work with a Lien Solutions partner that offers an efficient way to search federal and state tax lien databases.
What is a tax lien?
The definition of a tax lien is an interest recorded by a federal or state government agency against a person or business's assets, including real estate, personal property, inventory, equipment, and financial assets. A government agency acquires a tax lien when it levies a tax against a party, which then fails to pay it on time. The IRS or state records the lien against the debtor's property until they pay their tax liability in full.
Why do tax liens matter?
An IRS tax lien usually takes priority over other creditors — even those who perfected their interests before the federal tax bill came due. State income and property tax liens also take priority over other creditors in certain circumstances.
A tax lien differs from a UCC lien because a recorded UCC financing statement shows a borrower agreed to give a lender an interest in a particular property in exchange for a loan; it's a consensual lien. Tax liens, whether federal or state, are non-consensual. The borrower didn't agree to the government taking a security interest in their property.
In some cases, the debtor isn't even aware there's a tax lien against them. What does that mean for you? They wouldn't have disclosed it to you when applying for the loan. The likelihood of undisclosed tax liens is one reason why it's essential your due diligence includes state and local tax lean searches.
Some jurisdictions have a state tax lien registry
When someone doesn't pay their state income or property taxes, the state's taxing authority files a lien against their property, and they become a tax debtor. Where the government records its interest depends on state law. Some states require recording certain interests at the state level. For example, Colorado files tax liens with its Department of Revenue's Division of Taxation. Many others require agencies to secure liens in the county records office where the person, business, or property is located.
Another option is a lien registry, which several states have formed in recent years, and more may create in the future. A state tax lien registry is a centralized location for recording and searching for tax liens. For example, the Mississippi state tax lien registry started in 2015. Illinois and South Carolina formed state tax lien registries in 2018 and 2019, respectively.
These states file all tax liens with the registry instead of at the county level, giving you one place to look instead of searching for information in several county offices. But a potential hiccup is how far back the tax registry's records go. When Illinois created its registry, it attempted to include tax liens previously filed at the county level. But a registry might not go back decades, and older tax liens could exist.
Benefits of using a tax lien database
States' differing rules and procedures for filing liens complicate your tax lien search. When you want to uncover IRS and state tax liens, you have to inquire in various state and county offices based on where the borrower lives, does business, and owns property. There's a way to conduct a more efficient search: a state and federal tax lien database.
Tax liens are public records, which means a business can routinely pull these documents and create an easily searchable database. You can use an IRS tax lien database, a state tax lien database, or an organization that offers both records in one place.
Lien Solutions can search any tax database
What's more efficient than conducting a state or IRS tax lien search through a database? Working with a Lien Solutions partner that can search any tax lien database on your behalf. We perform the necessary due diligence, including a four-part search to uncover any state and federal tax lien records and UCC statements filed against the potential borrower.