Many people who owe taxes to the IRS are terrified that the IRS will swoop in and take their retirement nest egg or retirement income, thereby leaving them destitute for their golden years. Can the IRS really do that? Generally, such assets are “off limits” to creditors thanks to federal protections. But they are not off limits to the IRS. This fact is both surprising and upsetting to most of my clients. I imagine such news triggers their internal compass as being “not fair.” Saving for retirement in America is hard enough. Many of my clients have been working their whole life, are at or nearing retirement age, recently found themselves in tax trouble, and now the IRS wants to seize their sacrosanct nest egg?!? The good news is that there are actions that can be taken to prevent the IRS from destroying your retirement in the vast majority of cases. I will explain these actions below after first providing a basic overview.
An Overview of the IRS’s Ability to Take Your Property
The IRS cannot simply show up out of the blue and take your property if you owe it money. It must first satisfy a few procedural steps. The IRS must have a lien against you. This can happen through a “statutory” or “silent” lien, which goes into effect after a taxpayer fails to respond or pay after receipt of a balance due notice. Often, the IRS will also file a lien as a public record, through a Notice of Federal Tax Lien. This filing is a public notification, filed with the designated state and local jurisdictions, and it establishes the IRS’s claim to your property (and future rights to property) and its priority among competing creditors. Second, (with a few exceptions) the IRS must send you a Final Notice of Intent to Levy and allow the 30-day appeal deadline to lapse.
With those procedural formalities out of the way, the IRS now has the ability to levy and seize your property. But what exactly does that mean and what are its limits? Congress, through the Tax Code, has empowered the IRS to collect any delinquent tax “by levy upon all property and rights to property” of a taxpayer. The statute carves out an exception for very limited types of property listed in another statute, but otherwise, there are no restrictions to the IRS’s levy powers, as “no property or rights to property shall be exempt from levy.” Relevant to this article is that general retirement benefits and pensions are not on the list of exempt property. That means, by law, such property is “fair game” for the IRS to levy (take). Its power to do so is restricted only by one of the exceptions referenced above: the minimum exception for wages, salary, and other income. More on that soon.
Before diving in, I must make an important distinction: the rules are different concerning a levy of retirement income and a levy of the retirement fund itself.
IRS collection officers are given an express grant of authority to levy retirement, benefit, and social security income. This applies if you are already receiving (or have the legal right to receive) the income from one of these sources. A levy on such income attaches to all property in which the taxpayer has a “fixed and determinable right”—meaning that a levy on such income here attaches to more than just one payment, it reaches future payments as well, whether these will start in the future or whether you’ve even exercised your right to receive such payments. The result is that for each and every month into the future—even beyond the expiration of the IRS’s collection statute to collect on these debts—the IRS will capture some or all of your retirement income. As this applies mostly to those on a fixed income, this type of levy can be devastating.
How Can I Prevent a Levy on My Retirement Income?
Obviously, the best way to minimize the impact from a levy is to prevent it before it begins. A Revenue Officer (tax collector) is instructed to make certain considerations before levying any taxpayer asset. The first is the taxpayer’s financial condition: Will a levy of this asset create a financial hardship for the taxpayer? In other words, if the IRS takes this source of income, will the taxpayer still be able to meet their basic living requirements as defined by the IRS? If the answer here is no—a conclusion that often must be proven by the taxpayer—the source of income should not be levied upon. Other considerations include the taxpayer’s responsiveness to IRS communication, their filing and compliance history, their efforts to pay the delinquent tax, and whether they are keeping up with their current tax obligations.
If you are facing collections from the IRS, and it is threatening to levy a source of retirement income, the case you present in response should focus on the considerations above. Another, perhaps easier solution (depending on your current tax compliance), is to propose a suitable resolution alternative—i.e., an installment agreement or Offer in Compromise (tax settlement). A third option, as a last resort, is to file an appeal through the IRS’s Collection Appeal Program. There are also certain times when you could postpone, prevent, or reduce the chances of a levy by filing a Request for a Collection Due Process Hearing.
If the levy is already in place, your best means to terminate the levy are to: (1) pay the liability in full; (2) prove the levy is creating a hardship; or (3) reach an agreement with the IRS for the liability to be resolved (e.g., an installment agreement, Offer in Compromise, Currently Not Collectible Status, etc.).
401k and IRA Retirement Accounts
IRS collection officers are given an express grant of authority to levy funds held in pension and retirement plans. There are many types of retirement vehicles swept into this definition, which includes but is not limited to, 401Ks, Qualified Pensions, Profit Sharing, and Stock Bonus Plans under ERISA, IRAs, and Retirement Plans for the Self-Employed (together, “Retirement Funds”). Before doing so, however, IRS collection officers are to complete a three-step analysis. The analysis requires an affirmative answer at each step before it is appropriate to levy a taxpayer’s Retirement Funds.
The first step is to determine if there are any other assets available for a levy or if a payment agreement can be reached. If there are non-retirement assets available, those should be levied first. Similarly, if a payment agreement can be reached, the Retirement Funds should not be levied.
The second step requires the collection officer to make a determination on whether the taxpayer’s conduct has been “flagrant.” If the taxpayer’s conduct has not been flagrant, the Retirement Funds should not be levied upon. Of course, such a determination is fact-intensive and subjective, thus the IRS provides a handful of examples of conduct categorized as flagrant. Such conduct includes:
- Taxpayers whose failure to pay is based on frivolous arguments (as defined by the IRS);
- Taxpayers who voluntarily contributed to these accounts while having a tax deficiency or who continue to do so after notification by the IRS that such contributions are disallowed while claiming an inability to repay their tax debt (these do not apply to those taxpayers automatically enrolled in such plans by their employer);
- Taxpayers convicted of tax evasion, those who assist others in the evasion of taxes, and those assessed with a fraud penalty;
- Taxpayers with liabilities based on illegal income;
- In-business taxpayers that are pyramiding (continuing not to pay) payroll tax liabilities;
- Individual taxpayers with tax liabilities over multiple periods that have not adjusted their withholding or with multiple Trust Fund Recovery Penalty assessments;
- Taxpayers with a pattern of uncooperative behavior or those who have attempted to hide assets from the IRS; and
- Taxpayers whose collection status has been determined to be in jeopardy.
This is not an all-inclusive list, but it does give insight into the types of things the IRS will be considering. The most frequent traps are the ones concerning multiple periods of liability. The Internal Revenue Manual provides no guidance on how many delinquent periods it takes to trigger the “flagrant” label. Intuitively, most taxpayers facing a levy of their retirement assets only got to this point by having multiple periods of tax liability. It is important, therefore, to have a defense prepared for this argument when asserting that your tax behavior has not been flagrant. Also keep in mind that it is common for IRS personnel to interpret broad or vague language in a fashion that allows for levying. For example, terms like “flagrant” or “uncooperative behavior” could potentially be interpreted to mean relatively small offenses. Consequently, the danger of losing Retirement Funds can be a lot greater than it might sound, and preventative measures (e.g. resolving the liability) are strongly recommended even if you think you don’t fit the criteria for having Retirement Funds levied.
The third and final step considers whether the funds that make up the retirement asset are either necessary now or will be in the near future to provide for basic living expenses. This triggers the statutory exemption from levy noted in the beginning—the IRS is not supposed to levy your property if it leaves you unable to meet your basic needs. Specific calculations are made based on the IRS’s financial analysis standards and life expectancy. The closer you are to retirement, the stronger the case that can be made. The IRS is also supposed to consider any and all special circumstances present here, like other sources of income or extraordinary expenses.
It should also be noted that the IRS can only levy one’s retirement assets if the taxpayer has a present right to that asset. In other words, the IRS can only reach that money if the taxpayer has an ability to reach that money. If the taxpayer’s accrued benefits in the retirement plan have not yet vested, the IRS cannot reach the funds in the plan.
How to Protect Yourself
The information above should help you stand up to the IRS if you are in collections and wish to preserve your retirement income or assets. Proving a hardship can help dissuade the IRS from levying in either scenario, but until you’re in a repayment plan or some other formal resolution agreement, the IRS will still do what it can—by means of other levies and garnishments—to get the money it’s owed. Moreover, the further you are away from being at retirement age, the less receptive the IRS will be to this argument.
The best solution is almost always to enter into an agreement with the IRS for resolution of the tax liability. With few exceptions, no levy can be made against a taxpayer that has an installment agreement or Offer in Compromise pending or in effect. Even if the payment plan will not pay the liability in full—known as a Partial Pay Installment Agreement—the IRS should not levy the retirement funds or ask you to if the asset is necessary to fund the payment agreement or if selling/borrowing against the asset would result in an economic hardship.
If you have funds in a retirement account or are receiving retirement income and the IRS has issued a Final Notice of Intent to Levy, the situation is very serious. How you respond may determine whether you have the means to care for yourself after your working years. There are statutory and administrative protections that a competent tax resolution attorney can raise to ensure you can retire safely. If you find yourself in this situation, I strongly advise contacting a qualified tax resolution professional immediately to see what options may be available. In fact, you can simply contact my firm, Fortress Financial Services. We have knowledgeable pros available who will be happy to explain your options to you at no charge.