The IRS can obtain an interest in retirement vehicles like 401(k)s and IRAs. Once an assessment has been made against a taxpayer, the IRS gives the taxpayer notice of the assessed amount and demands payment. The initial notice and demand is, in effect, a bill for taxes due. If the taxpayer fails to pay the assessed amount after notice and demand for payment, the federal tax lien arises as a matter of law. The federal tax lien attaches to all of the taxpayer’s property or rights to property either owned on or acquired after the date of assessment, including retirement accounts such as 401(k)s and IRAs. With the federal tax lien in place, the IRS is then able to levy on property subject to the lien.
Don’t be naive, retirement vehicles are subject to IRS collections
Many taxpayers who are subject to IRS collections have funds stored away in a retirement account that they think is absolutely protected as a matter of public policy. That is not the case. While understanding that these retirement vehicles provide for the taxpayer’s future welfare, Uncle Sam isn’t going to let taxpayers accumulate a retirement fund while continuing to owe back taxes.
The somewhat good news is that retirement funds are usually not the first stop when the IRS seeks to collect. The IRS will usually determine a taxpayer’s non-retirement assets first and pursue assets like wages or money held in a bank account. However, the IRS usually comes around to retirement plan accounts and payments when there are no other collectible assets, especially if the taxpayer has engaged in flagrant conduct. The IRS will typically first ask the taxpayer to borrow against funds in his or her retirement account. But, in flagrant cases, the IRS will bypass this request and immediately slap a levy right on the retirement vehicle. Flagrant conduct may include taxpayers who voluntarily contributed to retirement accounts during the time period they knew unpaid taxes were accruing, taxpayers who are accumulating unpaid income taxes over multiple tax periods and will not adjust their withholding or make timely and adequate estimated tax payments to prevent future delinquencies, and taxpayers who have demonstrated a pattern of uncooperative or unresponsive behavior that delays the collection of the tax due. Note that a distribution pursuant to an IRS levy is not subject to the penalty for early withdrawal.
If the IRS chooses to levy a taxpayer’s retirement plan account to satisfy the taxpayer’s income tax liability, an IRA, KEOGH, or §401(k) account are all on the table. When it comes to retirement plan payments such as a pension, if a taxpayer has a fixed and determinable right to payments, an IRS levy may attach to that right. The IRS’s position is that a current levy reaches payments due in the future even if the taxpayer has not yet begun receiving payments when the levy is served. Thus, if, under the terms of a plan, the taxpayer has a present vested right to future benefits but is not yet eligible to receive an immediate distribution, the IRS may levy the plan benefits even though the plan is not required to honor the levy until the taxpayer becomes eligible to receive the future benefits. The plan participant’s right to pension payments may also include the participant’s present right to elect a form of distribution. If the taxpayer is already receiving periodic payments, the levy attaches to the payments due, as well as future payments as they become due so long as there is a fixed and determinable right to continue receiving the payments. Even the periodic payments of a non-liable spouse are subject to levy if the payments constitute community property of a liable spouse.
Protecting your retirement while discharging taxes in bankruptcy
When it comes to taxpayers who have filed bankruptcy and exempted a retirement account from the bankruptcy estate, these accounts are still subject to being levied to collect taxes that are discharged in bankruptcy, only if a notice of federal tax lien was filed before bankruptcy. For retirement accounts that are excluded from the bankruptcy estate (such as an ERISA-qualified retirement plan), the IRS may still levy on those accounts to collect taxes that are discharged in bankruptcy even when no notice of federal tax lien has been filed. It is only necessary that the discharged taxes were assessed, that notice and demand was given, and that the statutory lien arose before bankruptcy was filed. The IRS will certainly consider levying on the retirement account(s) if no other property survived the bankruptcy.
