Monarchies and governments have been collecting taxes since Pharaohs ruled ancient Egypt. The methods for collecting tax may have changed through the years, but a state or federal taxing agency still has the authority to seize a taxpayer’s property to satisfy a tax debt. Though this may bring to mind visions of Robin Hood and malevolent sheriffs, the U.S. tax system isn’t quite as scary. The IRS provides numerous ways for taxpayers to pay their taxes as well as allowing extended payment plans, offers in compromise to reduce tax debt, and temporary delays in collection.
Federal Tax Levies
If you do not pay your federal tax debt, the IRS can seize and sell your property, such as your car, boat or house to satisfy the debt. The IRS may also levy property that is yours but is held by someone else, such as your wages, bank accounts, and retirement accounts. (A tax levy is different from a tax lien. A lien is a legal claim against property to secure payment of a tax debt, while a levy takes the property to satisfy a tax debt.)
The IRS will usually levy only three things happen:
• The IRS sends a Notice and Demand for Payment to the taxpayer.
• The taxpayer does not pay the bill or otherwise contact the IRS to make arrangements to pay or to dispute the assessment.
• The IRS sends a Final Notice of Intent to Levy and Notice of Your Right to a Hearing (levy notice) to the taxpayer, and the taxpayer fails to respond within 30 days.
IRA Assets Subject to IRS Levy
If IRA assets become subject to an IRS tax levy, the IRS will send a Form 668-A, Notice of Levy, to the custodian holding the IRA. Upon receipt of the notice, the IRA custodian is required to freeze the IRA assets for 21 days. This provides time for the taxpayer to make arrangements to pay the tax or notify the IRS of errors regarding the levy.
After the 21-day period has expired, and the custodian has not learned of an error or revocation of the levy, the custodian is required to remit the IRA assets to the IRS. Any distribution fees cannot be subtracted from the levied amount. The fees must be withdrawn from the amount left in the IRA after the levy, if any. If a custodian fails to honor a levy, the IRS has authority to file a suit against the custodian, and impose a 50% penalty on the custodian if the failure is unreasonable.
Taxes on Taxes
If your Traditional IRA assets are subject to a tax levy, the amount withdrawn from the IRA will be treated as a taxable distribution (excluding any basis in the IRA). If your Roth IRA is subject to a levy and you do not meet the requirements for a qualified distribution, the amount distributed that is attributable to earnings will be taxable.
If you are under age 59½, the 10% early distribution tax will apply to the taxable portion of an IRA distribution made to satisfy a state tax levy. Federal tax levies are an exception to the 10% early distribution tax.
Mistaken Levies Can Be Returned to the IRA
If IRA funds have been levied by mistake, recent changes in the tax laws allow IRA owners to return the levied funds to their IRA when the IRS returns the funds to them. The return of the levied funds will be treated as a rollover into the IRA. IRA owners have until the tax-filing deadline plus extensions for the year the funds are returned from the IRS to complete the rollover.
For More Information
For more information on the IRS Collection Process, see IRS Publication 594. You can also go to the IRS’s Paying Your Taxes webpage or call 1-800-829-1040 (individuals) or 1-800-829-4933 (businesses).
IRS, Paying your Taxes, https://www.irs.gov/payments
IRS, Depositaries Requested to Adhere to Levy Compliance Rules, https://www.irs.gov/businesses/small-businesses-self-employed/depositaries-requested-to-adhere-to-levy-compliance-rules
IRS, What if I Get a Levy Against One of My Employees, Vendors, Customers, or Other Third Parties? https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/What-if-I-Get-a-Levy-Against-One-of-My-Employees-Vendors-Customers-or-Other-Third-Parties