Can the IRS Take Your 401k For Unpaid Taxes?

It takes a lot of self-discipline and sacrifice to save for retirement. To set aside hundreds or even tens of thousands of dollars each year in the hopes it will grow and be available for retirement isn’t always easy to do. Now imagine all that money and hard work potentially ready for the taking with an IRS tax levy because you have unpaid taxes.

The idea of the IRS taking your 401(k) or other retirement accounts is scary and unsettling. But before you start panicking because you owe the IRS money, be aware that usually, a lot must happen before the IRS takes your 401(k) for taxes owed. Let’s examine the scenarios in which the IRS can legally take your 401(k), as well as the procedural steps the IRS must follow before doing so. 

The Legal Basis for the Government to Take Your 401(k) 

If the IRS believes you have unpaid taxes, they will send you a series of letters and notices to try and persuade you to pay off your tax account or find another way to settle your tax debt. If this doesn’t work, the IRS will move on to other tax collection tools, such as liens and levies.

A tax levy allows the IRS to seize your property to pay off a tax debt. While wage garnishment and bank levies get a lot of attention (and for good reason), the IRS can also levy other assets, including retirement accounts, like your 401(k). If this sounds a bit off to you, it’s because the Employment Retirement Income Security Act of 1974 (ERISA) protects 401(k)s and many other retirement accounts from most commercial creditors, even during bankruptcy. One major exception to this protection is that it doesn’t apply to the IRS.

The IRS enjoys this exception because of how tax levies work. Levies normally only attach to a person’s property if that person has a legal right to access that property. Under the law and the terms of most 401(k)s, you usually have legal access to the funds in your 401(k) at all times. This is true even though you have to pay a penalty if you withdraw funds early.

Despite being able to levy retirement accounts like 401(k)s, the IRS usually won’t resort to this collection process for most taxpayers with unpaid tax accounts. One reason for this is that the IRS understands that taxpayers who have adequate financial resources during retirement are less likely to rely on public assistance when they retire. And most forms of public assistance are funded through taxpayer dollars. But before you get too excited about this “protection,” you need to be aware of two exceptions.

One, the IRS will levy a 401(k) or other eligible retirement account if they believe you’ve engaged in “flagrant conduct.” Two, the IRS will sometimes try to pressure taxpayers into accepting a “voluntary” levy on their retirement account, thereby bypassing the flagrant conduct requirement.

The Process of an IRS 401(k) Levy 

The IRS won’t go after your 401(k) the minute it discovers you have unpaid taxes. There’s usually an extended process between the moment there’s a tax bill and the IRS actually taking money out of a 401(k) retirement amount.

The first step is the tax assessment. This will usually occur within a few weeks to a few months of filing a tax return. After processing your return, the IRS may conclude you have a tax balance due.

The second step occurs when the IRS sends you a notice or letter, such as CP14, informing you of your unpaid tax balance. If you don’t pay off your taxes or reach some sort of settlement agreement with the IRS, you’ll usually have 60 days before the IRS takes more aggressive collection action. Until then, you may receive increasingly urgent or serious letters and notices from the IRS asking you to pay your unpaid taxes, including a Notice and Demand for Payment.

The third step is where things get more serious. Depending on your situation, the IRS may file a Notice of Federal Tax Lien (NFTL). This provides notice to the general public that the IRS has priority over other creditors when it comes to taking your assets to satisfy a tax debt. In most cases, the IRS won’t file an NFTL unless your tax debt is more than $10,000.

Understand that a tax lien can be attached to your property before the IRS files an NFTL. Usually, an IRS tax lien is created after you ignore the first tax bill the IRS sends you.

The IRS doesn’t always file an NFTL before using a levy to take your 401(k). However, they must send you a Notice of Intent to Levy (CP504) at least 30 days before seizing your retirement account. To prevent the levy, you must pay off your tax debt, make other arrangements with the IRS, or challenge the validity of your tax debt (by requesting a hearing) within this 30-day window. The IRS might also send you LT11 or LT1058 telling you of the IRS’ plan to use a tax levy.

The 30-day notice and hearing requirement won’t apply to all levies. In certain situations, the IRS might seize your 401(k) retirement account before giving you 30 days to request a hearing to challenge the levy. Some of these situations include:

• The IRS believes its ability to collect the tax is in jeopardy.
• The levy is used on a state tax refund.
• The IRS is trying to collect the tax debt of a federal contractor.
• A Disqualified employment tax levy is served.

Challenging the 401(k) Levy 

Most IRS collection actions, including the use of a levy, can be appealed to the IRS Office of Appeals. The exact process can vary, but the instructions on how to present your challenge to the IRS will be on your Notice of Intent to Levy and Notice of Your Right to a Hearing. If you want to file this appeal, you’ll need to act quickly, as you’ll have just 30 days from the date of your Notice of Intent to Levy and Notice of Your Right to a Hearing to request a Collection Due Process Hearing.

If you’re not happy with the decision from the Office of Appeals, you can ask for another review of the levy by the U.S. Tax Court. In situations where the Collection Due Process Hearing isn’t available to challenge the levy, there will be another appeal option, such as the Collection Appeals Program. 

How to Protect Your 401(k) from an IRS Tax Levy 

The best way to prevent the IRS from touching your 401(k) is to settle your tax debt. Ideally, this means paying off your entire debt as soon as you receive a tax bill from the IRS. When this isn’t possible because you lack the funds to immediately pay off your tax balance in its entirety, you can pay off your tax balance over time by making monthly payments to the IRS.

For example, you can set up a short-term payment plan that gives you up to 180 days to pay off the entire unpaid tax amount. Until this happens, you will accrue any applicable penalties and interest. If you need more time, you can ask for a long-term payment plan (also known as an installment agreement).

If you’re an individual taxpayer, you can have up to 72 months to make monthly payments to pay off your tax debt. During this time, interest and penalties will continue to accrue, although the IRS isn’t allowed to levy your property while you have a current or pending installment agreement.

If there’s no realistic option for you to pay off your tax debt, you have other options. One of the most popular is the offer in compromise (OIC), which allows you to settle your tax debt for less than the full amount. Sounds too good to be true, but it’s not, as the IRS is very particular about who it accepts into the OIC program. As is the case with installment agreements, a pending OIC request or approval into the OIC program will prevent the IRS from placing a levy on your property.

If your inability to pay your tax debt is temporary, you could be eligible for Currently Not Collectible (CNC) status. If you receive CNC status, the IRS agrees to pause its tax collection efforts against you. This pause usually lasts about one year and during this time, penalties and interest will continue adding up. Despite this fact, it offers you a reprieve that can protect your retirement 401(k) account while you find other ways to deal with your tax situation. 

When can a 401(K) Levy Help?

There are limited scenarios when it may make sense to let the IRS levy 401k proceeds. One such scenario is if the taxpayer would like to resolve the balance using their 401k funds, but is still below the threshold for withdrawing without penalty.  In cases such as these, we have requested the IRS to levy the funds to avoid the 10% early withdrawal penalty.  This is a limited circumstance, but for some, it can lead to substantial savings on the withdrawal penalty.  Of course, you need to discuss this action with your attorney to exhaust all other remedies before contacting the IRS. 

401(k) FAQs 

Can the IRS withdraw money from my 401(k) without notifying me? 

In most circumstances, no. However, if the IRS believes you might try to hide or transfer the money from your 401(k), then the IRS might use a jeopardy levy. This allows the IRS to seize your property without first warning you of its intent to levy your property. 

Can the IRS levy retirement accounts other than 401(k)s? 

Yes. The IRS can go after many other types of retirement accounts, such as:

• IRAs
• Profit sharing plans
• Qualified pensions
• Stock bonus plans under ERISA
• Keogh, SEP-IRAs, and other retirement plans for the self-employed
• Thrift savings plans

Keep in mind that the exact terms of the retirement plans and whether you have a vested right in the money in those plans will ultimately determine whether the IRS can attach a levy to them. The IRS can even levy your Social Security retirement benefits.

Are there any situations where my 401(k) is safe from the IRS? 

In theory, yes. If you have a pending installment agreement or OIC request (or have been accepted or approved for either), then the IRS won’t usually levy your 401(k) or any other property. Not having an outstanding tax balance with the IRS also ensures they won’t try to take money from your 401(k).

Even if the IRS decides to use a levy to collect money from you, they will typically hold off on placing a levy on a retirement account such as a 401(k) unless you engage in flagrant conduct. Just understand that “flagrant conduct” isn’t defined by the IRS and the IRS might try to get around this condition by pressuring you to agree to let the IRS levy your retirement account.

Can the IRS take all the money from my 401(k)?

Possibly, but it depends on how much your tax debt is and how much of your 401(k) you’re eligible to withdraw. In most 401(k)s, you can withdraw all of the money if you wish (subject to early withdrawal penalties and taxes, of course). But some employers offer 401(k)s that prohibit withdrawing money from the account as long as you’re still working for them. In this situation, the IRS may be prevented from taking any money from your 401(k) when using a tax levy. 

Are there tax consequences when the IRS levies a 401(k)?

If the IRS levies the funds in your 401(k), the withdrawal will typically be considered to be taxable income to you. However, regardless of your wage, you will not be subject to the early withdrawal penalty of 10%. 

Protect Your 401(k) and Other Assets from an IRS Levy 

The IRS using a levy to collect an unpaid tax means the IRS is serious about getting its money. And if they’re going after your 401(k), things might be even more problematic. This is because the IRS doesn’t usually try to levy retirement accounts unless they think you’ve acted improperly or the IRS convinced you to agree to a levy on your retirement account.

Regardless of how you found yourself in a situation where the IRS is going after your 401(k), there are things you can do. To learn more about these options and how to take advantage of them, consider the tax professionals at Damiens Law. You can call us at 601-202-4745 or use our online contact form.