When people face significant tax debt, they may wonder about how to protect certain assets, especially a windfall like an inheritance. There’s a common misconception that the IRS can’t seize inheritance funds or assets to cover tax debt. However, the IRS has every legal right to seize property, even an inheritance, to pay for unpaid taxes.
If you’re anticipating giving or receiving an inheritance, it’s important to know what will happen to the property if there’s an outstanding tax debt. Luckily, you can plan ahead to minimize the risk of the IRS seizing an inheritance. Call Damiens Law at 601-873-6510 to discuss your concerns with our team of tax professionals.
Key Takeaways
- No automatic protection – Inheritances aren’t automatically protected from the IRS and may be subject to seizure if either the decedent or beneficiary has a tax debt.
- No property is safe – Cash, real estate, vehicles, and collectibles can all be seized to cover the tax debt.
- It’s essential to plan ahead – If you owe money to the IRS and anticipate an inheritance, setting up payment arrangements in advance may protect you from losing your inheritance.
- Professional tax help is key – A tax attorney can help both beneficiaries and executors of estates with tax debt issues.
Why People Assume That Inheritances Are Safe (and Why That’s Not True)
If the decedent owes the IRS money and the IRS places a lien on their assets, that lien doesn’t go away when they pass away. The lien remains enforceable, and if the beneficiary of an estate owes the IRS money, the inheritance they receive becomes available to the IRS as soon as the beneficiary takes ownership of it.
Situations Where Your Inheritance May Be At Risk
An inheritance can be intercepted by the IRS if the decedent owed money to the IRS at the time of their passing or if the beneficiary has an outstanding tax debt with the IRS before receiving the inheritance.
The Deceased Owed the IRS Money
After someone passes away, their debts don’t automatically disappear. They become the debts of the estate, and those debts are to be paid off before any assets are distributed to beneficiaries. When an estate is in probate, creditors are given a chance to make a claim. They’re then paid out from the estate’s assets based on priority. The IRS is a priority creditor, which means they’re typically paid before any other creditors.
Once all verified debts have been paid and any other costs have been settled, the remaining assets are distributed to the beneficiaries. If the decedent doesn’t have enough assets to cover their debts, the estate pays what it can, and the rest is written off. In this scenario, if there’s no money left after debts are paid, there’s no inheritance to give the beneficiaries.
The Beneficiary Owes the IRS Money
If the individual receiving the inheritance owes the IRS money, they may still find their assets seized before they can access them. This risk is greater if the IRS has a Federal Tax Lien on the heir’s assets. A tax lien extends to all the assets the taxpayer owns at the time that the lien is placed, as well as all assets they own in the future until the lien is removed.
If the IRS has already placed a lien on your assets and you come into an inheritance, the lien automatically extends to that inheritance. Despite this fact, whether the IRS actually seizes that money depends on several factors.
If the IRS has already taken the steps necessary to levy your assets, the IRS may go ahead and seize your inheritance, whether it’s money in the bank, a vehicle, or real estate.
If the IRS hasn’t yet gone through the steps required to levy your assets, there may be some time for you to resolve the issue before the IRS seizes your inheritance.
If the IRS is notified of the inheritance, they may also send a seizure order directly to the executor and have the funds sent directly to them.
When the IRS Can’t Take Your Inheritance
If neither you nor the decedent owes the IRS money, the IRS can’t claim your inheritance. People sometimes worry about having their inheritance seized to cover the estate tax, but the vast majority of estates aren’t large enough to require an estate tax.
Additionally, there are assets that may pass directly to beneficiaries without being intercepted by the IRS, even if there’s a tax debt. For example, assets in an irrevocable trust may be able to pass to beneficiaries even if the decedent has tax debt. But this is only the case if the irrevocable trust existed before the decedent had tax issues.
If the decedent created the trust after getting into tax debt, the IRS can typically void transfers made specifically to escape tax debts as they are considered fraudulent transfers. Additionally, if the grantor maintains rights to any of the assets transferred to the trust, those assets are still treated as belonging to the grantor, not the trust. In that case, the IRS can seize the trust property to cover the tax debt.
Certain accounts are also protected from seizure. For instance, life insurance payouts are typically protected as long as the beneficiary doesn’t have tax debt. Payable-on-death or transfer-on-death accounts are also usually safe from IRS seizure if the beneficiary doesn’t have tax debt. Finally, there are also protections in place for beneficiary designations on retirement accounts.
Common Scenarios Involving Inheritances
Consider these common scenarios when thinking about how tax debt may affect your inheritance:
- Inheriting a home with an IRS lien: The lien stays on the property, and the beneficiaries can’t receive a clear title. The house may need to be sold and the proceeds used to pay off the tax debt before any remaining funds are given to beneficiaries.
- Heir with an IRS tax lien: The lien automatically extends to assets received by the beneficiary. After proper notice is given, the IRS may levy the money owed to the beneficiary to cover the beneficiary’s tax debt.
- Estate assets sold to pay off lien: If there’s a lien on the decedent’s assets, the estate may liquidate assets to pay off the lien. This may involve liquidating investment accounts, selling the family home, or selling other assets of value. Beneficiaries receive what is left after the debts are paid.
- Decedent had tax debt at the time of death: The IRS is a priority creditor. Once the tax debt is paid off, the remaining assets are distributed to the remaining creditors. Anything that’s left after that goes to the beneficiaries.
How to Protect Inherited Property When There’s a Lien
If there’s a lien on property you’re meant to inherit, there are options available to you. First, you may ask the IRS to discharge the lien.
A discharge removes the lien from the specific piece of property, but the taxes are still owed. This may allow you to sell or refinance the property in a way that allows you to keep it and still pay off the tax debt.
Second, you can request tax lien subordination. This doesn’t remove the lien, but lowers the priority of the IRS’s tax lien so that other creditors can move ahead. This makes it easier to use the property as collateral for a loan, with the proceeds from that loan going to the IRS to pay off the tax debt.
What to Do If You’ve Received an Inheritance and Owe the IRS Money
If you owe the IRS money and you have an inheritance coming, it’s important to be proactive. Should you ignore IRS notices and let the debt continue to grow, the risk of losing your inheritance only increases.
The IRS doesn’t like to levy assets as a way of settling tax debt. Whenever possible, the IRS prefers that taxpayers pay their debt voluntarily. Even if you can only pay your debt over time, you may be able to avoid losing your inheritance by setting up a payment plan.
Other payment arrangements, such as an offer in compromise or partial payment installment agreement, are unlikely to be available to you. This is because you’re required to disclose any inheritance you have coming, and that will likely disqualify you. Yet with a payment plan, you can stretch payments out while protecting your assets.
How a Tax Lawyer Can Help
Whether you owe money and expect an inheritance or you’re the executor of an estate for someone who had tax debt, working with a tax attorney early is crucial. There are various ways you can minimize the damage caused by tax debt, but the longer you wait, the fewer options you have.
When you’re ready to take steps to protect an inheritance, the team at Damiens Law is here to help. Schedule a free consultation to discuss your tax concerns and goals now. Just call us at 601-873-6510 or contact us online to get started.
Frequently Asked Questions
Can the IRS seize my inheritance if I don’t owe taxes?
The IRS may seize your inheritance before it is distributed if the decedent owed the IRS money. In this case, they would take whatever is necessary to pay off the debt, with the rest being distributed to you.
Can the IRS take my inheritance for my spouse’s IRS debt?
Possibly, but it depends on the details of your situation. Your filing status, where the inheritance is deposited, and whether your assets are commingled will all come into play.
What happens if I inherit a home with an IRS lien?
The lien remains in place until the lien is resolved or the IRS allows withdrawal or subordination.
How do I remove a tax lien?
You can remove a tax lien by paying it off, requesting lien discharge, requesting lien subordination, or otherwise negotiating with the IRS to pay off the lien with the proceeds of the property’s sale.
Does a trust protect an inheritance from the IRS?
An irrevocable trust may protect an inheritance from the IRS, but only when certain requirements are met. Revocable trusts offer little protection because the grantor maintains control over the assets until they pass.
Resources:
https://www.irs.gov/faqs/interest-dividends-other-types-of-income/gifts-inheritances
https://law.justia.com/cases/federal/appellate-courts/ca9/16-10152/16-10152-2017-04-20.html
https://www.law.cornell.edu/uscode/text/28/3304
https://www.irs.gov/publications/p559
https://www.taxpayeradvocate.irs.gov/notices/lien-release/
https://www.irs.gov/businesses/small-businesses-self-employed/understanding-a-federal-tax-lien
https://www.irs.gov/businesses/small-businesses-self-employed/what-is-a-levy
https://www.irs.gov/businesses/small-businesses-self-employed/levy
