Can the IRS take my 401(k) plan account for unpaid taxes? Does it have to wait until I take distributions from the 401(k) plan account? The IRS recently asked its tax attorneys this question in CCA 201927019.
About 401(k) Plan Accounts
The 401(k) plan account is the most popular method for saving for retirement. They have supplanted the use of defined benefit plans, such as traditional pensions, offered by employers.
Most funds that go into 401(k) plan accounts are tax-deferred. This means that the funds are not subject to income tax when they are contributed. This is accomplished by way of a tax-free contribution from an employer or a tax-free withholding from employee wages. For others, it may be a tax-deductible contribution.
Because of this, the funds are subject to income tax when withdrawn. If the owner is under 59 1/2 (or not disabled), the funds may also be subject to a 10 percent early distribution tax.
Newer 401(k) plans also allow for Roth contributions. These contributions have already been taxed before they are contributed to the account. Thus, they are not subject to income tax when withdrawn. The earnings inside the account also escape income tax on withdrawal if the owner had a Roth account for a certain period of time. There is generally no 10 percent early withdrawal tax for Roth contributions.
The IRS’s Levy & 410(k) Plan Accounts
With this background, this brings us to the IRS’s collection question. The IRS has broad authority to levy on property owned by a taxpayer to satisfy unpaid taxes. This includes 401(k) accounts.
The IRS’s levy powers are set out in Sec. 6334. This Code section provides several types of property that are exempt from levy. After the list is the general rule that no other property is exempt.
The courts have even concluded that ERISA-covered plans are not exempt, despite the ERISA anti-alienation provision (see, e.g., United States v First Bank & Trust, 477 F Supp 2d 777 (E.D. Tex. 2007). The courts have also looked at state property limitations for creditors generally, such as Texas Property Code’s retirement plan exemption under Tex. Prop. Code Ann. § 42.0021. The courts have held that the IRS is not limited by these provisions. See, e.g., United States v Citigroup Global Mkts., Inc., 569 F Supp 2d 708 (E.D. Tex. 2007).
But Not So Fast….
The IRS’s ability to levy on the 401(k) is possible once the contributions vest. Contributions vest in the employee when the terms of the plan are satisfied–which usually means the employee has worked for the employer for the period specified in the plan. This means that the taxpayer is the owner of the funds.
If the plan does not vest until the taxpayer retires or ceases employment, the IRS will not be able to levy the account. If the terms of the plan say that the taxpayer has an election to take a distribution, such as a one-time elective distribution while working, the IRS can reach that portion of the plan assets.
How the IRS Levies on 401(k) Plan Assets
If the IRS does levy on 401(k) plan assets, the levy will trigger additional income taxes. To account for this, the IRS will generally allow 20% reduction to the levy to account for taxes. This can allow the taxpayer to pay the income tax from the distribution.
In addition, the 10 percent early distribution tax does not apply if the IRS levies the account directly. The 10 percent tax does apply if the taxpayer voluntarily takes a distribution and then turns it over to the IRS.
The IRS has a practice of not levying on retirement plan assets if the taxpayer’s conduct isn’t flagrant and the taxpayer is dependent on the retirement funds for their living expenses. This hardship provision is often used to avoid levying on retirement plan assets. In lieu of this, the IRS often attempts to take other property or to secure higher monthly installment payments from taxpayers.
There are a number of other rules and IRS policies that apply to levies on 401(k) plan assets. There are also strategies for avoiding this in the first place. If you have a 401(k) and unpaid tax debt, you should consult with an experienced tax attorney.