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Antialienation/ IRS Tax Levy


Guest tonjer

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We have received a notice of a tax levy from the IRS for one of our 401(k) plan participants. Is there any fiduciary obligation on the part of the plan to investigate the tax levy, or not? I understand that a participant's benefit in his or her 401(k) is subject to a tax levy, I have been unable to find what fiduciary duty the plan has to investigate and/or what the Plan should do.

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At a minimum, I think you should discuss this with plan counsel.

With that said, I think the general rule is that the IRS may force a plan to distribute funds only if the participant is eligible for a distribution. However, some at the IRS may not be aware of the need to have the plan's terms control the timing of distributions.

If a participant is eligible fora distribution, then the tax levy essentially serves as the participant's election to have the distribution processed and forwarded to the IRS.

Things get tricky where a participant would be able to make a withholding election of state taxes. The IRS may not want their share of the distribution to be reduced. Then again, if properly elected, maybe the State wouldn't want their share to be reduced, either.

Hence the need for plan counsel.

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If the Plan provides for hardship distributions, does that make the participant eligible for a distribution and therefore serve as an election by the participant for a hardship?

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The 10% penalty does not apply to amounts "distributed" due to an IRS levy. A hardship distribution to pay off the tax levied would be subject to the 10% penalty. So it's best for the participant that the funds go directly from the plan.

I'm not sure this is what the previous post related to, but I think it's good information to be aware of.

Mary Kay Foss CPA

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Mary Kay Foss: Hi, neighbor. I'm curious. I thought that since the IRS has essentially admited that they can't get money from a qualified plan unless the participant is eligible for a distribution, the participant is subject to the taxes associated with the distribution. In the case of an inservice distribution before age 59 and 1/2 that would include the excise tax. Does the fact that the monies are paid directly to the IRS make the payment eligible for escape of the excise tax?

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The way I understand it, if the plan provides that a participant is eligible for a distribution at the age of 59 1/2 or that a participant can withdraw any portion of his rollover account, or elective contributions, etc., then if he is either 59 1/2 or has rollovers, etc., then he is eligible for a distribution with respect to those amounts and therefore those amounts are subject to the IRS tax levy and should be distributed to the IRS. Is my understanding correct?

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Mary Kay is right Mike - One of the exceptions to the 10 percent early withdrawal penalty is amounts paid as a result of IRS levy.

However, in order to be eligible for this exception, the levy must be direct to the plan or IRA. If the taxpayer makes an early withdrawal to voluntarily to pay his tax liability, the penalty will NOT be waives

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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I just got this same issue yesterday. I'm in-house benefits counsel and I leaning towards paying the levy out of the particpant's account with no 10% penalty and no 20% withholding. I think if the plan administrator wants to pay a levy that is directed to the plan, it can without risk of disqualification from the IRS or claim from the DOL. The model 402(f) tax notice says that a tax levy payment is not subject to the 10% penalty. If paying the levy doesn't violate the antialienation rules, I don't see a problem.

Looking at the regs under 401(a)(13), the Chief Counsel Memos and Field Service Advice, I don't think the IRS's position is that a plan is prohibited from paying on a levy when the participant's benefits are not distributable. I think the IRS's position is that if the plan administrator wants not to pay on the levy because benefits are not distributable, the plan administrator MAY not pay it and the IRS cannot force payment until a distributable event arises. If the plan adminstrator wants to pay on the levy, the plan adminstrator MAY pay it.

I am leaning on letting the participant make the call. The participant can choose to satisfy his or her tax debt with plan assets, with other resources, or not postpone paying it whil accruing additional taxes and penalties.

What do you think?

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You may be right. But I'd be very concerned of the potential consequences if you end up not being right. The IRS has multiple hands in this particular pot. The folks who want to levy the plan want the money. The good folks at TEGE will tell you that they are more interested in whether the plan will retain its qualified status. I've seen nothing directly on point, so maybe the CGM's and FSA's you reference provide a citation that I've not seen. But the conversations I've heard over the years generally say that if the IRS wanted to, they could assert disqualification for honoring the levy prior to the point in time that a participant has the ability to receive money from the plan.

But I'm not batting 1000 in this thread, anyway, so it wouldn't surprise me to find such a citation.

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Bud:

For what it's worth, my analysis is:

1. The 10% penalty does not apply so there is no withholding with respect to it.

2. If the distribution could have been rolled over, it is subject to the 20% withholding rules.

3. If the participant is entitled to receive a current distribution, the plan would not be disqualified for paying out the money.

4. If the participant is not entitled to a distribution, then the IRS cannot force distribution.

5. I don't think that the participant should have any say whatsoever with respect to whether the levy is honored.

Kirk Maldonado

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The IRS right to levy on a plan asset is no greater than the right that the participant has, e.g., if the participant does not have the right to withdraw the funds that are levied on by the IRS, then the IRS does not have the right to payment of the funds. Paying funds to the IRS which are not available for distribution (before age 59 1/2) could disqualify the plan. The participant would have a claim against the plan for paying the money on the theory that had the plan not violated the distribution rules the levy could expire before the distribution could be made under the plan terms or that the payment could have been made from other sources. There is no percentage to the plan admin. in paying the funds to the IRS if the participant cannot elect a distribution. A polite letter of denial from counsel will be sufficient.

mjb

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Thanks guys. Your replies are very helpful.

None of the GCMs or the FSA refer to the (a)(13) regs. Reading between the lines, that tells me (1) if the a plan administrator pays the levy, there may be trouble from the TEGE branch, but the plan admin may rely on the regs, and (2) if the plan admin doesn't pay the levy, there may be trouble from the income tax branch, but the plan admin may rely on the GCMs and FSAs.

In every one of our plan's cases, the participant wants the IRS to levy on their account because he or she wants to interest and penalties to stop asap. It makes sense to us, so we want to pay the levy.

Kirk, if we don't let the participant make the decision and we establish a pattern or a procedure to pay tax levies on participant accounts, there may be a participant in the future who doesn't want it paid. We have a large plan (over 30K), a fortune 100 company and see this come up 4 or 5 times a year. I wonder if it's worth the risk to make paying tax levies standard procedure.

mbozek's concerned that the participant would have a cause of action. I'm not so sure because payment of the tax levy doesn't violate antialienation. I'm not even sure it's a distribution. The participant has rights to his or her benefits. When h/h account is levied, I don't see the levied amount as h/h benefits. I think it belongs to the government, like benefits that belong to a alt-payee and no longer to the participant.

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In our situation, we have a participant who is not entitled to a distribution under the plan, so we are sending a polite response to the IRS stating that. My next question then is what happens now? Do we need to establish a separate account for the funds in the participant's account as of the date we received the levy and once the participant is entitled to a distribution, distribute the amount as of the levy date directly to the IRS?

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If you do not honor the levy, I see no reason to treat the participant differently. In fact, I would think it inappropriate to do so. If the plan has individually directed accounts and the participant wants to ensure that the funds are not diminished due to adverse investment performance, the participant can move the funds to the investiment that matches the participant's desires.

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That makes sense. Once the participant is entitled to a distribution, is the plan then obligated to distribute the the funds subject to the levy to the IRS?

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Bud:

You would refuse to honor an IRS levy simply because the participant doesn't want to lose the money? Have you ever had an employee that was ecstatic about paying taxes?

I'd much rather have a deadbeat employee unhappy with me than face the IRS and the court for refusing to honor an IRS levy where the benefits are currently available to the participant.

Kirk Maldonado

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My understanding is that once the participant is in fact entitled to a distribution, the plan must then distribute those funds subject to the levy to the IRS. Is this correct?

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Bud: I dont think you can pay out a benefit if a distributable event (e.g. attainment of age 59 1/2) has not occurred because the IRS has no greater right to a taxpayer's assets than the taxpayer. Otherwise the IRS could levy on vested accrued benefits in a DB plan prior to the date the benefits are payable (without regard to forfeiture if the particpant died prior to retirement). If the benefits are distributable then the levy must be paid to the IRS and the employee has no recource against the plan.

Also under the assignment of interest rule the taxpayer who earns a retirement benefit is liable for taxation even if the benefits are paid to another person, Duran v. CIR, 123 F2d 324, unless there is a statutory exemption, e.g., a QDRO. I dont know of any exemption from taxation for retirement benefits collected by the IRS because it would provide a tax benefit for deliquient taxpayers by allowing them to pay the back taxes with pre tax dollars. Congress has provided relief for hardship situations. There is an exemption from taxation of an IRA owner when the IRA assets are used by a trustee in bankruptcy to pay the debts of the IRA owner. IRC 1398(f).

mjb

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Kirk and Tonjer: I agree that paying a levy when the participant is entitled to a distribution is the right thing to do. My question is whether there is a problem with paying a levy when the participant is NOT entitled to a distribution and the participant WANTS the levy paid with his or her account.

mbozek says the plan administrator is prohibited from paying when the participant is not entitled. I don't think it's prohibited and I don't think it is required. I think it's permitted. None of my participants will complain if we pay it. In fact, they are asking the IRS to go after their accounts.

I think the IRS is at the mercy of the plan administrator. If the plan administrator doesn't want to pay it, the Service can't force payment if the vested benefits are not distributable (which is mbozek's point). If the plan administrator wants to pay it, the Service won't disqualify the plan because (1) it doesn't violate 401(a)(13) under the regs and (2) they caused the payment which, if you think about it, is like entrapment. If the plan administrator wants to pay it and the Service won't disqualify the plan, a non-consenting participant has no recourse because there is no law that says the plan administrator is prohibited from paying it when the benefits are not distributable.

I don't think the "the IRS has no greater right ..." principle means payment is prohibited. I think it means payment is not required.

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