Protect Yourself from IRS Post-Bankruptcy Retirement Account Seizure

Mary F. Lundstedt, Esq., Associate
Carly Steren, Legal Intern

Many taxpayers are surprised and alarmed to learn that Federal tax liens survive a bankruptcy discharge. In other words, the IRS can still enforce its lien and seize property, even though the underlying taxes were discharged. Perhaps even more alarming to taxpayers, is the fact that even retirement accounts are still vulnerable to post-bankruptcy seizure.

Taxpayers facing the threat of post-bankruptcy retirement account seizure have the best chance of reaching a favorable outcome if they work with an experienced tax professional, who understands the intricacies of the IRS procedures involved.

Background

Federal Tax Liens

Under Internal Revenue Code (IRC) §6321:

If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.

A lien imposed by IRC §6321 attaches at the time of assessment, and once filed, it attaches to any property acquired thereafter.[1] This type of statutory lien is known as a "secret lien" because it arises at assessment, without the necessity of a notice filing.

In general, an IRS lien survives bankruptcy unless it is invalidated by a bankruptcy provision.[2]

Bankruptcy

Upon filing a bankruptcy petition, a bankruptcy estate is created, which is comprised of "all legal and equitable interests of the debtor in property as of the commencement of the case."[3] Unless certain exclusions apply, all of the debtor's prepetition property becomes part of the bankruptcy estate and subject to creditors' claims.

The debtor may exempt certain property from the bankruptcy estate (such as retirement assets) to ensure that the exempted property will be there for debtor to begin his or her "fresh start."[4] Significantly, exempt property is initially estate property; however, during the bankruptcy case, it is returned to the debtor.[5] Exempted property is liable for prepetition debts secured by tax liens where a Notice of Federal Tax Lien (NFTL) has been filed.[6]

Furthermore, Federal law excludes some assets from the bankruptcy estate such as plans qualified under the Employee Retirement Income Security Act of 1974 (ERISA). ERISA contains an anti-alienation provision which bars creditors from enforcing liens against ERISA qualified plans, however, the federal government is excepted from this provision.[7] It is important to understand that, in contrast to exempt property, excluded property never becomes part of the bankruptcy estate.

Per 11 U.S.C. §544, the trustee in bankruptcy is entitled to prevail against unfiled tax liens outside of bankruptcy. In CCA 200634012, the IRS states that "this power only extends to avoiding such liens on property of the estate and not on property excluded from the estate." Specifically, the IRS considers that the trustee, as representative of the bankruptcy estate, will only have such avoidance powers enforced to the estate's benefit.[8] As such, the IRS noted that:

It is our position that the trustee's lien avoidance powers are limited to the extent that the lien avoidance benefits the bankruptcy estate and brings property of the debtor into the bankruptcy estate for distribution to creditors. Since the Supreme Court has held that excluded property is not property of a bankruptcy estate subject to claims of creditors, the excluded property should not be subject to a bankruptcy trustee's avoidance powers.[9]

Note that the Internal Revenue Manual (IRM) clarifies the treatment of exempt and excluded property as follows:

1. "[T]he Service may collect discharged taxes from property that is exempt from the estate if a valid NFTL was filed pre-petition."[10]

2. "A NFTL is not required to pursue collection from the abandoned or excluded assets after the bankruptcy discharge."[11]

Significantly, per 11 U.S.C. §524(a)(2), when a bankruptcy discharge order is entered, the debtor is protected from personal liability for the discharged liabilities. Unfortunately, the debtor is not protected from post-discharge enforcement of liens existing when the bankruptcy petition was filed.[12]

Limits on Post-Bankruptcy IRS Retirement Account Seizure

If the IRS threatens to seize a taxpayer's retirement account post-bankruptcy, it is important for the taxpayer to defend themselves and to remind the IRS of its own policy and required procedures before such action may take place. According to the IRM, IRS policy dictates that because retirement accounts are for the taxpayer's future welfare, the IRS must take specific steps prior to levying an account, including: (1) looking for alternative solutions; (2) finding taxpayer's conduct "flagrant;" and (3) considering taxpayer's dependency on the account for necessary living expenses.[13]

The first step that the IRS must take before seizing a retirement account is to determine whether there is other property or assets which can be levied instead. If the IRS finds other property, or if a payment agreement is feasible, then the IRS is under the obligation to consider these alternatives before levying the retirement account.[14] The IRM notes that "[l]evy determinations are made on a case-by-case basis and Revenue Officers must exercise good judgment in making the determination to levy."[15]

Next, the IRS is required to "determine whether the taxpayer's conduct has been flagrant."[16] The IRM provides numerous examples of what should be considered as "flagrant" conduct.[17] For example, taxpayers convicted of tax evasion or assessed a fraud penalty for the tax debt demonstrate flagrant conduct.[18] Significantly, the IRM emphasizes that extenuating circumstances, such as situations beyond the taxpayer's control (illness, loss of family, identity theft, etc.,) may be considered as mitigating flagrant conduct.[19] If the IRS find no evidence of flagrant conduct, then the IRS is not permitted to levy the retirement account. On the other hand, the IRM clarifies that a levy may need to be served based solely on flagrant conduct in cases where it is impossible to make determinations in steps 1 and 3. Specifically, the IRM provides that:

Taxpayers who have demonstrated a pattern of uncooperative or unresponsive behavior that delays the collection of the tax due, e.g., failing to meet established deadlines, failing to attend scheduled appointments, documented broken promises to pay, failing to respond to IRS employee's attempts to contact. In such cases, determining alternatives and the taxpayer's dependence on the money in the retirement accounts (final step) may not be possible, so a levy may need to be served without making those determinations.[20]

Third, the IRS must consider whether the taxpayer depends on the retirement account funds (or soon will) for necessary living expenses. The IRM directs the IRS to use the standards in IRM 5.15 (07-24-19) to establish necessary living expenses.[21] Life expectancy tables in Publication 590-B, Distribution from Individual Retirement Arrangements (IRAs) are used to "estimate how much can be withdrawn annually to deplete the retirement account in the taxpayer's remaining life."[22] The IRS must also consider any special circumstances involved, such as extraordinary expenses or other sources of income available to cover expenses during retirement. If the IRS establishes the taxpayer's dependency on the funds, the IRS is instructed not to levy the retirement account.

Finally, it's worth remembering that "a levy only reaches the taxpayers present rights under the plan."[23] Thus, if you have no right to access your account yet, then the IRS doesn't either.

Conclusion

Again, Federal tax liens survive a bankruptcy discharge. Even retirement accounts remain vulnerable to post-bankruptcy seizure. Although the IRS's own procedures for such seizure are meant to make such seizure is more of a "last resort," unfortunately, some IRS officials are aggressive in their pursuit. Taxpayers are well-advised to seek advice from a tax professional knowledgeable in this area.

If you find yourself facing an IRS threat of post-bankruptcy (Chapter 7 or Chapter 13) retirement account seizure, contact Frost & Associates, LLC today at (410) 497-5947.


[1] Glass City Bank v. United States, 326 U.S. 265, 66 S. Ct. 108, 90 L. Ed. 56 (1945). Note, however, that a prepetition tax lien for discharged taxes is inapplicable to property acquired after the petition is filed. In re Conner, 27 F.3d 365, 366 (9th Cir. 1994).

[2] In re Bisch, 159 Bankr. 546 (B.A.P. 9th Cir. 1993).

[3] 11 U.S.C. §541(a).

[4] 11 U.S.C. §522.

[5] 11 U.S.C. §541(a).

[6] 11 U.S.C. §522(c).

[7] 11 U.S.C. §541(c)(2). Patterson v. Shumate, 504 U.S. 753, 112 S.Ct. 2242 (1992).

[8] CCA 200634012 citing Moore v. Bay, 284 U.S. 4 (1931).

[9] Id. See also Rich v. United States, 197 B.R. 692 (1996), (where parties agreed that property excluded from bankruptcy estate is subject to statutory tax lien where Notice of Federal Tax Lien has not been filed yet).

[10] IRM 5.9.2.10.1.1(3) (08-05-2016).

[11] IRM 5.9.2.10.1.1(4) (08-05-2016), citing IRM 5.9.17.4.2(1) (12-09-2016).

[12] In re Isom, 901 F.2d 744 (9th Cir. 1990).

[13] IRM 5.11.6.3 (07-08-2019).

[14] IRM 5.11.6.3(4) (07-08-2019).

[15] Id. citing IRM 5.11.1.3.1 (11-09-2017).

[16] IRM 5.11.6.3(5) (07-08-2019).

[17] IRM 5.11.6.3(6) (07-08-2019). Note that voluntary contributions made to retirement assets after the bankruptcy petition was filed are not to be considered flagrant.

[18] Id.

[19] Id. citing IRM 5.1.10.3.2(9)(b). See also, IRM 5.11.6.3(6)(k).

[20] IRM 5.11.6.3(6)(K) (07-08-2019).

[21] IRM 5.11.6.3(7) (07-08-2019).

[22] Id.

[23] IRM 5.11.6.3(8) (07-08-2019).

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