IRS Law Blog

Here is an issue to be aware of before filing a Chapter 7 bankruptcy on the IRS:

I just completed a Chapter 7 bankruptcy.  It was determined to be a no-asset case.  A few months later,  I got a letter from an IRS Revenue Officer stating that even though the taxes were discharged, they are enforcing their tax lien post-bankruptcy on my retirement account, and want to seize the account.  I thought that the retirement account was protected, and anyways, weren’t the taxes eliminated?

To begin with, if the IRS did not file a tax lien before you filed the Chapter 7 and your taxes were discharged, the IRS cannot take your retirement account after the bankruptcy is over.  Without the tax lien, the IRS has no security in the retirement account, and no claim to it.  Case closed.

But what happens if the IRS has filed a tax lien against you (and your property) before your bankruptcy started?

How a tax lien can survive bankruptcy and impact your retirement account

First, it is important to understand the legal concept that a Chapter 7 bankruptcy does not automatically cause Federal tax liens to be released; it is discretionary with the IRS after the bankruptcy is over.  In other words, tax liens survive a Chapter 7 bankruptcy discharge, and the IRS can pursue enforcement of their lien against your property.

(For practical purposes, however, if you have minimal assets, the IRS does not pursue your assets or the lien after the bankruptcy is concluded, and tends to be fair in releasing the lien post-bankruptcy. Retirement accounts come under IRS scrutiny in enforcing their lien post-bankruptcy as these assets often have enough value to yield significant recovery.)

Second, know that retirement accounts are protected assets in bankruptcy; this means that bankruptcy law will allow you to come out of bankruptcy with your retirement account intact. In other words, retirement accounts are assets that are not lost in bankruptcy.

Now put these two parts together:  tax liens survive bankruptcy, and so do retirement accounts.  Hence, a surviving tax lien attaches to a retirement account, and the IRS maintains an interest in it post-bankruptcy, even if the underlying taxes were discharged.

But do not lose faith:  Even if you have a tax lien attaching to your retirement account after bankruptcy, there are still defenses to permit you to keep it and defeat the IRS’s desire to seize it.

Defenses to IRS seizures of retirement accounts after bankruptcy

Your primary defense to an IRS retirement account seizure is that the IRS stands in your shoes as it relates to their ability to take your property, including retirement accounts.  The IRS has the same rights to your property that you have – if you have no rights to an asset, neither does the IRS.  This applies equally to whether the IRS is seeking a post-bankruptcy enforcement of a tax lien or just a straight seizure without any bankruptcy involvement.

Applying this concept to retirement accounts means that if you are still employed, and cannot access your retirement account until separation from employment, death, or disability, neither can the IRS.  The IRS may have a tax lien on your retirement account, but has no right to enforce it because you have no right to the property.

Additionally, you should be familiar with the three factors in the Internal Revenue Manual used by the IRS in considering whether to levy and seize retirement accounts.

Here are the three factors to put to the IRS to show that retirement account seizure is not an administrative priority:

1.     Before levying on a retirement account, the IRS is required to first consider collection alternatives before levying on the retirement plan, including monthly payments.  The IRS generally does not desire to take retirement accounts; it tends to make for bad public policy.

2.     The IRS is generally interested in taking retirement accounts only if the conduct leading to the tax liability was flagrant. The IRS generally wants retirement accounts to pay a tax liability in cases of egregious behavior. Contributing to the retirement account while the unpaid taxes were accruing and a history of employment tax problems are factors in favor of account seizure.

3.     The final factor in whether the IRS will take a retirement account is whether you depend on the money in the retirement account, or will depend on it in the near future. Again, the IRS tends to be sensitive to retirement account seizures, and proving that the money in the account is important to meeting everyday living expenses can be a factor to keeping the money.

Make sure the Revenue Officer assigned to your case is aware of these factors and arguments; a post-bankruptcy Federal tax lien does not mean your retirement account is doomed – there are defenses.