Tax debt during retirement: How the IRS responds
The plan was to retire, payoff your house, maybe travel, devote more time to hobbies, and spend time with the family.
Then some mistakes were made in paying your taxes – maybe from a business you owned – and the IRS came calling.
Tax liens were filed on your house, ruining your credit. To make matters worse, you are always looking over your shoulder, fearful that the IRS will levy your wages, social security or retirement.
Some retirement, huh?
Let’s separate the myths from the facts so you can make it through the golden years intact and with some peace from the IRS.
Here are five things you need to know about how the IRS views taxpayers who owe money at retirement age:
1. Your Retirement Assets. In most situations, the IRS is very cautious about taking retirement accounts from taxpayers who are at retirement. It is generally viewed by the IRS as bad policy, and makes for poor public relations. The IRS tends to reserve seizing retirement accounts in severe situations of noncompliance.
Your risk for losing your retirement account to the IRS is based on a combination of factors, including the following:
- Can you withdraw the funds? Simply put, the IRS stands in your shoes when it comes to retirement accounts. If you don’t have access to make a withdrawal from your retirement account, neither does the IRS. Note that being able to borrow money from the account is not enough control over the funds to give the IRS access. For example, if you are still employed and have a 401k, the IRS has no rights to levy your retirement account. Also, if you have a 401k and have not reached age 59 1/2, the IRS cannot take your retirement account. In these two examples, you cannot reach the money by making a cash withdrawal, and neither can the IRS.
- How much do you owe the IRS, and how much is in your retirement account? If you owe the IRS $25,000 and have $5,000 in your retirement account, chances are the IRS is not interested. Seizing retirement accounts requires high-level management approval, and a balancing should occur by the IRS as to whether your situation dictates extreme measures. On the other hand, if you owe the IRS $500,000 and have $500,000 in a retirement account, your risk is more serious.
- Are you cooperating with the IRS? Because seizing retirement accounts is usually a sensitive matter for the IRS, they are often looking for a reason to clean you out. Don’t give it to them. Be responsive and courteous. Meet all deadlines given to you. And by all means, stay in compliance on your current filing and payment requirements. The IRS views a problem that is in the past much differently than a problem that is continuing. Don’t add fuel to the fire; when your head is in the mouth of the bear, say nice bear.
- Have you been contacted by an IRS Revenue Officer? Because levying retirement accounts tends to be a fairly big deal to the IRS, they need a local field agent, known as a Revenue Officer, to handle your case to even think about making it happen. If you have not been contacted by a local IRS collection agent, chances are you are not a risk. Letters and calls from the IRS Automated Collection Service should not amount to any degree of risk of losing your retirement. Automated Collection Service is an IRS call center – they do not have the training to get approval for a retirement account seizure.
- Does your situation fall within Internal Revenue Manual 22.214.171.124., Funds in Pension or Retirement Plans? This defense requires the IRS to consider three factors before levying your retirement accounts: First, can you make alternate arrangements to repay the IRS without having to resort to your retirement account? This can include monthly payment plans as an alternative to losing your retirement, even if the payments do not pay the IRS back in full. Second, did you act flagrantly in accruing the tax liability? Flagrant conduct is defined by the IRS to include tax evasion, tax fraud, illegal source income, and not cooperating with the IRS. Lastly, will you need the money in your retirement account to live on and pay your bills? If so, IRS should not put you in an economic hardship by taking your retirement.
2. Your Social Security Income. At worst, in most situations the IRS will limit itself to taking 15% of your social security benefits. If you cannot afford to lose 15% of your social security to the IRS, they need to know that. To stop the IRS from taking your social security – or to have an existing social security levy released – the IRS will need a financial statement from us proving that you cannot afford losing the money. The IRS wants us to use one of their financial statements – that is usually IRS Form 433A or 433F.
After completing the forms and providing supporting documentation (like bank statements and proof of living expenses), the IRS will back off from your social security if it is creating a hardship. The IRS calls this “currently uncollectible,” meaning they agree that you cannot afford to pay them back, and will mark their computers to not take any action to collect against you.
The IRS can also consider a payment plan as an alternative to taking your social security at a monthly amount that is less than what a social security levy would cost you.
3. Your House. Like retirement accounts, the IRS tends to tread lightly on putting a retiree out on the street. Generally speaking, the same IRS considerations for retirement accounts apply to houses. The IRS generally does not want to do it – again, bad policy. Cooperation, compliance, case assignment to Revenue Officer, and the ability to reach repayment alternatives to losing your house all factor in to the IRS decision-making process.
Most years, the IRS makes less than 500 seizures of real and personal property out of millions of tax accounts. Clearly, it is not a top priority in most cases, especially when adding the retirement factor.
And keep in mind one big factor about your house and the IRS: There needs to be equity in it for the IRS to take it. For example, if your house is worth $100,000 and you owe your bank $100,000, the IRS cannot take it.
4. Settlement with the IRS. Additionally, you may be interested in pursuing a settlement with the IRS to put the debt behind you. Known as an offer in compromise, the IRS can legally forgive your debt and give you a fresh start. In return, they will usually need you to pay them (1) the equity in your assets (including your retirement account and house) and (2) the amount of money you could pay them in an installment agreement, put at a present value of between 12 and 24 months. The IRS will give you up to 24 months to pay the amount of the settlement to them; after that, they will release all tax liens against you and give you a fresh start for the rest of your life.
5. IRS Statute of Limitations on Collection. Also, bear in mind that the IRS does have a limited time to come after you during retirement. The IRS has 10 years to collect a tax debt, so if you are 62 and owe the IRS from when you were 53, they may have only one year left to collect. This is called the statute of limitations on collection. When time is up for the IRS, you will no longer legally owe the debt to them. The IRS will make an entry in your record to clear your account balance to zero. Tax liens also will no longer be effective against your property.
No one plans to enter retirement with an IRS debt. The IRS usually does not want to upset your retirement, and even if they do, there are defenses to keep your life intact. With careful planning and negotiation, the IRS can be held at bay, permitting you to keep some shine on the golden years.