NTA Blog: IRS Policy Needs to Reflect the Reality of Retirement for Today’s Taxpayers

November 8, 2017

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Unlike private creditors, the IRS has wide discretion to exercise its administrative levy powers. Internal Revenue Code (IRC) § 6331(a) says the IRS can generally “levy upon all property and rights to property.” The IRS must make notice and demand for payment and in most instances provide collection due process (CDP) rights prior to levy. And under IRC § 6334, the IRS is prohibited from levying on certain sources of payments, such as unemployment benefits and child support. But overall, the IRS can cast a large net when it chooses to levy a taxpayer’s property, including funds in retirement accounts.  

However, the IRS takes a conflicting approach to funds in retirement accounts. On the one hand, the IRS considers retirement accounts to be “special” and created guidance particular to retirement accounts because “retirement vehicles provide for the taxpayer's future welfare.” (See IRM 5.11.6.3). However, a recent change in IRS policy has all but made the “special” guidance meaningless. Furthermore, the IRS refuses to take action to require meaningful analysis when projecting a taxpayer’s financial circumstances into the future.   

This is an important policy issue. According to one source, 45 percent of working-age households have no retirement account assets. The situation is particularly bleak for low income individuals. In one survey 96 percent of respondents earning at least $100,000 a year reported having at least some retirement savings, whereas only 44 percent of respondents making less than $40,000 per year had any retirement savings. Many of us will need to rely on some sort of retirement savings. The average worker who retires at age 65 will have only 38 percent of his or her earnings replaced with Social Security benefits, with an average annual benefit of under $16,000. (See Center on Budget Policy and Priorities). Therefore, as a matter of sound public policy, the IRS should adopt a policy that balances the future wellbeing of taxpayers with the need to efficiently collect taxes.

IRM 5.11.6.3 requires three steps of analysis before the IRS can levy on a retirement account:

  • Determine what property is available to collect the liability. If there is property other than retirement assets that can be used to collect the liability, or if a payment agreement can be reached, consider these alternatives before issuing a levy on retirement accounts;

  • Determine whether the taxpayer's conduct has been flagrant. If the taxpayer has not engaged in flagrant conduct, do not levy on retirement accounts; and

  • Determine whether the taxpayer depends on the money in the retirement account (or will in the near future) for necessary living expenses. If the taxpayer is dependent on the funds in the retirement account (or will be in the near future), do not levy the retirement account.

I’ve written about how the IRS must improve guidance for retirement levy cases here, here, and here. However, I am most concerned about two issues:

  • The IRS refuses to adopt a calculator to help determine if a taxpayer will rely on his or her retirement account now or in the near future; and 

  • The IRS recently adopted procedures to allow taxpayers to request levies on their retirement accounts.

Under IRM 5.11.6.3(7), IRS employees are instructed to use the standards in IRM 5.15 and the life expectancy tables in Publication 590-B to determine if a taxpayer will rely on the retirement account. This guidance is flawed. It provides no discussion on determining the taxpayer’s potential retirement income. It does not allow for factoring any growth in retirement funds or projecting future increases in necessary living expenses. There is no requirement to document the calculations, making it impossible to verify that a consistent method is used in all cases, or for taxpayers (or their representatives) to refute the IRS calculation. TAS has created a proposed model of a "retirement needs" calculator. The IRS has responded that it is confident IRM guidance allows for uniform calculations. (See Fiscal Year 2017 Objectives Report to Congress). I disagree that the IRM guidance ensures consistent treatment of taxpayers, and, more importantly, this approach does not achieve its purpose: to calculate if the taxpayer relies on the retirement asset now or in the near future.

My second concern relates to “voluntary” levies. First, I fundamentally disagree that a levy can be voluntary. The concept of a “voluntary levy” strikes me as absurd. It’s like a voluntary jail sentence or a voluntary fine. It’s a punishment, and nobody “volunteers” for a beating. The only sense in which it’s “voluntary” is that the taxpayer believes it’s better than the alternative. IRC § 72(t)(2)(A)(vii) imposes a ten percent additional tax on early distributions from a qualified retirement plan. However, this additional tax does not apply to distributions made from an account because of an IRS levy. As a result, some may view having a levy as a useful option to avoid the additional tax. Until recently, the IRM guidance for retirement levies clearly prohibited allowing a levy at a taxpayer’s request.  

The former IRM guidance read:

Because of the exception to the 10 percent additional tax made on account of a levy, occasionally taxpayers may ask the Service to levy the funds in the retirement accounts. Even though the taxpayer may be able to voluntarily withdraw money in a lump sum from a retirement account and apply it to the outstanding tax liability, do not levy on retirement assets at the request of the taxpayer.

IRM 5.11.6.3(3) now reads:

If the taxpayer requests the levy and you decide that the Service should levy after following steps 1 and 3 in paragraphs (4) and (7), respectively, before issuing the levy, verify that the taxpayer has received CDP rights. If the taxpayer has not received CDP rights, then follow the procedures in IRM 5.11.1.3.3.

The IRS made this change against TAS’s recommendation. When a taxpayer requests a levy on their retirement account, IRS employees are now instructed to forego a determination of flagrant conduct, which is otherwise necessary prior to levying on a retirement account. To its credit, the IRS accepted a TAS recommendation to make sure the taxpayer’s request is in writing and recorded in the case history.

In practice, it will not be as simple as the taxpayer choosing to pay his or her debt with a retirement account and asking for a levy. The IRS employee now will consider the retirement account while conducting his or her financial analysis under IRM 5.15.1.1. Once the retirement account is part of the analysis, a conversation about liquidating the asset can occur without regard to a flagrancy determination.  

The IRS justified this change by arguing that all taxpayers should be able to avoid the early withdrawal tax. While a “voluntary” levy may appear to be an attractive tool for taxpayers who want to avoid the additional ten percent tax on retirement distributions before the age of 59½, TAS is concerned that the special analysis that protects retirement accounts is lost with this new procedure. Taxpayers may not realize the long-term tradeoff they are making when they request this option or that the flagrancy determination provides a safeguard.  

The potential for abuse in this area is enormous. Since IRS employees are instructed to “emphasize to the taxpayer how much the Service expects from them rather than how the Service expects them to spend their money,” it is easy to see how in the normal course of working a collection case, the existence of a retirement account will now become a routine part of a financial analysis stripped of the necessary flagrancy determination – a determination that is the bulwark of the compelling public policy to encourage retirement savings and thus avoid poverty among the elderly. The typical taxpayer will feel pressure to give up his or her retirement account when it is part of a financial analysis and the IRS employee cannot establish flagrant conduct on the part of the taxpayer. In short, with this IRM change the IRS has reversed decades of sound public policy and is eroding the retirement security of U.S. workers.

Congress has granted the IRS the ability to levy on retirement accounts. However, given the impact this will have on Americans’ future wellbeing, the IRS should exercise this option only when the taxpayer’s behavior is flagrant and when the levy will not place the taxpayer in a situation where he or she cannot function in retirement. Last, adopting the use of a retirement calculator, such as the one TAS proposes, will allow for sufficient and consistent analysis prior to levying on a retirement account. Given the important issues at stake, it is not too much to ask that the IRS adopt our recommendation.

The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate is appointed by the Secretary of the Treasury and reports to the Commissioner of Internal Revenue. However, the National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.