Can the IRS Issue a Levy on Your 401k?

An Internal Revenue Service (IRS) levy is a legal seizure of property to satisfy an outstanding tax debt. This action allows the agency to take money from financial accounts or seize and sell assets. Retirement accounts, including 401k plans, are not shielded from this process. The IRS is authorized to levy retirement funds when a tax liability remains unpaid.

The IRS Levy Process on a 401k

The IRS levy process begins after the agency assesses a tax liability and sends a Notice and Demand for Payment. If the taxpayer does not pay the amount due, the IRS will issue subsequent notices. These communications inform the taxpayer of the delinquent amount and accruing penalties and interest.

The final step is the issuance of a “Final Notice of Intent to Levy and Notice of Your Right to a Hearing,” often designated as Letter 1058 or LT11. This document is the last warning before the IRS can legally seize assets. After this notice, a 401k is at risk of being targeted.

Upon receiving this final notice, the taxpayer has 30 days to request a Collection Due Process (CDP) hearing with the IRS Office of Appeals. Filing a timely CDP hearing request legally prevents the IRS from proceeding with the levy while the appeal is pending. This pause provides an opportunity to negotiate a resolution to the tax debt.

Executing the Levy on a 401k

If the 30-day period to request a hearing expires, the IRS can proceed with the levy. The agency sends Form 668-R, “Notice of Levy on Retirement Plans,” to the 401k plan administrator. The plan administrator must then liquidate the necessary portion of the taxpayer’s 401k assets and remit the funds to the IRS.

Tax Consequences of a 401k Levy

The amount the IRS seizes from a 401k is treated as a taxable distribution. This forced withdrawal is considered income in the year the levy occurs and must be reported on the individual’s tax return.

This can create a new tax liability. For example, if the IRS levies $30,000 from a 401k, that amount is added to the taxpayer’s income for the year, potentially pushing them into a higher tax bracket. The plan administrator will withhold a mandatory 20% for federal income taxes, but this may not cover the total tax due.

The 10% early withdrawal penalty for distributions taken before age 59½ is waived on funds taken via an IRS levy. However, the income tax impact remains. This can create a new tax debt from the action meant to resolve an old one.

Avenues for Resolving the Underlying Tax Debt

Negotiating a resolution with the IRS is the most effective way to prevent a levy on a 401k. When a formal agreement is in place, the IRS will halt collection actions. Several programs are available for taxpayers to address their liability.

Installment Agreement (IA)

An IA allows taxpayers to make structured monthly payments over an extended period, often up to 72 months. This option is for those who can pay their debt in full over time but lack the immediate funds. Once an IA is approved and payments are made on time, it protects assets from seizure.

Offer in Compromise (OIC)

An OIC allows a taxpayer to settle their tax debt for less than the full amount owed. This option is for those facing financial hardship who cannot pay the full amount. The IRS evaluates an OIC based on the taxpayer’s ability to pay, income, expenses, and asset equity.

Currently Not Collectible (CNC)

Taxpayers who cannot afford basic living expenses due to economic hardship may be placed in CNC status. This is a temporary suspension of collection activities, including levies. While in CNC status, the underlying debt remains and continues to accrue interest and penalties, but the IRS stops collection attempts.