Can the IRS Take Your IRA for Unpaid Taxes?

The Internal Revenue Service (IRS) has the authority to seize, or levy, an Individual Retirement Account (IRA) to satisfy unpaid federal taxes. While IRAs have protections from many creditors, these do not apply to the federal government collecting tax debt. Funds saved for retirement are not beyond the reach of the IRS. The process is not immediate and involves a series of required notifications before a seizure can occur.

Federal Protection Limits for IRAs

Federal law, such as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, provides protection for retirement assets against claims from creditors in bankruptcy proceedings. These shields help preserve retirement savings from being used to pay off debts like credit card bills or personal loans.

This protection, however, does not apply to the IRS. The agency’s authority to collect federal taxes is granted by the Internal Revenue Code, which supersedes the creditor protections in other statutes. Because the tax code is structured to ensure the collection of federal taxes, an IRA remains accessible to the IRS to satisfy a tax liability.

The IRS Levy Process on an IRA

Before the IRS can seize funds from an IRA, it must follow a legally mandated process. The procedure begins after the IRS assesses a tax liability and sends a Notice and Demand for Payment, which the taxpayer has neglected or refused to pay.

Following these initial steps, the IRS must issue a “Final Notice of Intent to Levy and Notice of Your Right to a Hearing.” This document warns the taxpayer of the seizure and provides a 30-day window to respond. During this period, the taxpayer can pay the debt, negotiate a payment alternative, or request a Collection Due Process (CDP) hearing.

If the taxpayer does not resolve the debt or appeal, the IRS sends a levy notice to the IRA custodian. The custodian must freeze the funds and hold them for a 21-day period before sending the money to the IRS. This hold gives the taxpayer a final opportunity to contact the IRS to arrange for the levy’s release.

Internal IRS procedures require additional review before levying a retirement account. Revenue officers are instructed to consider other assets for collection first and must obtain managerial approval before proceeding with an IRA levy.

Tax Consequences of an IRS Levy

When the IRS levies a traditional IRA, the amount seized is treated as a taxable distribution to the taxpayer. The levied funds are included in the taxpayer’s gross income for the tax year in which the seizure occurs and must be reported as income on that year’s tax return.

Normally, distributions from an IRA before age 59½ are subject to a 10% early withdrawal penalty. However, an exception exists for funds taken via an IRS levy, so distributions from a retirement plan for this reason are not subject to the penalty.

The tax treatment for a Roth IRA differs. The portion of the levy from the owner’s original contributions is distributed tax-free. Any portion from investment earnings is taxable if the distribution is not “qualified.” The same exception to the 10% early withdrawal penalty applies to levies on Roth IRAs.

IRS Collection Alternatives

Taxpayers facing a potential IRA levy have several options to resolve their tax debt and avoid seizure. One common method is an Installment Agreement, which allows a taxpayer to make monthly payments over a set period to pay off the tax debt in full.

Another option is an Offer in Compromise (OIC), which allows certain taxpayers with financial difficulty to resolve their liability for a lower amount than originally owed. The OIC program has eligibility requirements based on the taxpayer’s ability to pay, income, expenses, and asset equity.

For individuals facing severe economic hardship, the IRS may place their account in Currently Not Collectible (CNC) status. This temporarily suspends collection efforts, though the IRS will periodically review the taxpayer’s financial situation to see if their ability to pay has improved.