Lien foreclosure suits by the IRS

Levy couldn’t force early distribution of taxpayer’s state retirement account Chief Counsel Advice 200819001


In Chief Counsel Advice (CCA), IRS has concluded that it can’t, after serving a notice of levy on a state retirement fund, exercise the taxpayer’s right to suspend her membership in the fund in order to obtain an immediate distribution of her assets in the fund when she hasn’t yet reached retirement age.

Facts. Married taxpayers, who we’ll call Betty and Bob, have an unpaid joint income tax liability. Betty is 50 years old and not currently receiving benefits from a state retirement fund with which she has an account. Although she no longer works for the state, she has obtained other employment and is not retired. Under the terms of the retirement fund, she may elect to suspend membership in the retirement fund and receive a distribution of all assets in her account. If she doesn’t elect, when she reaches retirement age, she’ll be eligible to receive her retirement benefits from the account.

IRS served a notice of levy on the state retirement fund in order to collect Betty’s assets in the fund. The fund will not distribute the assets unless Betty elects to suspend membership in the fund. The IRS revenue officer asks whether IRS can “elect” on Betty’s behalf to suspend her membership in the fund.

Background. Under Code Sec. 6331(a), IRS can levy on all property and rights to property of a taxpayer on which there is a federal tax lien in order to collect delinquent taxes. Only property that is specifically enumerated in Code Sec. 6334(a) is exempt from levy, and funds in a state retirement fund aren’t so enumerated.

Can force immediate distribution. The CCA concluded that IRS can’t exercise Betty’s right to suspend membership in the retirement fund in order to obtain an immediate distribution of her assets in the fund when she hasn’t yet reached retirement age. IRS can levy on a retirement plan even if a participant has no immediate right to receive benefits. But, the fund is not obligated to turn over any assets under the levy until the taxpayer reaches the age in which she is eligible for retirement benefits under the plan or she voluntarily suspends her membership in the plan.

The CCA reasoned that while IRS’s levy attaches to Bob and Betty’s interest in the state retirement fund, it only extends to property rights and obligations that exist at the time of the levy. (Reg. § 301.6331-1(a)) Obligations exist for purposes of a levy when the liability of the obligor is fixed and determinable, even though the right to receive payment is deferred until a later date. Thus, even if Betty isn’t currently receiving benefits from the retirement fund, if a present right to a future payment exists, the levy reaches that present right. (Rev Rul 55-210, 1955-1 CB 544)

On service of a notice of levy, IRS steps into the shoes of the taxpayer and acquires whatever rights to the property she had possessed before the notice of levy. As a result, the levy only reaches property rights that exist at the time of the levy. Although IRS’s levy reaches Betty’s future right to retirement benefits when she reaches retirement age, it doesn’t entitle IRS to compel suspension of her membership in the fund. The state retirement fund would only have to honor the levy when the benefits become payable to the taxpayer under the terms of the retirement fund.

As an alternative to a levy, the CCA concluded that IRS may bring a lien foreclosure suit under Code Sec. 7403, i.e., an action in federal district court, to reach the funds. Lien foreclosure suits are typically brought where a third-party’s rights are involved so that the courts can resolve all parties’ rights to the property and force a sale. Because the administrative levy in this situation would not immediately entitle IRS to any assets, the CCA viewed a lien foreclosure suit as appropriate.

    Observation: IRS enforces its tax lienby one of two methods: sale of seized property; or suit to enforce the lien. If IRS sues before it seizes a taxpayer’s property, it can still avail itself of the seizure power later. Bringing suit doesn’t foreclose that right. The ultimate end of either method is to sell the liened property for the tax debt. When IRS sues to enforce a lien, it is actually bringing a suit to foreclose its right in the property.