What to do if you agree you owe your back tax bill, want to pay it off as soon as possible, but really can’t afford to make payments on an Installment Agreement?

If you have a retirement account you might think that liquidating that account to pay down the debt makes sense.  First, it’s likely that a tax debt is growing faster than your retirement (15% versus 5%-7%-9%?).  Second, carrying a tax debt over $25,000 on an Installment Agreement might require a persistent tax lien that can’t be easily negotiated, and a lien makes all sorts of other things expensive by ruining a credit score.  Third, paying more aggressively towards the debt opens up a swifter abatement of penalties.

Problem is, early withdrawal from retirement means paying taxes and early withdrawal penalties of 10%.  That means you may be having to take as much as 50% more than you “need” to have enough to pay the debt.  10% penalty doesn’t sound like a lot.  But, when 10% is ON TOP OF THE REGULAR TAXES, it hurts.  Recall that tax brackets run from 10% up to 39%, meaning the penalty might DOUBLE the cost of early withdrawal, or push you into a nearly-50% tax bracket.

However, the IRS code has traditionally held an exception to this penalty – the liquidation by IRS levy.  That is, if the IRS takes the account, you don’t pay the 10% penalty.

So, for years, our firm occasionally requested that the Revenue Officers on certain cases levy our clients’ retirement accounts.   With very rare exceptions, they declined.

The reason seemed to be that, even with the taxpayers’ ‘permission’, the processes for levies on retirement account were either unknown or untenable for our RO’s.  They didn’t know how, or didn’t want to bother.  They’d politely decline, then insist that either we pay the penalty and liquidate ourselves, or they’d threaten to levy income and bank accounts until the taxpayer would agree to an onerous Installment Agreement.

Here’s a scenario:  the delinquent taxpayer owes $125,000 in back taxes from a several bad years of self-employment, makes $150,000/year and is putting two kids through college.  They also have $100,000 in a 401k.   We know that IRS doesn’t think that helping your kids through college is an “allowable” expenses in their analysis of an Installment Agreement.  So, this RO is seeing thousands of dollars per month available in an IA payment.  If the taxpayer liquidates the 401k, they’re giving up $28k in taxes, and another $10k in penalties.  Leaving the net $62k, which brings the debt down to $63k.  This debt is still too big for the simple Direct Debit Installment Agreement, so the RO is STILL wanting thousands per month in an IA, likely wasting resources on the inevitable appeal of their determination.  If they’d just levy the thing, debt is then down to $53k, in striking distance of a simple IA that keeps the kids in college.

Now, the IRM allows them to do it.

But, they still kinda don’t.  At least, we’ve been trying since they added the provision last year and we haven’t seen one go through.  Problem is, they created the provision for the taxpayer to request the levy, but they didn’t remove the procedural hoops that the RO has to go through to get it done.  So, an inexperienced or overworked RO isn’t going to get it done very quickly.

Granted, I like that there’s somebody looking at the whole thing to make sure RO’s aren’t unduly pressuring taxpayers into a “voluntary” levy request.  But, it’s feeling like this needs another round of consideration to keep this from being one of those several programs that exist in theory in the IRM, but nobody has ever seen one.  (I see you Effective Tax Adminstration OIC  and Interests-of-the-Service Lien Withdrawal.).

So, please, IRS powers that be – streamline this thing, give us a form to use, so we can finally and easily, well, MAKE A BIG PAYMENT TOWARDS A TAX DEBT?