Close only counts in horseshoes and hand grenades as the saying goes--and tax relief provisions are in neither category as the taxpayer in the case of Thompson v. United States, Case No. 3:18-cv-01675, US DC ND CA discovered. The problem arose over an exception to the 10% premature distribution tax of IRC §72(t) for distributions made on account of a levy under IRC §6331.[1]

The exception, found at IRC §72(t)(2)(A)(vii) provides the early distribution tax does not apply “made on account of a levy under section 6331 on the qualified retirement plan.”

IRC §6331(a) describes the levy as follows:

If any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary to collect such tax (and such further sum as shall be sufficient to cover the expenses of the levy) by levy upon all property and rights to property (except such property as is exempt under section 6334) belonging to such person or on which there is a lien provided in this chapter for the payment of such tax. Levy may be made upon the accrued salary or wages of any officer, employee, or elected official, of the United States, the District of Columbia, or any agency or instrumentality of the United States or the District of Columbia, by serving a notice of levy on the employer (as defined in section 3401(d)) of such officer, employee, or elected official. If the Secretary makes a finding that the collection of such tax is in jeopardy, notice and demand for immediate payment of such tax may be made by the Secretary and, upon failure or refusal to pay such tax, collection thereof by levy shall be lawful without regard to the 10-day period provided in this section.

However, before the levy can take place, the IRS is required to give notice in accordance with IRC §6331(d) unless the jeopardy assessment provision of IRC §6331(d)(3) applies. The notice in question must be sent at least 30 days before the IRS is allowed to levy the property in question.[2]

In this case, the taxpayers withdrew more than $1 million from the IRS after receiving the notice of intent to levy under IRC §6331(d). As the District Court opinion states:

...Plaintiffs state in their Opposition brief (though not in their complaint) that the IRS “took all the legally required steps to set in motion a levy, issuing Final Notices/Notices of Intent to Levy on December 12, 2012.” Opposition at 3 (emphasis added). Plaintiffs contend the IRS “intended to file a potentially ruinous Notice of Federal Tax Lien at an early time” and that this posed a “threat to Mr. Thompson’s business, his livelihood and his ability to generate funds sufficient to pay the balance of the liability over time.”

However, the Court noted, that the IRS had not actually levied the account in question--merely gave notice that they had an intent to do so. Rather, as the Court noted:

Here, Plaintiffs’ retirement account was not, in fact, levied and the distribution was triggered not by any act of the IRS but by Plaintiffs’ own acts. In other words, Plaintiffs were actively involved in the distribution.

While the taxpayer had cited cases where the exception had been allowed without an actual IRS levy, the Court noted that, in those cases, the funds had been taken without the taxpayer’s active involvement--such as to satisfy a forfeiture judgment in the case of Murillo v. Commissioner, 75 T.C.M. (CCH) 1564 (T.C.), aff’d, 166 F.3d 1201 (2d Cir. 1998).

In a more relevant and recent case, the Tax Court had denied relief where the taxpayer had made the actual withdrawal of funds:

Finally, the tax court’s more recent decision in Willhite v. C.I.R., 98 T.C.M. (CCH) 470 (T.C. 2009), supports the conclusion that Plaintiffs have not sufficiently alleged a claim under the levy exception. In that case, the court found that where the petitioner had withdrawn funds from a qualified retirement account after receiving various notices of intent to levy under 26 U.S.C. § 6331(d), the withdrawal did not fall within the levy exception. The court in Wilhite distinguished Larotonda and Murillo on the basis that the petitioner “initiated, received, and controlled” the early retirement account distribution. Id. at *5. It also found that the notices of intention that had been issued under § 6331(d) were not sufficient to show that the petitioner had no other choice but to withdraw the funds to pay back his taxes, pointing out that there was nothing in the record reflecting that a notice of the petitioner’s right to a hearing had been issued under Section 6330(a); because such a hearing is a prerequisite to a levy, the Commissioner could not yet levy the petitioner’s assets to satisfy unpaid tax liability. Id.

As the result makes clear, details matter when dealing with an exception such as this. Had the taxpayers’ IRA accounts actually been levied, no tax under IRC §72(t) would have been due. But since they had withdrawn funds and paid the IRS to prevent the levy, they could not receive the relief granted by the provision since it only applies to involuntary distributions.

[1] IRC §72(t)(2)(A)(vii)

[2] IRC §6331(d)(2)