Can the IRS Take Your Work Compensation Settlement for Owed Taxes?

If the Internal Revenue Service determines that you owe back taxes and has been unsuccessful in recovering the money, they may levy your property. The IRS's power to levy is limited by statute which excludes specific types of property, including funds derived from workers' compensation. However, recent court decisions suggest that property acquired using proceeds from worker compensation amounts may not be protected by this statute and might be subject to a lien.

Tax Levies

If a taxpayer is liable for taxes but does not pay that amount within 10 days of being notified of his deficiency, the IRS can try to collect by levying his property. In addition to conventional assets like a house or car, the IRS may place levy on wages or other sources of income. The taxpayer must be given 30 days notice before the levy occurs, so he can have time to appeal the levy or settle the debt. If the levy is placed on the taxpayer's assets or wages, the IRS may seize the assets or garnish the taxpayer's wages until it recovers enough to satisfy the original debt, plus any accumulated penalties or interest.

Workers Compensation Excluded From Levy

The IRS's ability to levy is limited, as the tax code specifically excludes certain types of assets from being encumbered. One of the types of assets that is precluded is worker's compensation. To qualify, the amount in question must have obtained using a worker's compensation provision under federal or state law, or by a provision of the District of Columbia or Puerto Rico.

Liens May Be Applied

While a levy cannot be used on worker's compensation proceeds, the IRS might have other options to limit how the proceeds are used. In one case tried before a federal appeals court, the IRS placed a lien on a house purchased using worker's compensation proceeds by a delinquent taxpayer. A lien is a document that attaches to a piece of property that allows someone who is owed money to satisfy the debt from the proceeds of the future sale of the debtors' assets. The homeowners appealed, arguing that the home was purchased using worker's compensation benefits and were therefore outside of the IRS's reach. The court disagreed, and stated that the statute only excludes levies from being applied and not liens. Therefore, while worker's compensation cannot be taken directly, assets purchased using those amounts could be targeted by the IRS, depending on the circumstances.

Tax Tips

If you have further questions about owed taxes, it is a good idea to consult with a certified public accountant or licensed attorney, as they can best address your individual needs. If you have financial concerns that might make hiring a CPA or attorney difficult, there are alternative options such as Low Income Taxpayer Clinics or the Taxpayer Advocate Service, an independent organization operating through the IRS that provides aid to taxpayers under duress. Contact the IRS to find an LITC or TAS representative near you.

References

• Google Scholar: Matter of Sills: Court of Appeals, Fifth Circuit, 1996.
• IRS.gov: Many Types of Free Help Available From the IRS: Internal Revenue Service: 2011
• Cornell.edu: Section 6331- Levy and distraint: Legal Information Institute: 2010.
• Cornell.edu: Section 6334- Property Exempt from Levy: Legal Information Institute: 2010.