If you owe federal tax and fail to pay, the IRS has a federal tax lien on all of your assets. The lien can be a secret and exists even if the IRS has failed to file a Notice of Federal Tax Lien in the public records. This secret lien can take your retirement funds to pay a tax debt even after the tax has been discharged in bankruptcy.
Bankruptcy can discharge some types of tax liability. However, a properly recorded lien generally survives bankruptcy discharge. This is true for recorded tax liens as well as liens that are recorded voluntarily against property of the debtor in bankruptcy. The code specifically provides protection for assets of the bankruptcy estate that the debtor has claimed exempt unless the assets are encumbered by a properly recorded tax lien. However, to qualify for exemption, the property must have actually been part of the estate in the first place.
The US Supreme Court in the 1992 case of Patterson v. Shumate, 504 U.S. 573, decided that assets protected by The Employment Retirement Security Act (ERISA) are not automatically part of the bankruptcy estate and can be altogether excluded from the estate. This protects ERISA covered retirement funds from claims of trustees and creditors. Unfortunately, excluding the asset does not allow the bankruptcy court to remove a secret federal tax lien. In order to protect retirement funds from the IRS secret lien, they must first be included and then claimed as exempt.
The 9th Circuit Court of Appeals in Raines v. Flinn, 428 F.3d 893 explains that exclusion of ERISA assets is optional and that they can be voluntarily included in the estate. Once the assets have been included in the estate, code section 11 USC §522 permits them to be exempted and freed from the IRS secret lien. This must be done clearly and specifically or the IRS will retain their lien and can take the funds covered by their lien as shown by the 2010 US Tax Court case of Wadleigh v. Commissioner, 134 T.C. No. 10. In the Wadleigh case, the tax court agreed that the IRS retained the power to seize retirement funds, even after discharge, if the funds were excluded from the estate rather than exempted under the code.
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