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Death and Taxes

Posted on May 24, 2021

On the substantive side of tax issues Congress is focusing on death and taxes as it studies and debates whether to eliminate the stepped up basis currently given to property upon the death of the owner. This debate is not new. When I was in law school in the mid-1970s taking a class in estate and gift taxes Congress was engaged in the same debate and decided to eliminate the stepped up basis in the middle of my semester. The professor, a prominent local practitioner, deserved extra duty pay for trying to follow the twists and turns during the run up and passage of the repeal of the stepped up basis that semester. Of course, the following year Congress repealed the repeal of the stepped up basis putting us back where we are today. Because of my law school experience with this issue almost five decades ago and my personal experience as a beneficiary of the stepped up basis, I follow the debate with interest.

This blog focuses on procedure, however, and I wanted to bring to everyone’s attention to a death and taxes story playing out on the collection side of the house.  This story also has roots in the current pandemic and efforts for relief for those impacted by it.

On April 30, 2021, the IRS issued SBSE-05-0421-0031 “Levy Actions Involving FEMA COVID-19 Funeral Assistance Funds.” In this guidance the IRS instructs collection employees to release bank levies if the funds in the account include money received by the taxpayers as COVID-19 Funeral Assistance funds provided by the Federal Emergency management Agency (FEMA).

We have written before about tracing funds into a bank account and whether certain funds in a bank account that can be traced from sources on which the IRS could not levy at the time of payment should be protected from levy once placed in a bank account. See the excellent post by Les on this subject here. Generally, the IRS takes the position that money in a bank account is fair game for its levy no matter what source, protected from levy or not, generated the funds in the bank account. In the case Les discusses in his post the 10th Circuit hinted that maybe veteran’s benefits exempted from levy in the list at IRC 6334(a)(10) could retain protection if properly traced.

Despite its normal view that funds going into a bank account become fair game, the kinder, gentler IRS carves out an exception here if the funds subject to the levy have arrived in order to pay the funeral expenses of a loved one. It makes sense for the IRS to make this exception and avoid having to explain the taking of these funds but the decision raises again the issue of when the IRS should back away from funds in a bank account.

Backing away creates its own difficulties which drives the normal IRS position on this issue.  First, the IRS has no idea the source of the funds in a bank account and no realistic way to find out except from the taxpayer.  The notice contemplates that after a levy the taxpayer will tell the IRS that it has levied on the funeral funds.  That itself presents a couple of problems.  One concerns how many taxpayers will know that the IRS has created this exception.  The bank levy could easily be generated by an Automated Call Site (ACS) with little or no contact between the IRS and the taxpayer.  The taxpayer will learn from the bank, at some point, that the IRS has levied but is unlikely to be aware of this guidance and will only contact the IRS out of some sense of unfairness that it levied upon the funeral funds for a loved one, perhaps stopping the funeral.  That also raises the second problem of just getting through to the IRS to tell it about this issue even if you know about the policy.  Getting through is not easy and this will be a family in the midst of grieving.

Assuming the taxpayer knows about the policy or calls to complain generally and assuming the taxpayer gets through, then the IRS will request documentation to verify the funds came from FEMA, when they came, how much came, etc. Once the taxpayer satisfies the verification procedure, the IRS will release the levy on the verified funds.

The IRS has created a similar but more taxpayer friendly procedure for accounts with PPP funds and Recovery Rebate stimulus payments requiring the IRS to check before making the levy. As mentioned above, that can be difficult for the IRS.

The procedure for the FEMA funds tracks, in many ways, the procedure for levies where multiple parties own the bank account. Following its narrow victory in United States v. National Bank of Commerce, 472 U.S. 713 (1985) a procedure developed providing bank notification of the owners and a 21 day opportunity for owners of the account to come in and show that the money in the account belonged to them rather than to the taxpayer who owed the tax causing the levy. The taxpayer’s wife and mother jointly owned the account at issue in that case making for some interesting dinner table conversations. The verification that the wife and mother would have provided to show the money belonged to one of them rather than the taxpayer would track the verification procedures developed for the FEMA payments. The IRS and banks have used this system now for over 35 years and it seems to work.

What if all bank levies had a 21-day hold with the opportunity not only for co-owners to verify ownership but for the taxpayer to verify any funds that protected by IRC 6334 or by special designation such as the FEMA funds here? If such a system existed, taxpayers would not need to read SBSE memos to know when to raise their hand and they would have a process of talking to the IRS through the bank that might work better than trying to call a number where a low percentage of taxpayers get through.  Such a system would also eliminate the second hand taking of funds Congress sought to preserve for the taxpayer and would make it less necessary for taxpayers with outstanding liabilities to need to find alternatives to banking to preserve those special assets.

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