With mortgage delinquency rates at an all-time high, the IRS is trying to make sure owners who want to keep their properties out of foreclosure know their rights under the tax laws. The agency recently issued two releases highlighting policies that might help taxpayers at risk of losing their homes.
In a December 16 release, Internal Revenue Commissioner Douglas Shulman said the IRS is expediting requests for relief so that owners can refinance or sell property encumbered by a federal tax lien. If the homeowner is selling the property for less than the principal still owed on the mortgage, the IRS can discharge a lien placed on the property to ensure collection of unpaid taxes. If the owner is seeking to refinance a loan, the agency will consider making a tax lien on the property secondary to the new mortgage loan.
Generally, the process of releasing or subordinating a tax lien takes about 30 days, but the IRS said it is working to speed requests for lien relief in the wake of the economic slowdown. A request for lien relief can be made by the taxpayer or a representative, such as the mortgage lender. There are no forms to fill out; instead, the request is made in a letter to the Technical Services Group manager for the IRS Collection Advisory Group covering the area where the lien was obtained. Instructions for what to include in a letter asking for a lien to be discharged are in IRS Publication 783; for taxpayers seeking to have their liens subordinated, instructions are in IRS Publication 784.
The IRS encouraged property owners to contact the Collection Advisory Group early in the sale or refinancing process and to inform their lenders of the tax lien, to allow time for the agency to work through the expedited process.
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Shulman noted that releasing or subordinating the lien would not discharge the taxpayer’s debt; the taxes would still be due. He also said the agency is trying to provide relief for people who have a history of paying their taxes on time but have fallen behind because of the economy. That means that many of the million-plus federal tax liens currently outstanding may not be discharged or subordinated, but some property owners will likely qualify for this relief.
Retirement plan hardship withdrawals
Earlier in the fall, the IRS updated its Web page answering Frequently Asked Questions about hardship withdrawals from retirement plans set up under sections 401(k), 403(b) or 457(b) of the tax code. These three sections cover employer-sponsored individual accounts, individual annuities and governmental plans, respectively. Taking a hardship withdrawal means that a plan participant who is under 59 ½ years old doesn’t have to pay penalties that otherwise would be owed due to early withdrawal.
To withdraw money from any of these plans as a hardship distribution, the withdrawal must be made to satisfy an immediate or heavy financial need of the employee or his/her spouse, dependent or a “nonspouse, nondependent” beneficiary of the account. The plan document must specify what criteria will be used to determine whether a circumstance qualifies as a hardship.
According to the IRS, plans may allow hardship distributions to pay medical, educational, burial or funeral expenses, as well as to finance the purchase of a principal residence—but not for regular mortgage payments. However, plans can allow hardship distributions to avoid foreclosure on a mortgage.
Generally, a distribution can’t be made as a hardship withdrawal if the plan participant has other resources available to satisfy the need. Hardship withdrawals may be permitted by 401(k) and 403(b) plans even if the immediate and heavy financial need was foreseeable or voluntarily incurred, such as to purchase a residence or pay educational expenses. Under 457(b) governmental plans, hardship distributions can be made only if the need was unforeseeable and beyond the plan participant’s control. Such needs may arise from imminent foreclosure on the employee’s home or to pay medical or funeral expenses.
A retirement plan can allow hardship distributions only up to the amount of the employee’s elective contributions. The employer’s qualified matching contributions and any earnings on the account must remain in the plan. The amount withdrawn from a traditional account is taxed as regular income in the year the money is taken out of the plan, but the effect of taking a hardship withdrawal is to waive any penalties that would otherwise be owed due to early withdrawal. Since Roth distributions are not taxed, they can be taken without including the amount in income.