If you owe back taxes to the Internal Revenue Service, the agency has a number of collection methods at its disposal to get them paid. Whether you expect payments from a workers' compensation settlement or a settlement for back wages, your money might be within the IRS' reach. Through the use of levies, which are seizures of your personal property, the IRS can sometimes take the money you're expecting directly from the person or agency paying it.
TL;DR (Too Long; Didn't Read)
The IRS cannot directly levy any work-related compensation unless you deposit the compensation into a seized bank account or it is a fixed amount at the time the IRS issues a levy notice.
Workers' Compensation Settlements
Federal law gives the IRS extensive authority to levy various types of income and property when you owe taxes, but the law specifically excludes all types of workers' compensation payments. Therefore, once the settlement is finalized, you can rest assured that you'll receive your settlement payments without any reduction to them for the back taxes you owe.
Work Compensation and Other Property
The IRS is authorized to levy, or garnish, a substantial portion of your wages; to seize real and personal property you own, such as your home and car and even take money that's owed to you. To levy funds you haven't received yet, your right to collect the debt must be fixed, rather than conditional or uncertain, at the time the IRS serves you with notice of its intent to levy. For example, suppose you've settled a legal dispute with your employer over unpaid compensation.
If the dispute is settled the day before the IRS issues the levy notice, but you haven't received payment yet, the agency can take your settlement money since the amount owed to you is fixed and you have an unconditional right to it. If the IRS seizes, or freezes, your bank account and you deposited the settlement money into it, the agency can take as much of the balance as it needs to pay off your taxes. This is true even if the settlement relates to workers' compensation.
Refunds Applied to Tax Debt
Levying money that's owed to you isn't the only way the IRS can collect your back taxes. Until the tax debt is paid off entirely, the IRS can take your current and all future federal and state income tax refunds. Having an installment agreement in place with the IRS – which involves a payment plan for federal taxes -- is an effective way to avoid having your settlements, bank accounts and other personal property levied. However, it doesn't prevent the IRS from taking your refunds each year to get the debt paid down faster.
When to Expect Advance Notice
Seizure of your property is usually a last resort for the IRS, which is why it has to provide you with notice. When you owe tax, the IRS will first send you a notice and demand for payment. If you ignore this notice and don't pay the tax or get on an installment plan, you'll eventually receive a second notification of the IRS' intent to levy your property -- which can't occur within 30 days of the notice -- along with information regarding your legal rights to a hearing. If the agency plans on taking your state tax refund, you may also receive a separate notice for that levy as well.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.