Federal Payment Levy Program Causes Headaches for Government Contractors

For U.S. businesses, being awarded government contracts can be profitable and provide multiyear, predictable streams of revenue. If your business (large or small) is looking for opportunities, these contracts can stimulate innovation, create jobs, and build resilience amid economic uncertainties.

According to the Government Accountability Office, in fiscal 2024 alone, the federal government spent about $755 billion on contracts with businesses for a range of goods and services. However, this opportunity does not come without strings attached. Government contractors with federal tax indebtedness are subject to special rules when dealing with the IRS.

How Do Businesses Get Into the IRS Collection Program?

We’re all familiar with the standard ways a business can arrive at having a balance due, but it’s becoming more common to see employee retention credit reclamation adjustments and even balances due because of processing errors involving business income tax returns. In these two instances, the taxpayer is not afforded examination deficiency procedures—the deficiencies simply progress into the collection program. As soon as any of these balances are assessed, a first collection notice is sent.

Generally, businesses will only get a first balance-due notice and then a final notice several weeks later. Depending on the risk priority of the balance due, just over a month after the second notice (CP504) the business may receive the notice of intent to levy and right to a collection due process hearing in the IRS Independent Office of Appeals. If a business timely requests the CDP hearing, collection enforcement activities are usually suspended, pending the outcome in Appeals. If there is no response within 30 days of this notice, the IRS can seize just about any of the business’s assets.

IRS Treatment of Federal Contractors

Is there anything special about IRS treatment of federal contractors? You bet there is. If your business has contracts with the federal government, special rules must be followed, and enforcement happens on an accelerated basis. The IRS very likely knows if you have federal payments due to the business through special coding on its internal systems. If the IRS is aware your client is a federal contractor, the CDP notice will likely be sent a month after the CP504B.

And this is why the rules are special. While the federal payment levy program (FPLP) is also used to enforce collection regarding recipients of Social Security and federal retiree benefits, the Bureau of Fiscal Services
(BFS) offsets only 15 percent of the monthly amount due to those taxpayers. For federal contractors (that is, funds due from defense contracts, any contracts with a civilian agency, or to a Medicare provider), the amount offset is 100 percent. In addition, the collection method is a special post-levy CDP notice (CP297C), and it is issued to the business at the same time the levy is issued to the BFS.

While requesting a CDP hearing suspends enforcement action in nearly all cases, it will not be sufficient to release a FPLP levy for a business with funds due from federal contracts or Medicare. If your client’s business has been systemically selected for FPLP, a transaction code 971 with action code 060 will appear on IRS systems. If the BFS has a match or a payment due to the business, a transaction code 971 with action code 062 will also appear. In an initial engagement with a federal vendor client owing the IRS, tax professionals want to look for the following on the transcript(s): Code 971, “Account Match for Federal Payment Levy Program.”

A business may reach this destination quickly, often without even realizing they’ve arrived. But exiting this enforcement program can be anything but fast — even after fully paying the amount past due. Collection will only reverse the FPLP levy once payment is received in full or a suitable collection alternative is approved (that is, an installment agreement, offer in compromise, etc.). Those all take time, and it won’t be uncommon for the business to seek professional tax assistance until the CP504B is received and they see the word “seize” on it. In many situations, there will be much for you to unwind.

What Could Possibly Go Wrong?

Here’s an example. Corporation X, which operates pain management clinics, engages tax counsel because it received IRS reclamation letters for ERC refunds for Form 941-X, “Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund,” for the first and second quarters of 2021 and Letters 6577-C, “Employee Retention Credit Recapture,” totaling $450,000. The taxpayer’s counsel is unsuccessful in justifying the (already paid) ERC claims, and the corporation has received balance-due notices, but it does not have administrative appeal rights. The client and counsel plan to assert their right to the ERC amounts in Appeals and await the CDP notice. A second balance-due notice is received (CP504B) followed by the CDP notice (CP297C) several weeks later—along with an alert that Medicare amounts due to the business of over $300,000 are being offset by the BFS against the balance due. The taxpayer’s counsel calls the toll-free number and argues for reversal of the FPLP and release of the levied amounts.

During the call, their attorney learns the business is over $100,000 behind on making current federal tax deposits, it defaulted on an IRS installment agreement three years ago, and it will owe a large balance to IRS by the end of the quarter. Lack of compliance weighed against qualifying for a resolution, and the case must be sent to field collection. In the interim, FPLP cannot be reversed. During the next few months before the CDP hearing is scheduled (or are venue officer is assigned the case), the BFS may continue offsetting Medicare payments due to the business and potentially satisfy the remaining balance due. If that transpires, Corporation X will lose its ability to challenge the underlying liability in Appeals. Also, because FPLP levy offsets are not required to be suspended while in Appeals, the business could lose its right to challenge the liability later in Tax Court if not satisfied with the CDP determination. If this sounds like Zuch, it’s because it is.

Examples like this can happen — and have. The example above involved an ERC clawback but could have involved any type of balance due for a federal contractor or Medicare provider — that is, business income taxes, employment taxes, or a large penalty assessed. Whether or not the balance due involved deficiency procedures, one concern is consistent. Once the balance is owed, federal contractors and Medicare providers move quickly into the FPLP, and its consequences to their cash flow can be devastating.

Lessons Learned

Twenty-seven years after CDP hearings were made available in our tax code, the process might seem routine, and there’s a (sometimes incorrect) assumption that the CDP process always provides a backstop against enforcement. It does not. For clients with defense contracts, health care providers receiving Medicare funds, or any civilian federal agency contracts, a careful review of their case should happen as soon as possible.

Consider the following in any review:

• Determine whether they have contracts with the government or are a Medicare provider.
• Secure transcripts and verify whether they’ve been identified for FPLP and whether a match has been determined by the BFS (see the system codes mentioned earlier).
• Know your client’s compliance history because this will be critical in negotiating input of a FPLP block on the account or a FPLP reversal if they’ve already been levied.
• Understand you do not have 30 days from the CDP notice before levy—you must act in the days and weeks after the CP504B but before the CDP notice to avoid an FPLP levy. The best approach is to act on the first collection notice and demand a FPLP block.
• Verify whether the client protested any of the earlier notices or requested a collection appeal program hearing. If the levy was premature, it could be the basis for getting the FPLP reversed or making the case for input of a FPLP block.
• If you haven’t had an opportunity to challenge the underlying liability, request the CDP hearing and argue to collection or Appeals that you must have FPLP reversed top reserve your rights because of the precedent set in
  Zuch. (If levy action fully satisfies the account, even while in Appeals, you lose the liability dispute right in CDP.)
• Become familiar with Internal Revenue Manual 5.19.9.4 (10-20-2016) — the federal payment levy program.

But What Does This Have to Do With AI?

In a few words, it has to do with agility, speed, and the future. Artificial intelligence should further enhance case selection and notice treatments in collection cases. On May 6, 2025, Treasury Secretary Scott Bessent told lawmakers on the House Appropriations Committee that cuts to the IRS workforce won’t affect tax collection because an AI boom will pick up the slack. The IRS has been candid in recent months that the agency will continue to prioritize the use of AI and machine learning capabilities in many circumstances, including collection work — an area in which AI will likely soon demonstrate an ability to increase accuracy, enhance service, and negate the need for some personnel.

The most prolific source of enforcement revenue collected by the IRS comes from collection notices, which constitute over 73 percent of the total amount. But there’s more than meets the eye. A great deal of science goes into each notice, particularly the kind used and the number of them issued to a taxpayer. Data scientists and policy analysts combined forces in the collection notice redesign initiative to bring rigor to notices, focusing on the salience, simplicity, and reduced cognitive load for each notice. All this has been designed by a limited number of human experts. While at the IRS, I saw impressive gains in both compliance and revenue from many of these redesigned notices. However, analyzing results and designing future improvements took perhaps a year or more. Integrating machine-learning AI will accelerate improvements by analyzing results and suggesting more probable improvements in a much shorter time frame—merely weeks and months

I predict there will be continued experimentation with the content, cadence, and number ofnotices. This is already happening to some extent, but machine learning will bring deeper scrubs of significant volumes of information and increase the accuracy of assumptions. Thus,case life cycles will be shortened. For federal contractors who are not regular customers ofthe IRS’s collection products, time is (already) not your friend. As time passes, optionsavailable to avoid enforcement quickly narrow. AI is going to accelerate things, as it may beexpected to identify government contractors with a tax balance and notify the BFS morerapidly after an abbreviated initial notice period.

And because handling these situations often involves many discussions with live personneland long hold times, what about an AI voice or chatbot? IRS collection has already provenadept here: On June 14, 2022, it launched the use of authenticated voice and chatbots to setup pay plans with taxpayers. Within a year or so, other repeatable and predictable aspects ofengagement with businesses could be handled similarly. There would be no waiting on holdto speak with them, and the business or tax professional could arrange a payment plan toavoid FPLP or lodge a valid protest to avoid it. A future like this may not be far off.