Hi,
My security officer just received an IRS levy. The question is,
we want to take our fee ($50) when we restrict the funds
as a service fee to us even if the balance in the account
is less than the amount of the levy. Is this illegal??????
We've been doing this for years, uh oh...

I believe you can charge a reasonable fee as long as there are sufficient funds available...but I can't find the cite.

Me either, that's why I'm begging at the boards again!
I did find Form 8546 which is to reimburse bank fees
in the event of an erroneous levy, which leads me to
believe, if you can be reimbursed for fees for an erroneous
levy, then you cannot be reimbursed for fees for a
legitimate levy...

IRM 5364.5(6) indicates financial institutions are not entitled to reduce the amount of the levy proceeds to collect their fee. In other words, the IRS gets their money first, and if there is funds left for your fee, you get it.

(at least that's the way I read it)

No, you can't take your fee first. You must levy the funds in the account, up to the amount of the levy first. If the amount for the levy is more than the amoount in the account, you must take the whole amount. If you charge your fee, you can, in that case, draw the account negative and hope for the best. The IRS could care less about the fees.
Also, remember to read each levy carefully, I have seen some with printed restrictions regarding the amount of the processing fee allowed, and some have different quidelines for IRA or retirement accounts.

KK and Anon are correct, from the IRS' point of view: Levy first and then fee. The language from the IRS manual does not reflect any underlying law or regulation, only the IRS' opinion, but you can pick better people to fight with over $50.