When you get involved in the audit process with the IRS and end up owing money, the IRS collections area uses a very specific process to determine what they think you can afford to pay. If you understand their process, it makes it simpler to reach a reasonable agreement that will allow you to pay off what you owe. Working with your tax attorney, you’ll be able to deal with the IRS demands and ultimately emerge in a way that will allow you to pay off the money owed and continue to live your life in a reasonable manner.
In a nutshell, the IRS works to determine what your total income is and what your expenses are. Based on these numbers (usually gathered using IRS forms 433-A, 433-B, 433-F), they use a series of standards that compare your numbers to national standards and they then make their determination. Keep in mind that while the IRS seems like a large, unfeeling bureaucracy, the agent you and your tax attorney work with is, indeed, human and does understand that each case is unique and each family or person has specific issues that factor into the numbers.
The IRS collections financial standards are used to help determine your ability to pay a delinquent tax liability. Allowable living expenses are those expenses that meet the IRS’s necessary expense test which are expenses that are necessary to provide for you (and your family’s) health and welfare and/or ability to earn a living.
The national standards for food, clothing and other items apply no matter where you live and you are allowed the total national standards amount for your family size, without questioning the amount actually spent. National standards have also been established for minimum allowances for out-of-pocket health care expenses and you and your dependents are allowed the standard amount on a per person basis, without questioning the amount you actually spent.
Maximum allowances for housing and utilities and transportation, known as the local standards, vary by location. In most cases, you are allowed the amount actually spent, or the local standard, whichever is less.
Generally, the total number of persons allowed for necessary living expenses should be the same as those allowed as exemptions on your most recent year income tax return.
If the IRS determines that using the standards is inadequate to provide for your basic living expenses, they may allow for actual expenses. However, you must provide documentation that proves that using the standards leaves you an inadequate means of providing for basic living expenses. Your attorney can advise you on specifically what the IRS is looking for.
To get an accurate idea of what the IRS thinks you should be spending, you should look at the National Standards which cover five necessary expenses: food, housekeeping supplies, apparel and services, personal care products and services, and miscellaneous. Try the link to the national standards for food, clothing and other items web page.
Out-of-pocket health care standards have been established for health care expenses including medical services, prescription drugs, and medical supplies (e.g. eyeglasses, contact lenses, etc.). Additional information and the standard amounts are available on the Out-of-Pocket Health Care Standards web page.
The housing and utilities standards include mortgage or rent, property taxes, interest, insurance, maintenance, repairs, gas, electric, water, heating oil, garbage collection, residential telephone service, cell phone service, cable television, and internet service. Additional information and the standard amounts are available by state or territory on the Housing and Utilities Standards web page.
The transportation standards for taxpayers with a vehicle consist of two parts: Nationwide figures for monthly loan or lease payments referred to as ownership costs and additional amounts for monthly operating costs. The operating costs include maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking and tolls. Additional information and the standard amounts are available on the Transportation Standards web page.
The IRS collections area uses all of these financial standards in cases requiring financial analysis to determine your ability to pay. The vast majority of installment agreements secured by IRS employees are streamlined agreements, which require little or no financial analysis and no substantiation of expenses.
In cases where you cannot full in pay and do not meet the criteria for a streamlined agreement, you may still qualify for the six-year rule. This rule allows for payment of living expenses that exceed the collection financial standards, and allows for other expenses, such as minimum payments on student loans or credit cards, as long as the tax liability, including penalty and interest, can be paid off in six years. You are required to provide financial information in these cases, but do not have to provide substantiation of reasonable expenses. Again, your lawyer can be a real asset in figuring out how this will work for you.