This discussion typically happens when we complete a financial analysis and realize that the client has little-to-no ability to repay the IRS, but they have expenses that the IRS are unlikely to consider in their financial analysis. The result, in some instances, is that the IRS is going to request a monthly repayment amount that is higher than the client can actually afford given the assumption that they will continue to pay their actual and necessary expenses.
What Are "Allowable Living Expenses?"
The IRS’s definition of an allowable or necessary living expense includes “expenses that are necessary to provide for a taxpayer’s (and his or her family's) health and welfare and/or production of income.” Immediately, I think back to when we were in school learning about what living things need to survive – air, water, food, and shelter. Unfortunately, the IRS uses the same bare-bones principles for their allowable expenses.
On top of what expenses are allowable, the IRS has also pre-determined — based on a local or national level — what necessary expense amounts can be considered reasonable. This limits not only the type of expense allowed, but also the amount being allowed on the financial analysis. The IRS derives their information from the U.S. Census Bureau, American Community Survey, and Bureau of Labor Statistics data. I personally know that the amount the IRS allows for housing and utility expenses for one person in New Haven County, Connecticut is not realistic if you live in one of the nicer towns where home prices and taxes are high. IRS employees are loathe to ever consider these realities when reviewing someone’s financial situation. They want to collect as much money from you as they can. By pointing out that they're not following the same standard for reasonable expectations they ask of you, you're not likely to make any friends.
In the chart below, you can see how the IRS’s allowable expenses rules can result in a repayment of $1,092.00 per month for someone who doesn’t have the ability to meet their actual living expenses — by nearly $3,000.00.
Most people would agree that an income of $15,000.00 per month is very comfortable living. What they fail to realize is that the money now owed was at one point at the disposal of the taxpayer to pay for their personal expenses, and possibly expenses that they would not have been able to afford had they been paying sufficient taxes all along. When the IRS finally wants payment for those liabilities, the taxpayer may be stuck with expenses that cannot be reduced or eliminated overnight. This forces them to choose between paying their mortgage and paying the IRS. I know that some of our clients feel like this is an impossible situation to be in, and it's unfortunate that the IRS is not known for their sympathy.
The IRS’s main goal is to receive full payment of a liability within the CSED (Collection Statute Expiration Date). The IRS’s default minimum acceptable Installment Agreement is generally a full payment of tax, penalties, and interest within a six year time-frame. This assumes that none of the liabilities will expire within that time, and that there are no other assets that can be liquidated and applied to the liability.
Taxpayers who owe under $50,000.00 are generally able to enter into a Streamlined Installment Agreement. This agreement only requires the minimum amount to repay the liability fully in six years, regardless of them being able to afford more. Taxpayers who have a liability of $100,000.00 or greater don't share this luxury because the IRS wants to collect the amount of their actual monthly disposable income after deducting out the expenses the IRS deems allowable.
IRS Conditional Living Expenses
These collection rules seem grossly unfair to anyone making a more-than-decent living. Taxpayers with a small disposable income and a large liability will likely have luck with an Offer in Compromise. However, there is some hope for taxpayers who find themselves in a situation where they have high income and a large liability. The IRS may allow conditional living expenses in order to reduce the monthly Installment Agreement payment up to, but no lower than, the six year repayment amount (except in instances where the liability is at risk of expiring). IRS personnel routinely claim that conditional expenses can’t be considered when determining a taxpayer’s monthly ability to pay, so it can be somewhat of an uphill battle to get conditional expenses accepted. There are also arguments why some expenses should be considered necessary even if they deviate from the IRS’s collection rules. An experienced Tax Attorney will know what expenses can be argued and will be honest with you when they've come to a payment that cannot be negotiated any lower based on your specific financial circumstances.
Illustration: Bob and Cindy were married. Bob was retired and Cindy worked as a nurse in White Plains, NY. They both had accrued debt on their taxes. Bob had respiratory ailments that made it very difficult for him to live in White Plains year round. Bob wants to claim that he should be entitled to two housing bills. One for a house in White Plains and also expenses for a modest home in Bonita Springs, Florida. Cindy could not find a job in Florida that would pay her the same wage she was making in New York. Can Bob use both household expenses in calculating his ability to pay the IRS? Maybe. In such cases where we are able to show that while an expense is higher than the standard, it should be allowed since it is a necessity; sometimes the IRS will agree to the conditional living expense. In Bob's case, the IRS allowed it and subsequently made him eligible for currently non-collectible status, meaning his monthly installment agreement amount is so low that it's actually $0 per month (personal details have been changed; results may vary).
Installment Agreement Options
There is also another option which is frequently overlooked in tax resolution: the one-year, five-year Installment Agreement. If you truly have little or no ability to repay the IRS, but have an expense that the IRS won’t allow, they may grant you a nominal payment plan for one year if your intention is to adjust your finances in order to repay the liability in full. Keep in mind that the IRS still wants to be paid in full within six years, which means that once your first year of nominal payments expire, you are going to have to repay the entire balance within the next five years. It's possible, if you have a very large disposable income, that they may require payment even sooner.
IRS debt negotiations come down to maximizing allowable and/or conditional living expenses
The IRS allowable livings expenses can be beneficial to some taxpayers and detrimental to others. The harsh reality of the IRS’s determination on Installment Agreements is that sometimes, there is simply not enough money to go around. This is likely to happen when you are up against collection rules that don’t do taxpayers any favors or have any sympathy for their financial circumstances. The bright side may be that it forces taxpayers to take a hard look at what they are spending their money on, and if they are living beyond their means when current taxes and payments for past due taxes have to be factored back into their financial picture. Taking the IRS’s austere approach can be an opportunity to turn a negative into a positive and get the IRS out of your life for good while simultaneously building a healthier financial plan for the future.