IRS collection standards and "reasonable and necessary" expenses 2/24/14
- Collection Options:
- extension up to 120 days to pay taxes in full
- currently not collectible (hardship) status – delay collection until financial condition improves
- installment payments
- expiration of Statute of limitations
- offer in compromise – settle for less than full payment
- See also: collection standards
- financial Information forms
- collection due process hearing right
- IRS Taxpayer Advocate Service (TAS)
- IRS Form 911 – Request for Taxpayer Advocate Service Assistance/ hardship relief
- Low Income Taxpayer Clinic (LITC)
- determining the correct tax
- audits / record keeping
- IRS correspondence audits
- notice of deficiency
- Tax Court
- what if you haven't filed returns
- trust fund recovery penalty
- what if you can't pay your taxes
- what if my spouse owes taxes but I don't
- can I really settle for pennies on the dollar ?
- innocent spouse relief
- injured spouse relief
- tax liens & levies
- subordination of lien
- can the IRS take my house
- abatement of penalties
- discharge of property from lien
- subordination of IRS lien, e.g., to refinancing
- bankruptcy doesn't remove a tax lien even after the tax is discharged
- trust fund recovery (responsible person) penalty
- private party (non-IRS) debt collectors
- tenancy by the entirety protections US v. Craft
The IRS requires you to provide detailed financial information on forms 433-A or 433-F (individual) and 433-B (e.g., sole proprietor and incorporated businesses).
The IRS uses the forms AND ITS OWN STANDARDS to determine how much "cash flow" is available monthly to meet the household living expenses, and the allowable "reasonable and necessary" expenses. Just because you have the expense does not mean the IRS will allow it.
Tithing and college expenses are conditionally allowed and "necessary and reasonable" only if taxpayer can pay in full within 5 years 13/21/13
An individual’s church tithing expenses were only allowed as "conditional expenses" to determine how much he could pay in a partial installment agreement because the classification: (1) conformed to the Internal Revenue Manual guidelines; (2) did not violate the Free Exercise Clause of the First Amendment; and (3) did not violate the Religious Freedom Restoration Act of 1993 (RFRA). Tithing as a “condition of employment” is related to production of income, and it was not an abuse of discretion to limit “condition of employment” to “compensated employment” (taxpayer was not compensated). The court found it was reasonable to interpret “health and welfare” as not including petitioner's “spiritual” health and welfare. Taxpayer's children’s college expenses were also "conditional expenses". Taxpayers must be able to fully pay their tax liabilities within 5 years for "conditional expenses" to be classified as "necessary expenses." George Thompson v. Commissioner, U.S. Tax Court, CCH Dec. 59,469, 140 T.C. No. 4, (Mar. 4, 2013.
The IRS issued new collection allowable expense standards on March 1, 2011 3/11/11
The IRS issued the 2007 allowable living expense standards. IR-2007-163, Oct. 1, 2007. 10/2/07
The standards have been redesigned to incorporate:
- new category for out of pocket health care expenses
- elimination of income ranges for national standards for food, clothing and other items
- nationwide tables for national standard expenses, eliminating separate tables for Alaska and Hawaii
- expanded number of household categories for housing and utilities
- allowance for cell phone costs in housing and utilities
- equal allowances for 1st and 2nd vehicles under transportation expenses
- fewer Metropolitan Statistical Areas for vehicle operating costs
- separate nationwide public transportation allowance
Necessary Expenses — The allowable payments to support you and your family’s health and welfare and/or the production of income. This expense does not apply to businesses. If facts and circumstances of your situation indicate that using the scheduled allowance of necessary expenses is inadequate, the IRS will allow an adequate means for providing basic living expenses. It may be difficult to convince the IRS additional amounts are necessary and you must provide documentation that using national and local expense standards are inadequate to provide for basic living expenses.
Expenses Not Generally Allowed (unless you can prove that they are necessary for: 1) health and welfare or 2) production of income).
Current Value — The amount expected from the sale of an asset (e.g., willing buyer and seller under no compunction). Determined from realtors, used car dealers, publications, furniture dealers, or other experts on specific types of assets.
Quick Sale Value (QSV) — The amount expected from the sale of an asset if sold it quickly, typically in 90 days or less, generally 80%.
Realizable Value — QSV minus secured debt with priority over a filed IRS Tax Lien.
Reasonable Collection Potential (RCP) — The total realizable value of your assets plus your future income (generally the minimum offer amount).
Future Income — The amount the IRS could collect from your future income by subtracting necessary living expenses from your monthly income over a set number of months.
While IRS employees are typically reluctant to deviate from the standard allowances, they can in appropriate circumstances. You have to make your case.
Additionally, if the tax liability can be repaid within 5 years, the IRS has discretion to allow all expenses.
It is the amount of "cash" available monthly to the household monthly to spend, so e.g., the IRS considers child support paid or received, which is not deductible from or includible in your income for tax purposes, but reduces or increases your cash flow.
Also, the IRS considers the full month loan payment (if the loan is considered allowable, e.g., a car loan up to the maximum allowed) rather than just deductible interest, and ignores depreciation for depreciable business items.
The IRS generally requires payment of the excess of cash flow over "reasonable and necessary" expenses to be paid monthly. The amount of the liability has little or no bearing on the options to deal with your tax liability. The question is "how much can you pay ?" (if anything) after meeting your "reasonable and necessary" living expenses.
Time to adjust your expenses
The IRS can also allow up to 1 year to eliminate the "unallowable" expenses, but this may be quite difficult to accomplish, particularly in the current economic environment where, e.g., house prices are down, so a sale may not generate sufficient proceeds to pay off the mortgage(s), and a potential wiling buyer is finding it difficult to obtain financing even if you can find a willing buyer,for you to be able to move to less expensive housing.
You should fill the forms out carefully:
- Even inadvertent omissions can raise IRS suspicion that you are not being forthcoming, and can in turn make the IRS collection employee difficult to work with;
- Failure to fully disclose is grounds for the IRS to void an offer in compromise, even years after it is accepted;
- Sections that do not apply (e.g., life insurance or stocks if you do not have any) should be marked "not applicable" or "NA" to confirm you considered the question and no entry is needed;
- Attach items specified on the form (433-A or 433-B) (e.g., proof of income for 3 months such as pay stubs);
- Because of the various limitations (see "caps" below) on allowable expenses, it is important to list all expenses that the IRS allows, e.g., health care expenses are freely allowed if you are paying them
- expenses you are supposed to make but are not making are not counted
- The small monthly expenses taken together can make a significant difference in the monthly installment payments the IRS will request you to make or the amount of an offer in compromise, e.g., regular dental cleaning and infrequent expenses such as eyeglasses.
"Reasonable and necessary" expenses may be subject to "caps" or maximum amounts, including housing expenses limits determined for every county in the country, and transportation ownership determined nationally, and car operating expenses costs regionally.
For expenses subject to a "cap" or maximum, you are allowed the lesser of the amount spent or the cap. Where maximum allowances are exceeded (e.g., housing and transportation), the IRS will not tell you can not make the payment, but will only allow the "cap" amount (so you may not have the funds to make the payment), and it is up to you to determine how to live on the amount the IRS determines is reasonable.
To prevent hardships, the IRS will typically permit some time, e.g., 12 months, for you to adjust your finances before they insist on payments of the indicated amount. E.g., if you child is in private school tuition is not "allowed", but rather than (in effect) requiring your child change schools mid-term, the IRS would allow time to finish the current school year before moving schools; or, if your mortgage / housing costs are over the cap, the IRS may allow time for you to refinance or sell and purchase or rent a residence within the allowable amount.
The following are considered by the IRS in determining your "reasonable and necessary" living expenses (updated by the IRS 1/09)
5 necessary expenses:
- housekeeping supplies
- apparel and services
- personal care products and services, and
The standards include a table based on number of persons in the household, and is allowed without verification. (prior chart considering range of income eliminated 10/1/07. The IRS previously, but no longer, required substantiation of amounts spent.)
If the amount claimed is more than allowed by the national standards, the taxpayer must provide documentation to substantiate those expenses are necessary living expenses. Generally, the total number of persons allowed for National Standards should be the same as those allowed as exemptions on the taxpayer’s most recent year income tax return. Alaska and Hawaii no longer have a separate table.
- mortgage or rent
- property taxes
- maintenance and repair
- utilities: gas, electricity, water, heating oil, garbage collection, and telephone
Housing expenses are subject to a "cap" or maximum amount allowed based on number of persons in the household from a schedule for each separate county in each state;
An allowance for cell phone costs based on BLS expenditure data has been included in the Housing and Utility standards. 10/2/07
separate allowances for:
- Car ownership / lease. You are allowed the lesser of national cap or actual ownership expenses. No amount is allowed if you so not have a loan or lease payment.
- Operation expenses, subject to area or regional caps on operating expenses (insurance, gas and oil, maintenance, license, etc.).
Ownership and operating cost allowances for a 2nd vehicle are the same as the allowances for the 1st vehicle. 10/2/07
There is a single nationwide allowance for public transportation based on BLS expenditure data for mass transit fares (bus, train, taxi, etc.) for travel within and between cities (replaced the "no car" allowance). The public transportation allowance was removed from vehicle operating costs resulting in a reduction of operating costs allowed.
Taxpayers with no vehicle are allowed the public transportation standard, per household, without questioning the amount actually spent.
If a taxpayer owns a vehicle and uses public transportation, expenses may be allowed for both, provided they are needed for the health, and welfare of the taxpayer or family, or for the production of income.
- optical (eyeglasses, contacts), etc.
Health care expenses are freely allowed if you are paying the costs, but you will have to substantiate (document) them.
A new table based on MEPS (Medical Expenditure Panel Survey) expenditure data has been established for a minimum allowance for out-of-pocket health care expenses using an average household standard amount per person for taxpayers and their dependents under 65 and those individuals that are 65 and older as a floor on a per person basis, and
The IRS no longer requires taxpayer documentation for medical expenses unless the amount claimed exceeds the standard. 10/2/07
Court ordered payments
to a limited extent
The IRS typically does not allow you to claim the following as necessary living expenses:
- tuition for private schools, public or private college expenses
- charitable contributions
- voluntary retirement contributions
- payments on unsecured debts such as credit card bills
- cable television charges and other similar expenses
The IRS may allow these expenses when you can prove that they are necessary for the health and welfare of you or your family or for the production of income.
The IRS generally reviews your financial status every 6 to 36 months depending on circumstances to see if you are then able to make or increase payments (the IRS is now required to review your financial condition every 24 months 1/14/07). If you income has been stable for many years the period is typically longer, and if you are unemployed and seeking a job, the time between reviews is shorter. If you file a return that shows significantly increased or new income the IRS may also request updated financial information.