This section only applies to taxpayers with total tax debt greater than $50,000. For debt less than $50,000, the process is different.
Example: Bob has $100,000 of total tax debt. He has gross monthly wages of $150,000. He has $25,000 equity in his home and $75,000 in his company 401(k). After his attorney reviews his options, they decide that an installment agreement will be his only option.
IRS’ goal: Receive full payment of the debt in the shortest period of time possible.
Bob’s goal: Minimize his monthly payment and protect assets from seizure.
Will the IRS Enter into an Installment Agreement?
The IRS will consider an installment agreement only if the taxpayer is current on his tax liabilities, which means that:
- Bob must have filed all of his tax returns
- Bob must be in compliance with his current year tax obligations. He needs to be current on his withholdings and estimated tax payments for this year. If in 2016 Bob files his 2015 return and owes on the return and is unable to pay, the IRS will not enter into an installment agreement. He will have to wait until 2017. He should adjust his withholdings so that he isn’t in the same tax owed position in 2017. Bob may not have the option to wait until 2017, in which case he should take out a loan to pay off his 2015 return liability before applying for an installment agreement
How will the IRS Determine the Monthly Payment Amount?
The IRS will look at the taxpayer’s monthly income, assets, and expenses to determine the amount of disposable monthly income available.
- Bob has $12,500 gross monthly income ($150,000 wages/12)
- Bob lives in an upscale apartment and pays $2,500/mo. He drives a luxury car with a $1,500/mo payment. He dines at expensive restaurants and has a shopping addiction. At the end of the month, he saves on average $100. Bob thinks his discretionary income is $100.
- The IRS cares very little about how much Bob actually spends. The IRS has federal and local standard tables based on the taxpayer’s family size and location. For example, based on Bob’s location and family size (1 individual), the IRS applies the following federal standards:
- Food – $307
- Housekeeping supplies – $30
- Apparel & Services – $80
- Personal care products and services – $34
- Miscellaneous $119
- Vehicle ownership (lease or monthly payment) – $471
- Local standards:
- Housing – $1,457
- Vehicle operating cost – $281
- Additionally, the IRS allows actual expenses for the following expenses:
- Health insurance
- Court ordered payments (e.g., child support)
- Child/dependent care
- Term life insurance
- Tax withholdings (Federal, FICA)
- Secured debts
- Certain expenses (e.g., required continuing education for job)
- After applying the above standard and actual expenses, the IRS determines that Bob actually has $6,200 discretionary income, not $100.
The IRS will expect you to adjust your living standards in order to make the monthly payment based on the calculated discretionary income. You can elect for the IRS to allow 1 year of actual expenses for car payments, private school/university education, and housing in order to give you time to modify your current spending.
While the IRS standard expenses are not cast in stone and there is some flexibility, you should not expect much deviation unless you meet the 6 year rule* or have a very good argument why a particular expense should exceed the federal or local standards. The amount of flexibility will be determined by your attorney’s knowledge of procedure and negotiation skills, the personality of the IRS representative, and your particular situation.
- Bob has $25,000 equity in his home, some of which is available to be borrowed against through a home equity loan
- Bob has $75,000 in his 401(k). His 401(k) plan allows Bob to take a loan up to 50% of the value
- If the installment payments will not result in full payment of debt before the expiration of the collections statute, the IRS will likely require Bob to tap into the equity of his home and/or take a 401(k) loan to make additional payments to cover the shortfall.
If the monthly payments will not result in full payment of debt before the collections statute expires, the IRS will determine if you have any equity available in your assets to borrow against or if you have any assets that can be sold (e.g., jewelry, collectibles, etc)
Alternatives to Installment Agreements
While taxpayers with little income and future earning potential are able to negotiate a lump sum deal with the IRS through an Offer in Compromise, Bob has a good, steady source of income. He does not qualify.
His only other option is bankruptcy. Taxes can be discharged in bankruptcy subject to certain requirements. The main requirements are that 240 days have passed since the taxes were assessed and at least 3 years have passed since the due date for the tax return. It is possible to have part of the debt discharged in bankruptcy if 3 years have passed for some of the tax years but not others. It is also possible to enter into an installment agreement for 3 years and then file for bankruptcy. We will go over all of your options with you. While we do not currently represent clients for bankruptcy, we can refer you to a reputable bankruptcy attorney.
The Doing Nothing AKA “Sticking your head in the sand” Method
If you do absolutely nothing and ignore the collections notices, the IRS will start levying, which can involve garnishing your wages, levying your bank accounts, seizing your vehicle, and sending levy notices to anyone that has issued you a 1099 in the past instructing them to send any payments owed to you directly to the IRS. In extreme cases, the IRS will seize your home and keep the equity up to the amount of your debt. The IRS will be more aggressive where there are multiple tax years, a large amount of debt, and/or a short collections statute.
Sometimes the doing nothing method works out if you don’t have a large balance (over $50,000) and the IRS is not able to identify any assets or sources of income (i.e., you don’t receive W-2s or 1099s, and have no reported assets and bank accounts). I still would never recommend this method to a client.
Some clients have asked, “if the IRS will require monthly payments anyway, why not do nothing and let the IRS garnish my salary.” Because the IRS will leave you with as little as $400 after garnishment on your biweekly pay. Additionally, your employer will now know about your IRS debt, which may be embarrassing or damaging to your reputation.
The longer you wait to resolve your tax debt, the more you limit your options.