Bob winds up with $250,000 of total tax debt. He earns net business income of $150,000/yr. He has $200,000 equity in his home and $75,000 in his IRA. After a visit from a revenue officer to his home, he contacts us. He mentions that he heard about the “Fresh Start Program” from a company on the radio and asks if we can get his debt settled for pennies on the dollar.
We quickly let him know that an offer in compromise would not be an option for him because his reasonable collection potential is more than the debt he owes. His best bet will be an installment agreement.
Will the IRS Enter into an Installment Agreement?
The IRS will consider an installment agreement only if a 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 estimated tax payments due for the last quarter
How will the IRS Determine the Monthly Payment Amount?
The IRS will look at Bob’s monthly income and expenses to determine the amount of disposable monthly income available.
- Bob has $12,500 gross monthly income ($150,000 business income/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 Hermes tie addiction. At the end of the month, he saves on average $300. Bob thinks his discretionary income is $300.
- 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
- After applying the above standard and actual expenses, the IRS determines that Bob actually has $6,200 discretionary income, not $300.
The IRS will expect Bob to adjust his living standards in order to make the monthly payment based on the calculated discretionary income. In some cases, it is possible to get 1 year of actual expenses allowed for car payments, private school/university education, and housing to give the taxpayer time to modify their current spending habits.
- Bob has $200,000 equity in his home, which is available to be borrowed against
- Bob has $75,000 in his IRA. His IRA 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 try to borrow against his home equity and IRA. In rare cases, the IRS will seize a taxpayer’s primary residence and retirement accounts.
Alternatives to Installment Agreements
Bob doesn’t qualify for an offer in compromise but he isn’t ready to fork over $6,200 to the IRS every month.
Another option is a Chapter 7 bankruptcy. Taxes can be discharged in bankruptcy, subject to certain requirements. However, if the IRS has filed a lien, the debt will be secured. So although the debt will be discharged, the lien will remain on the taxpayer’s assets.
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. If you’re self-employed or a small business owner, they’ll even send levy notices to anyone that has issued you a 1099 in the past and instruct 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.
The longer you wait to resolve your tax debt, the more you limit your options.