Determining Allowable Expenses In IRS Payment Plans
The Internal Revenue Manual very broadly defines necessary expenses as “expenses that are necessary to provide for a taxpayer’s and his or her family’s health and welfare and/or production of income.” To make this determination, agents usually rely on a mixture of the average household expenses for the nation or that region and the taxpayer’s unique needs. It is a bit more complicated than it my seem, however, and a talented tax attorney can be a valuable asset in determining the allowable expenses in your IRS payment plan. Read on to find out how the IRS financial analysis process works.
Key Expense Categories
The IRM (IRS manual) definition is simultaneously objective and subjective. To determine the objective portion in the IRS financial analysis process, the Service looks at:
- National Standards: For out-of-pocket medical expenses, like prescription drugs and copays, and the five-item “food, housekeeping supplies, apparel and services, personal care products and services, and miscellaneous” category, the IRS allows a no-questions-asked allowance for the average national expense as determined by the Bureau of Labor Statistics. One significant weakness in the national standards is that they do not account for dependent ages, and scientific studies have conclusively confirmed that teenage boys eat a lot more than preschool girls.
- Local Standards: Since housing/utilities and transportation expenses vary so much according to locality, the IRS usually breaks down these expenses by county. Even this division is normally insufficient, since there is a big difference between posh suburbs like Gross Pointe and urban neighborhoods like Herman Gardens, although both are in Wayne County.
On this point, the IRM is on the taxpayer’s side, because IRS financial analysis procedures require the agent to make an adjustment if the national or local standards are inadequate.
Next, there’s the amorphous “other expenses” category, which the IRS splits into conditional and necessary costs. Some examples include:
- Child Care: This expense is normally necessary if both parents work and the child is quite young. But expect the IRS to fuss if the child has an older sibling at home, one parent works from home, the cost is abnormally high for that area, or there are other red flags.
- Charitable Contributions: The IRS almost always rejects these conditional expenses unless they are directly related to employment (e.g. a minister who must tithe per the employment contract).
- Domestic Support Obligations: Alimony and child support are almost always necessary, unless they involve an otherwise unallowable expense, like college tuition.
- Special Needs Children Educational Expenses: Historically, the IRS has been rather liberal in this area, but the Supreme Court recently ordered public schools to provide greater services to special needs kids, so this allowance may be harder to claim in the future.
Special rules apply to non-IRS taxes that are delinquent, like state income taxes and property taxes.
IRS Financial Analysis, the Six-Year Rule, and the One-Year Rule
All this sounds terribly complicated, but in some cases, the IRS does not scrutinize expenses nearly as closely. Some taxpayers who do not qualify for streamlined installment agreements may qualify for special IRS payment plans under IRM 5.14.1, otherwise known as the six-year rule. If the taxpayer can satisfy the outstanding debt within six years, the IRS automatically allows all reasonable expenses without requesting additional documents or asking additional questions. Furthermore, under the one-year rule, taxpayers have one year to trim disallowed expenses. In so doing, they may reduce expenses enough to pay off their debts sooner, thus qualifying for the six-year rule and all its benefits. So for example, a family could trade in a loaded Lexus SUV for a baseline Chevy crossover and stay in a larger house.
This section only applies to individuals and not to corporations or businesses.