What are the steps in the financial analysis handbook?
Almost all tax payment alternatives, from installment agreements to the Offer In Compromise program, mostly depend on the taxpayer’s ability to pay. To ensure consistent results between different field offices, IRS agents use the financial analysis handbook to make these determinations. It may seem like a simple task to subtract expenses from income, but the IRS financial analysis process is almost always much more involved.
Income Step One: Bank Accounts and Other Liquid Assets
If the taxpayer is an individual, the IRS financial analysis process dictates that agents count all sources of income. Typically, the Service lifts the values off the gross income section in the first part of the 1040, and not the adjusted gross income section later on the form. Furthermore, unlike most other creditors, the IRS includes all DSOs (domestic support obligations like child support, alimony, and medical bill reimbursement) as income. The IRS uses the amount that the obligor is supposed to pay, not the money s/he actually paid.
Business income works differently in the IRS financial analysis process, especially if the delinquent taxpayer is an individual who has an ownership interest in a corporation, LLC, or other limited liability entity. In addition to data on tax returns, IRS agents also examine business records to identify:
- Buildings and other tangible assets,
- Cash equivalents (short-term investments), and
- Intangible assets, like business goodwill and intellectual property.
Typically, the IRS cannot take corporate income or assets into account when determining collection activity against an individual.
The IRS bases the collection decision on the income data it collects, a company-provided cash flow analysis, and the taxpayer’s ability to raise money by selling or borrowing against tangible assets.
Income Step Two: Fixed Assets
The IRS uses FMV and QSV to determine an asset’s cash equivalent. The IRS financial analysis handbook defines Fair Market Value as “the price set between a willing and able buyer and the seller in an arms-length transaction,” taking into account variables such as “market conditions, age of the asset, condition of the asset, zoning requirements, technology, demand, fitness for use, and other factors.” Quick Sale Value is presumptively 80 percent of the FMV, if the sale can be completed in fewer than 90 days.
For many taxpayers, their largest asset is their house, and in this area, things get really complicated. Assuming that existing homes stay on the market for more than 90 days in your location (the nationwide average is sixty-five days as of November 2017), the 80 percent presumption is arguably inapplicable. Instead, a better QSV may be 50 percent of FMV, which is usually a home investor’s first cash offer. If the taxpayer has a written offer from a home investor, that’s even better.
Furthermore, most homes are jointly owned, and if the other owner does not owe money to the IRS, the Service must reduce the FMV to reflect the taxpayer’s actual ownership interest. Finally, the IRS financial analysis process must determine if the house has any mortgage or other liens, including non-IRS tax liens.
In a future post, we’ll look at the procedure to determine allowable expenses, because these questions are litigated much more frequently.