In light of the current Covid-19 pandemic, the Internal Revenue Service (IRS) extended the April 15, 2020, filing and payment deadlines for federal individual income taxes for the 2019 tax year to July 15, 2020. Due to the pandemic, many taxpayers are finding themselves in difficult financial circumstances. They are unable to pay their outstanding federal tax liabilities by the July 15, 2020 deadline and wonder what they should do.
If a taxpayer is unable to pay their tax liabilities on time, there are many options to try to resolve their federal tax liabilities. Two common options, which we will address in this article, are: (1) an installment agreement or (2) an offer in compromise.
Even if a taxpayer is unable to timely pay their taxes, the taxpayer should still timely file their tax return. By timely filing their return, the taxpayer can avoid late filing penalties. The filing of the return also triggers the IRS’s statute of limitations to assess additional tax and to collect the liabilities (addressed below).
An installment agreement is essentially a payment plan. The IRS considers a number of factors in determining whether to accept an installment agreement request .
The most important factors are generally: (1) the amount of time remaining on the collection statute of limitations (also known as the collection statute expiration date, or “CSED”), (2) the taxpayer’s “reasonable collection potential” (RCP); and (3) the amount at issue.
Statute of limitations. There are generally two relevant statutes of limitations: (1) the Assessment Statute of Limitations, and (2) the Collection Statute of Limitations, or the CSED.
The Assessment Statute of Limitations is the amount of time the IRS has to assess additional tax against the taxpayer for a particular tax period. The Assessment Statute of Limitations is triggered by the filing of a tax return. If no tax return is filed, the Assessment Statute of Limitations is not triggered, and the IRS can effectively audit/assess additional tax for that tax period indefinitely. This is an important reason to file a tax return, even if you cannot timely pay the liability owed. Generally, the Assessment Statute of Limitations is three years from the due date of the tax return or the date on which it was filed, whichever is later.
The CSED is the amount of time the IRS has to collect the tax liabilities from the taxpayer. In general, this is 10 years from the assessment date. Initiating the CSED is another important reason to file your tax return, even if you are not able to timely pay the liability.
- RCP. A taxpayer’s reasonable collection potential, or RCP, is a calculation made by the IRS to determine the taxpayer’s ability to pay the debts. Generally, the two main factors in the IRS’s RCP analysis are the taxpayer’s: (1) equity in assets and (2) excess monthly income.
- Equity in assets. A taxpayer’s equity in assets includes their equity value in bank accounts, investment accounts, retirement accounts, vehicles, their home, and other real and personal property (such as boats, snowmobiles, etc.), as well as ownership interest in a business, etc.
- Excess monthly income. A taxpayer’s excess monthly income is generally the taxpayer’s average monthly income less their monthly expenses.
A number of factors are considered by the IRS when determining a taxpayer’s allowable monthly expenses, including household size and special circumstances (for example, if the taxpayer or dependant has a medical issue that requires substantial out-of-pocket costs).
The IRS generally caps monthly expenses based on its “national standard allowances,” unless special circumstances apply. Read more about the IRS’s national standard expense allowances here.
To determine a taxpayer’s RCP, the IRS generally requires the taxpayer provide a completed financial statement. Generally, for individuals, this is a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, or Form 433-F, Collection Information Statement. For businesses, this is generally a Form 433-B, Collection Information Statement for Businesses.
The IRS also generally requires the taxpayer provide financial information and documentation to verify the accuracy of the information reported on their financial statement, such as bank statements, investment statements, retirement account statements, mortgage statements, vehicle loan statements, etc.
Amount at issue. The amount at issue generally includes all outstanding federal tax liabilities that the taxpayer owes (including tax, penalties, and interest) for all periods. In general, for any installment agreement, the taxpayer must pay the liabilities in full, via equal monthly payments, within the CSED of within 72 months, whichever occurs sooner.
Below we address some of the most common types of installment agreements:
- Guaranteed installment agreement. If the amount at issue is less than $10,000, generally a taxpayer is guaranteed to be accepted for an installment agreement without providing financial information and documentation, so long as the taxpayer pays the liabilities in full via monthly payments made within the CSED or within 72 months, whichever occurs sooner.
- Streamlined installment agreement. If the amount at issue is less than $50,000, a taxpayer may qualify for a “streamlined installment agreement,” without providing financial information and documentation, so long as the taxpayer pays the liabilities in full via monthly payments within the CSED or within72 months, whichever occurs sooner.
- Regular installment agreement. If the amount at issue is more than $50,000, the analysis can become more complicated. Generally, the IRS will require the taxpayer provide financial information and documentation as part of the installment agreement application process, and the IRS will likely file a federal tax lien, if applicable, to secure its interest in the debt.
Like the guaranteed and streamlined installment agreement options, a taxpayer applying for a regular installment agreement generally will be required to pay the liabilities in full via equal monthly payments within the CSED or within 72 months, whichever occurs sooner.
However, whether the IRS will accept a regular installment agreement request, and the amount of the monthly payments, will likely depend on the taxpayers’ RCP.
For example, if the taxpayer has equity in assets sufficient to fully pay the liabilities, the IRS may not consider a request for an installment agreement, unless the taxpayer can show good cause as to why the IRS should accept the installment agreement request in lieu of requiring the taxpayer to liquidate assets.
On the other hand, if the taxpayer does not have significant equity in assets but has significant monthly income in excess of its national standard allowances (which, for many taxpayers are much lower than their actual monthly household expenses), the IRS may require monthly payments equal to its calculation of the taxpayer’s excess monthly income, without consideration of the taxpayer’s actual monthly household expenses, unless the taxpayer can show good cause as to why the IRS should accept a lower monthly payment (or, the taxpayer may attempt to negotiate a “tiered installment agreement,” addressed below).
Special Installment Agreements. In some circumstances, the IRS may consider other special kinds of installment agreements, such as a tiered installment agreement or a partial payment installment agreement, to resolve a taxpayer’s outstanding federal tax liabilities.
- Tiered installment agreements. A tiered installment is basically a regular installment agreement that starts at a lower monthly payment rate for a period of time and then increases to a higher monthly payment rate for the remainder of the installment agreement term. For example, if a taxpayer has higher monthly expenses than the IRS’s national standard expense allowances and cannot afford to make the payments proposed by the IRS based on its calculation of the taxpayer’s excess monthly income, the taxpayer could propose making monthly payments equal to the taxpayer’s excess monthly income based on the taxpayer’s actual monthly expenses, and then start making monthly payments at the IRS’s calculated rate after one year, during which time the taxpayer may work to get their financial house in order to reduce their monthly household expenses.
- Partial Payment Installment Agreement. A partial payment installment agreement is basically an agreement in which the taxpayer pays as much as they can via an installment agreement by the CSED, and after the CSED expires, the remainder of the debt is forgiven.
Generally, to qualify for a partial payment installment agreement, a taxpayer will first need to pay the IRS the value of the taxpayer’s equity in assets as well as monthly payments via an installment agreement until the CSED expires.
There are also many other factors that may be considered in determining the terms of an installment agreement, including whether the taxpayer has any special circumstances (medical conditions, dependants to support, age, etc.), or whether assets are required for the production of income, etc.
To that end, for taxpayers owing more than $50,000, it can be very helpful to work with a tax professional to determine their options and to assist them in obtaining the best installment agreement option possible based on their circumstances.
Offer in Compromise
An offer in compromise is an offer to pay less than the full amount of the liability owing to resolve the entire liability owing.
In general, there are two types of offer in compromise, an offer in compromise based on doubt as to liability and an offer in compromise based on doubt as to collectibility.
Doubt as to liability exists when a taxpayer disputes the amount of the tax itself (for example, if the IRS made an additional tax assessment via audit or assessed the taxpayer personally for business tax liabilities (see our blog article here regarding this kind of “trust fund recovery penalty” assessment)). For purposes of this article, we will only address the offer in compromise for doubt as to collectibility.
To qualify for an offer in compromise, doubt as to collectibility, the taxpayer must show that their RCP is not sufficient to fully pay the liabilities within the CSED.
This means that the taxpayer must be able to show that the value of their equity in assets plus the present value of their future monthly excess income during the CSED is less than the total amount owing.
The amount offered for the offer in compromise generally must be more than the taxpayer’s RCP and must effectively be paid in a “lump sum” within a relatively short period of time from the date of acceptance of the Offer in compromise.
If the taxpayer can verify that their RCP is not sufficient to pay the liabilities in full within the CSED and the IRS accepts their offer in compromise proposal, the taxpayer will generally have five months from the date of the IRS’s acceptance of the offer in compromise to pay the offered amount in full.
If the taxpayer fails to fully pay the offer in compromise amount within that time frame, the IRS may default the offer in compromise and reinstate the liabilities in full.
Consequences of Not Timely Paying Taxes or Making a Payment Proposal
If a taxpayer does not timely pay their federal tax liabilities, the IRS has many options to try to collect the funds from the taxpayer.
For example, the IRS may issue federal tax liens against the taxpayer’s home or other property, levy the taxpayer’s bank, investment, or retirement accounts, garnish wages, initiate a lawsuit to foreclose on the taxpayer’s home or other property, etc.
Generally, after a taxpayer submits a payment proposal, such as an installment agreement request or offer in compromise to the IRS, the IRS will withhold most collection actions.
To that end, if a taxpayer owes federal tax liabilities, it is very important for the taxpayer to work with the IRS to resolve the federal tax liabilities as soon as possible to avoid IRS collection action.
There are many factors that are considered by the IRS in setting the payment terms for an installment agreement and in determining whether to accept an offer in compromise and in what amount.
Negotiating these terms tends to get more complex as the amount of tax liability increases. To that end, taxpayers with substantial outstanding tax liabilities may benefit from the assistance of a tax professional experienced in negotiating installment agreements and offers in compromise to assist them with assessing their options and resolving their liabilities in the most favorable way possible.
Our firm has assisted countless taxpayers in resolving their outstanding federal tax liabilities via an installment agreement or offer in compromise. Please feel free to contact us to discuss whether our services are the right fit for you.