|Relief from federal income tax liabilities during the recession: A fresh start
IRS loosens rules for offers in compromise and payment plans.
June 14, 2012
Hard economic times have made it increasingly difficult for many people to keep current on their bills, not least of which are their federal income taxes. The IRS has responded to these challenges by liberalizing its rules for offers in compromise and installment payment agreements as part of its Fresh Start program.
An offer in compromise is an agreement between a taxpayer and the IRS settling the taxpayer’s tax liability for less than the full amount owed. Installment payment agreements require taxpayers to pay the full amount of tax owed in monthly installments over a period of up to six years. Installment agreements reduce the amount of penalties owed, but interest must be paid on the balance due.
Offers in compromise
An offer in compromise is generally not accepted if the IRS believes the taxpayer can pay the liability in full as a lump sum or in an installment agreement. The IRS looks at each taxpayer’s income and assets to determine whether and how much the taxpayer can pay (the IRS calls this reasonable collection potential). Part of this analysis involves calculating allowable living expenses, which are set using national standards to determine average expenditures for the cost of basic necessities in similar geographic areas. The ability to pay is also determined by looking at the taxpayer’s future income (IR-2012-53).
Under the new rules, in calculating a taxpayer’s reasonable collection potential, the IRS will now look at only one year of future income (down from four years) for offers in compromise that will be paid in five or fewer months, and two years of future income (down from five years) for offers paid in six to 24 months. The program will now also permit equity in income-producing assets (e.g., a machine used in manufacturing) to be excluded from the calculation of reasonable collection potential for an ongoing business.
In addition, the IRS has narrowed the definition of “dissipated assets,” which are assets that were sold, transferred, or spent on things that are not necessary living expenses after the tax was assessed or within six months before the tax was assessed (IR-2012-53, Internal Revenue Manual §§188.8.131.52.1, 184.108.40.206(1)).
To respond to what the IRS characterizes as “real-world situations,” allowable living expenses used to determine a taxpayer’s reasonable collection potential now include credit card payments and bank fees. Allowable living expenses now also include payment of federally guaranteed student loans and payment of a certain percentage of delinquent state and local taxes (IR-2012-53).
Taxpayers who do not qualify for an offer in compromise may find that an installment agreement is a painless way to discharge a federal tax liability. The IRS charges taxpayers a $105 user fee to set up an installment agreement ($52 for direct debit accounts and $43 for low-income taxpayers). A large number of taxpayers now qualify to pay by installment without providing financial information.
The IRS is required to enter into an installment agreement if the taxpayer does not owe more than $10,000, and he or she (along with his or her spouse if they file a joint return) has not failed to file a return or pay any income tax and has not entered into an installment agreement in the past five years. And, in March 2012, in IR-2012-31, the IRS announced the expansion of its program of “streamlined installment agreements,” which are installment agreements for which the taxpayer does not have to provide financial information on Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, or 433-F, Collection Information Statement.
The maximum amount taxpayers can owe and still qualify for a streamlined installment agreement was increased from $25,000 to $50,000, and the maximum payment term was increased from five years to six years. Although these agreements still have to be approved by the IRS (they are not automatic as are the $10,000-and-under installment agreements), eliminating the requirement to provide financial information makes it much easier for taxpayers to qualify. Taxpayers can apply for and set up an installment agreement on the IRS website.
If you represent individual taxpayers who are experiencing hard times and cannot pay their tax liability, be sure to explain that the best way to handle the problem, as is true for any financial difficulty, is not to ignore it. Taxpayers who file their returns and pay what they can will probably find a sympathetic ear somewhere in the IRS, and the installment agreement and offer in compromise programs may offer welcome relief.
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Sally P. Schreiber, J.D., is a senior editor in the AICPA’s magazines and newsletters group. She contributes to The Tax Adviser and Journal of Accountancy as well as the Corporate Taxation Insider and Tax Insider newsletters.