Clients should always be encouraged to file their returns on time and pay as much of the balance due as possible, but those that cannot pay in full are not out of options. Changes the IRS has made as part of its “Fresh Start” initiative over the past two years have made it easier for taxpayers to qualify for alternative payment programs. Ignoring a tax bill is never a good option, and the Fresh Start changes should provide a good incentive for taxpayers to work with the IRS to resolve past due taxes.
If a client is unable to pay in full, Sec. 6159 allows the IRS to enter into a monthly payment plan (installment agreement). The IRS also has the authority to settle the tax, penalties, and interest by negotiating an offer in compromise (OIC). This is a contract between the taxpayer and the government to settle the tax debt for less than the full amount owed.
The IRS changed the rules governing installment agreements as part of its Fresh Start program, making it easier to qualify for an installment agreement if the taxpayer owes $50,000 or less (IR-2012-31 (3/7/12)). The Fresh Start program also extended the period of time in which a taxpayer must pay any balance due. The IRS has also changed the OIC program over the past two years, making the qualifications for a settlement more flexible (IR-2011-20, IR-2012-31, and IR-2012-53). The IRS still does not consider itself a bank and will request cooperation in paying the tax obligation in full if the taxpayer has the ability to do so. However, when the tax obligation cannot be fully paid, there are circumstances where an installment agreement is automatically accepted.
An installment agreement allows the taxpayer to pay the tax debt in monthly payments, provided certain prerequisites are met. To qualify for an installment agreement, the taxpayer must be currently compliant. This means that (1) all required tax returns have been filed and (2) the taxpayer is up-to-date with current-year tax obligations. Once an agreement is established, the IRS requires the taxpayer to stay in compliance to avoid “pyramiding” additional taxes onto those that are already owed. For this reason, practitioners should advise a client to increase payroll tax withholding or remain current with estimated taxes to avoid a default on the installment agreement.
Example. Mr. Smith cannot pay the full tax with his return. He follows his practitioner’s advice and files a timely tax return even though he cannot pay the taxes in full. The practitioner has Mr. Smith submit Form 9465, Installment Agreement Request, with the tax return. The form can be attached to the front of the tax return or filed separately. Form 2848, Power of Attorney and Declaration of Representative, can be submitted to the Centralized Authorization File (CAF), authorizing the practitioner to represent the client. The Form 2848 can be mailed or faxed to the CAF Unit in the Ogden, Utah; Memphis, Tenn.; or Philadelphia service center, depending on the state mapping for CAF Units (available at tinyurl.com/cgp3x8m).
$50,000 OR LESS OWED
If Mr. Smith owes income tax of $50,000 or less on Form 1040, he can request an installment agreement without submitting the financial information normally required on Form 433-F, Collection Information Statement. Taxpayers who owe $25,000 or less should use Form 9465, Installment Agreement Request. Form 9465-FS should be filed by taxpayers who owe more than $25,000, but not more than $50,000. Mr. Smith should not use Form 9465 if he can fully pay his obligation within 120 days. Instead, he should call the IRS at 800-829-1040 or apply online to request the option to pay in full.
If the taxpayer owes $10,000 or less, the IRS cannot turn down the request if the taxpayer meets the requirements for a guaranteed installment agreement. In addition to the $10,000 limit, the following rules apply to qualify for a guaranteed installment agreement (Form 9465 instructions):
- During the past five years, the taxpayer (and spouse if filing jointly) has timely filed all income tax returns and paid all income taxes without entering into an installment agreement.
- The taxpayer must agree to pay the full amount owed within three years and comply with all filing requirements and payment of tax while the agreement is in effect.
The IRS historically has allowed up to 60 months to pay the obligation in full. Under the Fresh Start program, it is now allowing up to 72 months to pay (IR-2011-20, IR-2012-31, and IR-2012-53).
Mr. Smith will be charged interest and late payment penalties. The law allows the normal 0.5% per month late payment penalty to be cut to 0.25% for the months during which the installment agreement is in place if the tax return to which the past due tax relates was timely filed (Sec. 6651(h)). As long as the taxpayer timely filed the federal return (including extensions), the failure-to-file penalty (up to 25% of the tax owed) is avoided.
Form 9465 can also be used by individuals for the following types of taxes:
- Trust fund recovery penalties;
- Self-employment or unemployment taxes (if the individual is no longer running a business); or
- Partnership or limited liability company taxes (if the individual is personally responsible for the taxes and the business is no longer operational).
Form 9465 can be filed with a return or separately after a return has been filed, including in response to an IRS notice.
Because he owes $50,000 or less, Mr. Smith can apply online for an installment agreement by going to the “Online Payment Agreement Application” page on the IRS’s website at tinyurl.com/yggtp9. It often takes 30 to 60 days for the IRS to approve or deny a request for these types of installment agreements.
APPLICATION USER FEES
Taxpayers must pay a user fee to establish an installment agreement. The fee is based on the method of payment (see Exhibit 1). User fees can be reduced to $43 based upon the taxpayer’s income. The IRS determines if a taxpayer is eligible for the reduced user fee, or a taxpayer can file Form 13844, Application for Reduced User Fee for Installment Agreements, to request the reduced fee.
MORE THAN $50,000 OWED
If Mr. Smith’s tax liability exceeds $50,000, another set of rules applies to establishing an installment agreement. He might have to work with Automated Collection System (ACS) personnel at an IRS call site. When the liability exceeds $100,000, the case is referred to the field.
ACS will require Mr. Smith to complete Form 433-F or Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals. He will probably need an experienced practitioner to assist him in filling out one of these forms. Typically Form 433-F is used by IRS call sites and requires less information than Form 433-A.
The usual procedure for establishing an installment agreement for taxpayers who owe more than $50,000 is to call the IRS-ACS at 800-829-3903 or the Practitioner’s Hotline at 866-860-4259 (select option #4) and read the financial information over the telephone to an IRS Collection employee. If Mr. Smith’s financial information fits within the national Collection Financial Standards (discussed below), an agreement can be reached over the phone. If some or all of the categories listed on Form 433-F exceed the national standards, the IRS will require more financial information either by fax, if less than 10 pages, or by mail. This can delay entering into a formal installment agreement for months.
It is wise to discuss making voluntary payments with the client while this process is pending prior to calling the IRS. Normally, the IRS employee will recommend making voluntary payments during that first telephone call, and it is advisable to confirm whether voluntary payments can or cannot be maid. The IRS employee notes the conversation on the IRS computer system, and any future communication with the IRS will typically require an explanation why a client did not make payments pending the approval of an installment agreement. The payments show a good-faith effort that a client is working toward resolving his or her debt with the IRS, which helps the negotiation process for monthly installment amounts. The voluntary payments will not guarantee that a levy or lien will not be filed, but the IRS typically respects the good-faith payments and will delay collection action until a settlement is reached.
PARTIAL PAYMENT INSTALLMENT AGREEMENT
The IRS does offer another payment option called “partial payment installment agreements” when it is not possible for a client to fully pay his or her tax liability before the expiration of the 10-year collection statute of limitation. This type of agreement can be discussed with the IRS if an OIC is not accepted or if a client is not eligible for an OIC. In most cases, a client will be expected to use equity in assets to pay liabilities prior to entering into a partial payment installment agreement (Internal Revenue Manual (IRM) §22.214.171.124). This is not part of the Fresh Start program, but it is worth discussing with the IRS as an alternative to an OIC.
The IRS uses the Collection Financial Standards to help determine the taxpayer’s ability to pay a delinquent tax liability. The standards vary in amount based upon the size of a family and the state and county where the taxpayer resides. They are intended to be “guidelines,” but the IRS has historically been inflexible if the tax cannot be fully paid within 60 months (currently expanded under the Fresh Start program to 72 months). The IRS says the Fresh Start program “includes a variety of changes to help individuals and businesses pay back taxes more easily and with less burden, including the issuance of fewer tax liens” (IR-2012-31 (3/7/12)).
The dollar amounts of the standards are adjusted, typically annually, to account for inflation and other factors. Therefore, it is important to check the IRS website periodically for updates. Detailed information on the national standards is available on the “Collection Financial Standards” page of the IRS’s website at tinyurl.com/4mhnc.
The Collection Financial Standards include amounts for:
- Food, clothing, and other items;
- Housing and utilities;
- Out-of-pocket health care expenses; and
These are considered “necessary” expenses, but there are other necessary expenses the IRS recognizes, such as health insurance premiums, court-ordered payments, certain taxes, and secured debt (see IRM §126.96.36.199). “Conditional” expenses (expenses that do not meet the definition of necessary expenses) are also allowed if the tax liability (including the interest and failure-to-pay penalties) is paid within five years (IRM §188.8.131.52).
The IRS has guidelines for collection procedures and guidelines of what constitutes necessary and conditional expenses. The “Financial Analysis Handbook” portion of the IRM is available at tinyurl.com/74u6rso.
LIENS AND LEVIES
The IRS has historically filed liens for tax liabilities that exceed $25,000. It recently announced that, in an effort to help struggling taxpayers, it was changing its lien practices (IR-2011-20 (2/24/11)). There will be a significant increase in the dollar threshold, which the IRS stated in the news release would be announced in about one year. Check irs.gov routinely for updates.
To prevent a wage or bank levy, a practitioner should stay in periodic communication with the IRS-ACS while the installment agreement is pending. Once the installment agreement is established, the client is free of the threat of levy or other collection actions as long as payments are made as agreed.
As client advocates, practitioners can assist individuals with their current tax responsibilities and work with the IRS to establish a workable and sustainable installment agreement.
OFFERS IN COMPROMISE
The IRS announced another expansion of the Fresh Start program by initiating a more flexible OIC program (IR-2012-53 (5/21/12)). Some of the changes are:
- Revising the calculation for the taxpayer’s future income;
- Allowing taxpayers to repay student loans;
- Allowing taxpayers to pay delinquent state and local taxes; and
- Expanding the Allowable Living Expense allowance category and amount.
Other significant changes are in the calculation of the taxpayer’s reasonable collection potential. The IRS now looks at only one year of future income for offers paid in five months or less, down from four years, and two years of future income for offers paid within six to 24 months, down from five years. Form 656, Offer in Compromise, and Form 656-B, Offer in Compromise Booklet, have been revised to reflect these changes.
The changes to the installment agreement and OIC programs should offer more individuals who have been struggling with the economic downturn in the last several years a new opportunity to resolve their debts with the IRS.
The economic downturn has made it more difficult for many people to pay their taxes when they are due.
Practitioners should ensure their clients know that the worst thing they can do when they cannot pay their taxes is to ignore the problem and hope it goes away. Even if they cannot pay their taxes, they should file on time.
In recognition of the tough economic times, the IRS has expanded its “Fresh Start” program, which, among other things, has made it much easier for taxpayers to qualify for installment agreements that allow taxpayers to pay over time (up to six years).
Installment agreements are now available for taxpayers who owe $50,000 or less without having to provide detailed financial information.
The IRS has also liberalized its requirements for offers in compromise, which permit taxpayers to settle tax debts for less than the full amount owed in certain circumstances.
Mary Lou Gervie (email@example.com) is a director at Watkins Meegan LLC, a public accounting firm in Bethesda, Md.
To comment on this article or to suggest an idea for another article, contact Sally P. Schreiber, senior editor, at firstname.lastname@example.org or 919-402-4828.
“Strategies for Compromising Tax Debts,” June 2011, page 50.
Tax Insider article
“Has the IRS Levied Tax Assessment on Your Client That Can’t Be Paid Immediately?” Nov. 10, 2011
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IRS "Fresh Start" Initiatives for Tax Liens, Installment Agreements and Offers in Compromise (#WBC12342I, Nov. 28; # WBC12343I, Dec. 11)
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