How Does the IRS Decide What I Can Afford to Repay?

If you’re struggling to pay off tax debt, it may seem like the IRS is completely arbitrary as it determines your repayment options and whether you qualify for any tax relief.

When considering your ability to repay, the IRS’ Collection Financial Standards (CFS) is used to determine a taxpayer’s living expenses. In addition to considering the taxpayer’s age and family size, the IRS uses a set of National Standards that assigns a set monetary value to five types of necessary household expenses, which scales up depending on family size:

• Food: Food items purchased at grocery stores as well as meals, snacks, and tips at restaurants
• Housekeeping supplies: Laundry and cleaning supplies, postage, delivery services, and lawn and garden supplies
• Apparel and services: Clothing, footwear, alterations and repairs, dry cleaning, and jewelry and jewelry repair
• Personal care products and services: Products for hair, oral hygiene, shaving needs, and bathing; cosmetics are also included
• Miscellaneous: Expenses that are not included in the previous categories (e.g., school supplies, reading material, credit card payments, bank fees and charges), or for overspending in any of the other categories

There are also national standards for out-of-pocket health care expenses and public transportation, local standards for housing and utility costs, and, for vehicle-owning taxpayers, transportation standards.

Some necessary household expenses aren’t subject to the Collection Financial Standards, including taxes paid, childcare, court-ordered payments (i.e., alimony, child support, etc.), and premiums for health insurance and life insurance.

For taxpayers more than 120 days in arrears, the IRS allows you to make other arrangements, depending on your financial status. These arrangements could involve a repayment plan or a hardship agreement, such as an Offer in Compromise (OIC), where the taxpayer settles a tax debt for less than the amount owed. Depending on your financial situation, you may be eligible for an installment agreement or an OIC.

What Is an Installment Agreement?

An Installment Agreement is a payment plan between you and the IRS to pay your back taxes and penalties over an extended time frame (longer than 120 days). You can apply for an installment agreement if you:

• Filed your tax returns
• Owe the IRS no more than $50,000
• Can pay off what you owe in up to 72 months (6 years)

In November 2020, the IRS announced its Taxpayer Relief Initiative for taxpayers struggling to meet their tax burdens because of the COVID-19 pandemic. Highlights of the new initiative include:

• Taxpayers who qualify for a short-term payment option now have up to 180 days to pay their tax debt (instead of 120 days).
• For taxpayers unable to pay on the balance of existing Installment Agreements, the IRS will automatically add certain new tax balances to help payers avoid defaulting on the agreement.
• To reduce paperwork burdens for taxpayers, certain qualified individual taxpayers who owe less than $250,000 may set up Installment Agreements without providing a financial statement or substantiation if their monthly payment proposal is sufficient.
• Some individual taxpayers who only owe for the 2019 tax year and who owe less than $250,000 may qualify to set up an Installment Agreement without a notice of federal tax lien filed by the IRS.

What is an Offer in Compromise?

An Offer in Compromise (OIC) is an agreement between the taxpayer and the IRS to settle a tax debt for less than the amount owed. To begin the OIC process, you must submit an application and present the IRS with an offer for the amount you can pay toward your outstanding tax debt. But, before you do that, you must:

• File all required tax returns
• Have received a bill for at least one tax debt
• Make all required estimated tax payments
• Paid the application fee
• Not be in open bankruptcy proceedings

If you meet all the eligibility requirements listed above, you can visit the IRS’ Offer in Compromise Pre-Qualifier to confirm your eligibility and start preparing a proposal offer. You must also submit the following forms:

• The most current form of Form 656—Offer in Compromise
• Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals
• If you’re filing on behalf of your business, you may need to also submit Form 433-B, Collection Information Statement for Businesses.

RELATED: I was turned down for an Offer in Compromise I filed on my own. Is there any help for me?

Can I Qualify for an OIC if the IRS Determines I Can Pay My Amount in Full?

The IRS will examine your ability to pay based on your income, expenses, and assets. You won’t qualify for an OIC if, after reviewing your financial situation, the IRS determines you can fully repay your tax debt, either through an Installment Agreement or equity in assets.

When considering your ability to pay, there are certain assets that the IRS can exclude from consideration, such as up to $1,000 of a bank balance or $3,450 against the value of a vehicle.

An experienced tax attorney can help you prepare your application to the IRS.

What Does the OIC Process Look Like?

If you meet the threshold requirements listed above, the IRS will generally take about a month to determine whether you qualify. If you do, your offer will be assigned to an OIC examiner. The examiner will consider everything in your application and determine your reasonable collection potential (RCP).

The reasonable collection potential includes the value of your assets, including real estate, cars, bank accounts, and other property. The RCP also considers anticipated future income (taking into consideration your age and ability to work) minus certain amounts of money set aside for basic living expenses.

You should expect the OIC process to take at least six months — possibly longer if you decide to dispute the examiner’s findings or appeal a rejection.

Need Help With an Installment Agreement or OIC? Contact S.H. Block Tax Services

If you’re struggling with outstanding tax liabilities and would like to learn how one or more of the tax resolution strategies listed above might fit your unique situation, please contact S.H. Block Tax Services today. Our mission is to help you find an efficient and affordable resolution to your tax problems so you can start rebuilding and moving forward.

To schedule your free initial consultation and speak with a tax expert from our team, call (410) 872-8376 or use the contact form on this page.

The content provided here is for informational purposes only and should not be construed as legal advice on any subject. Please read our full disclaimer here.