Written for the Maryland Society of Accountants
One of the tasks most frequently faced in representing clients before the IRS Collection Division is negotiating an “installment agreement” — an arrangement under which the taxpayer makes monthly payments against the outstanding tax debt, free of the threat of levy and distraint action. Despite the Service’s imposition of a system of miserly national and local expense “standards” in August 1995, there is still considerable room for effective advocacy. Furthermore, the new IRS Restructuring and Reform Act of 1998 will make changes to the negotiation and legal consequences of installment agreements, and place greater emphasis on their use. In this article we will explore the present rules for installment agreements, as well as the changes we can expect as the IRS digests and implements the new law.
Identifying the objective
As Revenue Officers are fond of saying, the IRS is not a bank. And unless there is no reasonable alternative, the Collection Division will not accept a monthly payment agreement.2 In many cases, however, there simply is no reasonable alternative. The task then becomes one of getting the client the best possible deal. This requires an understanding of the client’s objectives.
For some clients, the goal is the full payment of the taxes as quickly as possible to minimize interest and late payment penalties. Other clients, however, have managed to create tax liabilities so large that full payment is simply not in the cards. These poor souls must look toward the expiration of the statute of limitations, the resolution of the liabilities through the offer in compromise process, or the discharge of the taxes in bankruptcy. For them, an installment agreement is only an interim solution, and the objective is usually negotiating the smallest monthly payment the IRS will accept. Not surprisingly, the IRS’s goal is exactly the opposite — the Revenue Officer wants the largest monthly payment the taxpayer can afford.3
A prerequisite to any installment agreement is “current compliance.” This is IRS jargon meaning that all required returns have been filed, and that the taxpayer is on a pay-as-you-go basis for current period taxes.4 For business taxpayers, the Service will demand proof that current payroll tax deposits are being made on a timely basis. For individuals, there must be evidence of adequate withholding from the taxpayer’s wages or compliance with the obligation to make adequate estimated tax payments. A taxpayer who is piling new liabilities on top of old ones is said to be “pyramiding” in IRS-speak. A Revenue Officer will more likely be thinking about putting such a taxpayer out of his misery, rather than allowing him to make monthly payments against the delinquency. Particularly for business taxpayers, the pyramiding of withholding taxes precludes any relief from the onslaught of levies and seizures. You will get much farther on your client’s behalf in discussions with a Revenue Officer by focusing first on current compliance. Indeed, by using the IRS’s own terminology and showing that you understand the importance of current compliance, you will demonstrate that you know what you’re doing, and that you are trying to make the Revenue Officer’s task easier. Revenue Officers have the worst job in the IRS, and most appreciate working with a courteous and professional representative who understands the demands and standards the system imposes upon them.
Collection Information Statements
Being a bureaucracy, the IRS naturally has its own forms for everything. In dealing with a Revenue Officer the Rosetta Stone is the “Collection Information Statement.” There are two versions: Form 433-A for individuals, and Form 433-B for businesses.5 The single best way to help a client with a tax collection problem is to assist him in completing these forms accurately and with full substantiating documentation. Every number shown must be correct and substantiated, not only because the form is signed under penalties of perjury, but because an incomplete or inaccurate form will destroy your credibility with the Revenue Officer.6
Sources of information
Because of the need for complete accuracy in preparing Forms 433-A and 433-B, for new clients it is helpful to obtain copies of any such forms previously filed. You can make this request (after filing the required Power of Attorney form) directly with the Revenue Officer handling the case. If no Revenue Officer is assigned, consider filing a Freedom of Information Act request with the District Disclosure Officer.
While we’re on the subject, in all new cases you should also obtain from the IRS complete IMF or BMF “transcripts” for all relevant tax periods. These transcripts will give you details on every transaction for each tax period, including assessments of tax, penalties, and interest, payments, refunds and refund offsets, lien filing dates, statute of limitations extensions, and a host of other invaluable information.7 Knowledge is power, and you need to know at least as much about your client’s accounts as the Revenue Officer with whom you are dealing.
Selling or borrowing against assets
Forms 433-A and 433-B include balance sheets, requiring a taxpayer to list all assets and liabilities. Before discussing a client’s ability to make monthly payments from future income, the Revenue Officer will want to talk about selling or borrowing against assets. An installment agreement is allowed only if the taxpayer has no ability to liquidate or borrow against assets to pay or reduce the liability. The IRS “Collecting Contact Handbook” gives explicit instructions to Revenue Officers about how to approach these issues:
Analyze income and assets to determine ways of liquidating the account. Your goal is to collect the tax liability as quickly as possible. Follow these steps:
- If the taxpayer has cash equal to the tax liability, demand immediate payment.
- Otherwise, consider other assets which may be pledged or readily converted to cash.
- Consider unencumbered assets, equity in encumbered assets, interests in estates and trusts, lines of credit from which money may be borrowed, and the taxpayer’s ability to get an unsecured loan.
- If there are assets with value and a taxpayer is unwilling to raise money from them, consider enforcement.
- If there appears to be no borrowing ability, ask the taxpayer to defer payment of other debts to pay the tax.
By being aware of what the IRS expects the Revenue Officer to do, you can be prepared to meet these questions in a manner designed to achieve the most favorable result for your client.
With respect to assets, there are two critical issues: ownership and valuation. Form of ownership is particularly important in a case where the assets are jointly owned, and yet only one spouse is liable for the tax. Maryland, D.C. and Virginia8 follow the majority rule in offering a high degree of protection for “tenants by the entireties” property. No creditor, not even the IRS, can reach tenants by the entireties property to satisfy one spouse’s separate debt. Similarly, partnership property cannot be reached to satisfy the personal tax debts of a partner. Most Revenue Officers understand these rules, but some do not.
Valuation offers many opportunities for creative advocacy. It is important that the Form 433-A or 433-B and accompanying materials adequately and fairly present the net amount which could be realized from a sale of the client’s assets. Thus, the sale of investment securities might result in a current period tax, which would reduce the net after-tax proceeds. A premature withdrawal from an IRA or qualified pension plan could result in a penalty in addition to a current period tax. A sale of the client’s house could require closing and brokerage costs, again reducing the realizable value. All of this can and should be explained in the Collection Information Statement. For a large asset, such as a residence, it may be quite helpful to obtain an appraisal. (Explain to the appraiser that you are looking for a forced or distress sale value, since that more closely reflects what the IRS itself would get if it seized and sold the property.) The costs attendant to moving and securing new housing are also relevant in presenting the net amount realizable from residential property.
Income and expenses
Having demonstrated current compliance, and addressed the question of ability to pay by selling or borrowing against assets, you will finally be in a position to talk about the client’s monthly income and expenses in an effort to determine the required monthly installment payment. This discussion, however, will be very much constrained by the standardized expenditure allowances which the IRS imposed in August 1995 to force more uniform analysis of financial information in collection cases. Under this system, expenditures are divided into “necessary expenses” and “conditional expenses.” The IRS publishes tables, based on income level and family size, for three categories of necessary expenditures: “national standard” expenses, housing expenses, and transportation expenses.9 In computing ability to pay, necessary expenses are allowed whether or not the proposed installment agreement would result in full payment in three years. Conditional expenses, however, are allowed only if the tax liability, including projected appeals, can be paid within three years. The IRS Collecting Contact Handbook contains the following discussion of these expense categories:
Necessary expenses. These must meet the necessary expense test: provide for a taxpayer’s and his or her family’s health and welfare and/or the production of income. The expenses must be reasonable. The total necessary expenses establish the minimum a taxpayer and family need to live. Three types of necessary expenses are:
- National Standards. These establish standards for reasonable amounts for five necessary expenses. Four of them come from the Bureau of Labor Statistics Consumer Expenditure Survey: food, housekeeping supplies, apparel and services, and personal care products and services. The Service has established standards for the fifth category, Miscellaneous.
- Local Standards. These establish standards for two necessary expenses: housing and transportation. Utilities are included in housing.
- Other. Other expenses may be allowed if they meet the necessary expense test. They must be reasonable in amount. Since there are no nationally or locally established standards for determining reasonable amounts, you must determine whether the expense is necessary and the amount is reasonable.
Conditional expenses. These expenses do not meet the necessary expense test. However, they are allowable if the tax liability, including projected accruals, can be fully paid within three years.
So-called necessary expenses up to the amount of the national and local standards are always allowed in computing installment agreements, although technically the Revenue Officer could disallow those expenses which are not “reasonable.” This does not mean, however, that you should give up on necessary expenses which exceed the standards. Nor should you abandon so-called conditional expenses even if the taxes cannot be paid within three years.
First, while it is easier to rigidly adhere to the standards, Revenue Officers do have the authority to allow excess necessary or conditional expenses for the first year, even if the proposed installment agreement would not pay the liability in three years. This gives the taxpayer a reasonable “adjustment period” to bring his expenditures within the standards:
One-year rule. A taxpayer may have up to one year to modify or eliminate excessive necessary or not-allowable conditional expenses if the tax liability including projected accruals cannot be fully paid within three years.
Revenue Officers will seldom volunteer to apply this one-year relief provision, so it is up to you as the taxpayer’s advocate to know about and argue for the application of this rule if it would be beneficial to your client.
Second, many expenses are “necessary expenses,” even though they fall outside the lists of expenditures covered by the national and local standards. While the standards are designed to achieve more uniformity, they do not constitute a rigid, mechanical cap; expenses in excess of the standards may be allowed if the taxpayer can provide substantiation and justification:
National Standards eliminate the need to require justification or substantiation for a number of recurring expenses.
- Allow taxpayers the total National Standards amount for their income level. Taxpayers making more than the highest income level shown in the National Standards will be limited to the maximum amount allowed by the National Standards unless they can substantiate and justify a larger amount.
- How the amount allowed for National Standards is spent is up to taxpayers. For example, they may spend less for clothing and more for entertainment (including cable TV); or they may decide to apply part of the amount to conditional unsecured debts.
- A taxpayer who claims more than the total allowed by the National Standards must substantiate and justify as necessary each separate expense of the total.
Thus, if the client is willing to go to the trouble of substantiating and justifying the excess expenditures, the Revenue Officer can deviate from the standards. Examples of necessary expenditures which fall outside of the national and local standards are the following:
- Child care.
- Dependent care (for the elderly, invalid, or disabled).
- Health care.
- Court-ordered payments.
- Involuntary deductions.
- Secured or legally perfected debts (minimum payments).
- Life insurance (term only).
- Charitable contributions (if necessary for health and welfare or required as condition of employment).
- Education (for handicapped dependent if services are not provided by public schools, or if required as condition of employment).
- Disability insurance (for self-employed individuals).
- Union dues.
- Professional association dues.
- Accounting and legal fees (for representation before the IRS, and other fees for health and welfare and/or production of income).
- Optional phone services (if for health and welfare and/or production of income).
The Form 433-A has lines labeled for some of these items, but others might easily be overlooked if you simply follow the form without checking the IRS’s pronouncements, including the Internal Revenue Manual and the Collecting Contact Handbook (from which the above list was drawn).10
Finally, you should know that the national and local standards change periodically. Merely following the instructions issued with the Form 433-A does not insure that you have the latest numbers. Indeed, the instructions printed with the currently available version of Form 433-A refer to national standard numbers which are out of date. The same is true of IRS Publication 1854 “How to Prepare a Collection Information Statement Form 433-A.”11 However, you can get the current national and local standards in several ways. First, using the internet you can connect to the Service’s own web site.12Second, you can use the web sites of subscription services like BNA or CCH. Third, you can refer to standard looseleaf reporter services such as the CCH Standard Federal Tax Reporter. But whichever method you choose, make sure you have the latest standards for national standard expenses, housing expenses, and transportation expenses. This will allow you to look at the income and expenditure analysis through the Revenue Officer’s eyes before actually submitting your client’s Form 433-A to the Service.
IRS Restructuring and Reform Act of 1998
The IRS Restructuring and Reform Act of 1998, signed by President Clinton on July 22nd, has several provisions which will have an impact on the negotiation and use of installment agreements. The most important of these is a greatly expanded right to appeal threatened collection actions, thereby providing a forum in which to argue that an installment agreement should be made available to the taxpayer as an alternative to enforced collection action.
Availability of installment agreements in small cases.
First, the new law in some cases “guarantees” the availability of installment agreements. Specifically, it requires the IRS to grant an installment agreement if the liability is $10,000 or less (excluding penalties and interest); in the past 5 years the taxpayer has not failed to file or to pay; financial statements are submitted and the IRS determines that the taxpayer is unable to pay the tax in full; and the agreement provides for full payment within 3 years.
Reduction in late payment penalty.
Second, the new law reduces the amount of the late payment penalty when a taxpayer has an installment agreement. Clients are often shocked to find that the IRS continues to assert interest and the 1/2% per month late payment penalty even after they have entered into installment agreements. Instead of eliminating the penalty, however, Congress merely cut it to 1/4% per month for months during which an installment agreement is in place. This modest relief applies only to individuals, and only if the original return was filed on time. It is effective for months after December 31, 1999.
Extensions of statute of limitations.
Third, changes are made with respect to extensions of the statute of limitations. Previously, entering into an installment agreement did not automatically extend the ten-year statute of limitations on collection. Often, however, the Revenue Officer demanded that the taxpayer “voluntarily” extend the statute of limitations on collections to a date far in the future before an agreement would be granted.13 In general, the new law eliminates the IRS’s ability to demand these voluntary statute extensions. In the case of an installment agreement, however, the IRS will continue to have the right to ask for an extension for the period of time by which the agreement would continue beyond the normal ten-year statute expiration date, plus 90 days. One would expect that for installment agreements entered into after December 31, 1999, the IRS will add an automatic statute extension provision to its Installment Agreement form (Form 433-D).
Annual statements to taxpayers.
Fourth, starting in July 2000, the IRS must send every taxpayer in an installment agreement an annual statement showing the initial balance owed, the payments made during the year, and the remaining balance. Many of us have had clients who have paid under installment agreements for years while receiving no periodic statements, only to find that their tax liabilities have actually increased despite the payments. This may still happen due to the magic of compound interest, but at least taxpayers will get annual statements showing where they stand.
Right to appeal proposed collection actions.
While the procedural changes described above will be helpful, the greatest impact on the use of installment agreements will come from the opportunities the new law gives taxpayers to appeal proposed collection actions. This will have the effect of forcing the IRS in many cases to abandon more aggressive collection techniques, and rely more heavily on installment agreements.
Effective 180 days after enactment, the IRS cannot levy against property unless it has given the taxpayer a “Notice of Intent to Levy,” similar to that currently required by IRC 6331(d). Subject to certain exceptions, no levy could occur until 30 days thereafter. During that 30-day period, the taxpayer may demand a “pre-levy hearing” in the IRS Appeals Office. New IRC 6330 lists the issues which may be raised at this appeals hearing:
(A) In general: The person may raise at the hearing any relevant issue relating to the unpaid tax or the proposed levy, including–
(i) appropriate spousal defenses,14
(ii) challenges to the appropriateness of collection actions, and
(iii) offers of collection alternatives, which may include the posting of a bond, the substitution of other assets, an installment agreement, or an offer-in-compromise.
Given the ability to easily appeal proposed levy actions, it is likely that in the future we will be representing many more clients before the Appeals Office.