In previous posts we’ve discussed the IRS Collection process - including items such as “Reasonable Collection Potential” (RCP) and the “Statute of Limitations” (SOL). These terms are relevant to this discussion so you should review the Collections post before continuing on with this post.
The most common tax debt settlement solution used by taxpayers is referred to as an Installment Agreement (IA). This type of arrangement allows for payment of a tax debt over time. Note that for the period of time that any tax obligation remains outstanding interest continues to accrue on the unpaid balance. This payment arrangement provides two benefits - it stops the IRS from other collection activities (i.e. seizing of assets) and provides for tax debts to be paid over time.
If you’ve read our previous posts you know that the IRS also has a program where they will compromise the amount owed - i.e. reduce the debt (Offer In Compromise or OIC). Given the availability of this program why wouldn’t everyone with a tax debt opt to compromise the debt vs. paying it all over time.
The short answer is that the IRS will not agree to a compromise unless you can demonstrate that they will not be fully paid by the expiration of the SOL. In order to make this determination they require the taxpayer to compute the RCP. If the RCP is sufficient to fully pay the tax debt within the SOL the IRS will not agree to a compromise. In these situations an installment agreement may be an appropriate means to deal with the tax debt.
In a future post we’ll get into the details of computing RCP. In short the IRS looks at your assets and future earning potential in order to determine if you have the means available to satisfy your tax debt. This determination is made under IRS rules - it uses concepts of fair market value, net realizable value, actual projected income and expenses, and IRS allowed expenses. It’s meant to approximate what the IRS could recover if the taxpayer sold assets and turned over future earnings (after an allowance for living expenses) in satisfaction of the tax debt.
So back to IA - if the government believes you can fully pay your tax debt - before the expiration of the SOL - an IA may be an available alternative to immediate payment of the debt. Basically the IRS will allow for taxpayers to pay their debts on credit.
There are four types of IAs:
- Automatic
- Streamlined
- Regular
- Partial-Pay
Automatic: in order to qualify for this type of IA you must owe less than $10k; not have owed any tax or had an installment agreement during the past 5 tax years; and will pay the debt within three years. Applying for this relief involves making a request online (or filing a form) and paying a user fee.
Streamlined: generally for debts less than $250k; has not owed any tax or had an installment agreement during the past 5 tax years; and will pay the debt within 6 years (or before expiration of the SOL). For taxpayers dealing directly with an IRS Revenue Officer the limit is $50k.
Regular: unlike the last two options a Regular IA requires submission of financial information to the IRS. A regular IA is usually used where the tax owed is greater than $50k or where more than 6 years is needed for repayment. The taxpayer is required to complete a Collection Information Statement (IRS Form 433) which will include gross income and allowable expenses (allowable under IRS rules - amounts which are often less than actual amounts). The net amount from this computation will be the monthly installment amount. Provided the tax debt will be repaid within the SOL the agreement will be classified as a “regular installment agreement”.
As noted the IRS usually uses “allowable”expenses - which may be less than actual expenses. However in certain circumstances actual expenses may be used. The so-called “six year rule” provides that actual expenses (which must be reasonable) may be used in the determination of the monthly payment amount provided the full tax debt can be repaid within 6 years (and before expiration of the SOL). If using actual expenses does not allow for full payment within 6 years actual expenses may be used for the first year of payment only - increasing to an amount using the IRS allowable expenses after the first year.
Partial-Pay: where a Regular IA results in a payment amount that will not provide for full payment before expiration of the SOL. Under this arrangement the IRS revisits the arrangement every 18 months to determine if a larger payment can be made under the agreement.
For many taxpayers an IA may provide a convenient way to deal with outstanding tax debt. As discussed the process for debts less than $50k is relatively straightforward. However in each situation the taxpayer should evaluate their financial condition with a view towards compromising the tax debt (through an OIC). For relatively small debts owed by taxpayers with significant future income an IA usually provides a way to make payments over time and to put the IRS tax collectors at bay. As tax amounts gets larger and future income gets smaller the extra effort involved with determining the RCP may prove beneficial - in either minimizing the monthly payment or compromising the total debt.
In our next blog post we’ll discuss OIC - Offer In Compromise.
Link to Outline Slides: Installment Agreements
Link to Video: Installment Agreements Video
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