In our last post we discussed the concept of Reasonable Collection Potential - RCP. In this post we’ll get into some details relating to the rules around specific RCP amounts.
As a refresher RCP is the key metric in evaluating potential options when dealing with your tax debt. It’s intended to provide the IRS with an amount which they believe is available to settle the debt. It’s an approximation of what they could collect through “forced” collection methods - liens and levies.
The first component of RCP relates to your assets. This includes all assets - your home, car, RV, money in your bank account, retirement accounts. For assets other than cash the IRS allows a discount of 20% to an assets fair market value. This discount - referred to as a “quick-sale” discount is intended to reflect the fact that the full market value of an asset may not be realizable in a seizure and immediate sale of an asset.
From the quick-sale value an allowance is made for debts secured by the assets. Generally debts incurred before the tax debt are allowed for these purposes. Typical debts include the mortgage debt related to your house, a loan used to buy your car, etc. The IRS does not “jump ahead” of these other debts. The concept is that the IRS “steps into your shoes” when it comes to evaluating your interest in assets. For example if you sold your house you would generally not be allowed to keep the total selling price - your right to proceeds would be after payment of your mortgage debt - the net equity. Since the IRS obtains the same rights to property that you have they only have an interest equal to this net equity.
The next component of RCP relates to your future income - calculated on a monthly basis. The IRS views future monthly income as amounts available to satisfy your tax debt. Future income consists of income and expenses expected in the future. In many situations the IRS will base your future income on your current income - i.e. current wages or earnings from self-employment. However this is not always the case - for example if you are self-employed and your most recent earnings are low the IRS may require an average of your earnings from the past 3 years, if you have recently changed jobs your new salary may be used, if you are currently unemployed your expected income from a future job may be considered, etc.
For expenses a number of rules are used by the IRS. The starting point in any analysis is to summarize expected actual future cash expenditures. To these amounts the IRS applies their rules many of the expenses in order to determine future expenses that can be included in the RCP computation. Many of their rules are based on published “standards” (usually based on Bureau of Labor Statistics surveys). The intention of these rules is to somewhat standardize the collection process so that the IRS is not put in the position of evaluating the appropriate amounts for individual situations. This methodology results in a more efficient processing of collection alternatives and provides equity among similar situated taxpayers.
In many situations the IRS standards result in expense amounts less than actual expenses - for example housing costs. In these situations taxpayers will often ask “does the IRS expect me to sell my house and move”. The short answer is no. These rules are applied only to determine an amount - perhaps the monthly payment amount in an Installment Agreement or a settlement amount in an Offer In Compromise. Once amounts have been determined the IRS is only interested in being paid - how the funds are generated is left up to the taxpayer.
As an overall principal expenses can be broken down into two types: necessary and conditional. Generally necessary expenses can be claimed for any debt payment alternative - whether paying over time (i.e. an Installment Agreement) or settlement of the tax debt for an amount less than owed (i.e. an Offer In Compromise). Conditional expenses are generally allowed where full payment of the tax debt is expected - usually a full pay installment agreement.
Necessary expenses are those that are required “for the production of income or for the health and welfare of the taxpayer’s family”. These expenses can be viewed “food, shelter, clothing” - i.e the basic living expenses. The following expenses are considered “necessary”:
- Food, Clothing, and Miscellaneous - includes clothing and services, food, housekeeping supplies, personal care products, and miscellaneous (i.e. credit card payments, bank fees, school books and supplies) - a national standard amount is provided (based on size of the household)
- Out of Pocket Health Care Expenses - medical services, prescriptions, medical supplies - a national standard amount is provided - per person - additional actual amounts allowed if substantiated
- Housing and Utilities - mortgage or rent, maintenance and repairs, insurance, dues and condominium fees; utilities including gas, electricity, water, heating oil, propane, trash collection, cable, internet, telephone and cell phone - a local standard amount is provided (based on size of the household) - the allowed amount is the lesser of actual or standard
- Transportation Expenses - Auto - two components: 1) Ownership Costs: monthly payment (lease or purchase) and 2) Operating Costs: vehicle insurance, maintenance, fuel, registration, inspection, parking, tolls - local standard amounts are provided for each (per car - one vehicle allowed per taxpayer) - these costs are allowed based on the lesser of the actual amount spent or the standard amounts
- Transportation Expenses - Public - taxpayers without a vehicle are allowed a national standard amount is provided (per household) - for those with a vehicle the amount of the allowable expense is the lesser of actual costs or the standard
- Other Necessary Expenses - examples include: accounting and legal, child care (in order to allow for work), certain court ordered payments (i.e. alimony, child support), involuntary wage deductions (i.e. union dues, uniforms), life insurance (term policies only), secured debt (i.e. home equity line of credit), current year taxes, delinquent state taxes (limitations may apply), student loan payments (if guaranteed by the federal government)
Conditional expenses are those that are incurred but are not considered “required” (as per above). These expenses are usually allowed with installment agreement arrangements that use either the six year or one year rule. Generally taxpayers can use actual expenses (including conditional expenses) for installment agreement arrangements that allow for the full payment of the tax debt within six years. For arrangements that allow for full payment but not within six years actual expenses may be used for the first year of the agreement.
Examples of conditional expenses include minimum payments on credit cards, retirement plan contributions, unsecured debt payments, court ordered payments for child’s education, etc.
As mentioned in the introduction the RCP computation is critical in evaluating any payment alternative with the IRS. In the determination of taxable income the IRS follows a set of rules with little room left for judgement. In the collection area amounts are determined based on broad principles of taxpayer equity and fairness - with the IRS granted broad authority in implementing the rules. Taxpayers seeking assistance in the tax collections area should make sure that their service provider not only has a solid knowledge of tax law but also knowledge of, and experience with, the specific rules that relate to IRS collection activity.
In our next blog post we’ll discuss CNC - Currently Not Collectible.
Link to Outline Slides: RCP Detailed Outline
Link to Video: RCP - Detailed Rules