San Mateo, CA: When you submit an Offer in Compromise or a request for an installment agreement, the IRS wants to know your monthly income and expenses using financial disclosure forms. The IRS wants to ensure that you are paying the most you can without causing a hardship. This often leads to a conflict of what the TAXPAYER THINKS they can afford and what the IRS THINKS the taxpayer can afford!
When calculating the reasonable collection potential (RCP) for an Offer in Compromise (OIC) or an installment agreement, the IRS does not simply accept whatever expenses a taxpayer claims each month. Instead, the IRS uses national and local standards to determine allowable expenses, which can differ significantly from a taxpayer's actual expenses.
Allowable expenses are standardized amounts published by the IRS for basic living expenses such as food, clothing, housing, and transportation. These standards are designed to ensure that taxpayers have enough to cover their basic needs while still paying off their tax debts. For example, the IRS has specific guidelines for housing, vehicle, and utility expenses based on the taxpayer's local geographic location. The allowable expenses are often less than the taxpayer's actual expenses.
Actual expenses, on the other hand, are the amounts that a taxpayer actually spends each month. While taxpayers might think that all their actual expenses will be considered, the IRS only allows expenses that meet their necessary expense test and are "capped" by the allowable expense tables. If a taxpayer's actual expenses exceed the IRS's allowable standards, the excess amounts are generally not considered when calculating the RCP.
In some rare cases, the IRS may allow deviations from the standard amounts if the taxpayer can demonstrate special circumstances Such circumstances include advanced age, poor health, or a disability that may justify higher expenses.
Understanding the difference between actual and allowable expenses is crucial for taxpayers considering an OIC or installment agreement. By knowing what the IRS will and will not accept can mean the difference between having your OIC or installment agreement accepted or rejected.
While taxpayers may have various actual monthly expenses, the IRS uses standardized allowable expenses to determine what can be claimed. While this ensures consistency and fairness in the collection process, it also means that not all your actual monthly expenses will be considered. Taxpayers should be aware of these limits when preparing their financial information for an OIC or installment agreement and be prepared to explain why they need to deviate from the allowable expenses, if requested.
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Disclaimer: The information provided is intended to provide a general overview of the topic presented. It is not intended to be a legal interpretation of your individual tax or legal situation. If there is a conflict between the information provided and any legal authority implementing or interpreting the topic, the legal authority shall prevail. Always seek legal advice from a licensed attorney. This article does not in any way establish an attorney-client relationship. That relationship can only be accomplished with both parties signing a mutual, written agreement.
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