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February 21, 2019 Practice Point

Navigating IRS Collections and Presenting Special Circumstances

By Erin H. Stearns, Associate Professor of the Practice of Taxation and Director of the Low-Income Taxpayer Clinic, University of Denver, Denver, CO, and Tameka E. Lester, Clinical Assistant Professor and Associate Director of the Philip C. Cook Low-Income Taxpayer Clinic, Georgia State University College of Law, Atlanta, GA

Receiving a notice from the IRS can be frightening.  Tax liabilities arise from any number of issues.  Many taxpayers do not have adequate withholding or fail to make estimated tax payments to cover taxes due and then cannot pay the bill when they file their returns.  Some taxpayers’ returns are selected for audit, which often results in the IRS concluding that additional tax payments are due.1  The IRS may also prepare returns for taxpayers who have failed to file returns for themselves.2  For many of these taxpayers, the IRS will assess the tax and begin collection efforts.  Although there will always be some taxpayers who will go to great lengths to avoid paying taxes, many simply cannot pay because their assets or income are insufficient, they have high medical bills or unexpected expenses, or they have experienced increased child care costs, loss of a job, or a failed business venture.

IRS Initiates Collection Efforts: What’s the Worst That Can Happen? 

A 10-year statute of limitations generally governs the period of time during which the IRS can collect from taxpayers.3  Once the IRS begins collection efforts, it has various tools that may make the collection situation considerably more difficult for taxpayers.

A potentially harmful but commonly used tool is the Service’s ability to retain future refunds to apply against past-due tax debt.  Low-and moderate-income taxpayers often depend on receiving tax refunds to provide budgetary relief to their families and allow them to purchase items they would not normally be able to purchase during the year, such as appliances, vehicles, electronics, and clothing.  Not receiving refunds can therefore create stress and worry for taxpayers who cannot make these needed purchases.  This is especially true when the IRS keeps refundable credits explicitly designed to help pull families out of poverty, such as the Earned Income Tax Credit or the Additional Child Tax Credit.  These credits fail to meet their objectives when they are applied to past debts, and the family must forgo the credit.

The IRS may file a Notice of Federal Tax Lien (NFTL) against taxpayers, a remedy ordinarily reserved for taxpayers who owe more than $10,000.4 Such a lien impedes the affected taxpayer’s ability to transfer title to real estate and other assets without first satisfying the tax debt or obtaining a withdrawal of the NFTL.5  The three major credit reporting agencies—Equifax, Transunion, and Experian—no longer include NFTLs on taxpayers’ credit reports (as of April 2018), so credit scores are not affected by NFTLs. The IRS may also levy taxpayers’ wages from employment, bank accounts, and even Social Security.6  Generally, the maximum Social Security levy is 15% of the total benefit.7  In rare circumstances, the IRS may also seize assets such as real property, vehicles, and retirement accounts.8

In 2015, Congress gave the IRS authority to certify seriously delinquent debts of more than $50,000 (including penalties, interest, and an annual inflation adjustment) to the State Department for action.9  A debt is not considered “seriously delinquent” until 1) the taxpayer has received notice under section 6323, and 2) administrative rights under section 6320 have been exhausted or a levy is filed under section 6331.  Furthermore, debts are not considered seriously delinquent if there is a due process hearing pending or underway, or if section 6015 innocent spouse relief has been requested.  The State Department may revoke the taxpayer’s passport until the certification is reversed by payment of the debt.

My Client Is in IRS Collections: What Can I Do?

Despite the many tools available to the IRS, representatives have several options to assist their clients in collection disputes.  Knowing these collection alternatives exist and understanding when to apply them can allow clients to pay no more than what their financial circumstances permit and can significantly reduce their stress.

The IRS will accept three main collection alternatives.  They are discussed in more depth below, but by way of introduction include the following:

  • An installment agreement, where the taxpayer pays either some or all of the tax, interest and penalties over time;
  • Currently not collectible (CNC) status, where the IRS determines the taxpayer cannot meet necessary living expenses and also pay the IRS.  As a result, the IRS places a hold on collection efforts.  CNC is typically an option only for low-income individuals or moderate-income individuals with high allowable expenses such as medical bills; and
  • An offer in compromise (OIC), which is a settlement that a taxpayer offers to the IRS based on their reasonable collection potential (RCP).10  In determining a taxpayer’s RCP, the IRS considers 1) the equity in a taxpayer’s assets, and 2) a taxpayer’s average monthly income after expenses projected over the period of time proposed for paying the amount offered in the OIC.

Taxpayers should enter into only one of the three alternatives, and a representative would want to determine which is most appropriate.  The most compelling reason to enter a collection alternative is that it removes the client’s case from IRS Collections and prevents future levies.  It is worth noting that the IRS will continue to apply overpayments to unpaid liabilities rather than issue refunds.

IRS Financial Analysis

The starting point for determining whether the IRS will accept a collection alternative and which to propose is to go through the same financial analysis undertaken by the IRS.11  While sometimes the results can be exceptionally favorable and yield a low-dollar settlement or reasonable payment plan, there is little magic to the analysis.12

The IRS will first consider the amount of equity in the taxpayer’s assets after factoring in certain exemptions.13  Second, it will consider the difference between the taxpayer’s monthly gross income and allowable living expenses.14  There are four main categories of allowable expenses, with caps based on national and local trends:

  1. Food, clothing and other items such as housekeeping supplies and minimum monthly payments on credit cards;
  2. Housing and utilities;
  3. Transportation and vehicle lease and loan expenses; and
  4. Out-of-pocket health care expenses.

The IRS will also allow expenses applicable to the particular taxpayer for items such as health insurance, payment of student loans and other secured debts, delinquent state and local taxes, current year taxes, child support, and union dues, among others.  The taxpayer must substantiate payments of these amounts.

Naturally, the parties’ goals are at odds. The IRS’s goal is to determine the most the taxpayer can pay.  The representative’s goal is to determine the least amount the IRS will accept.  Careful adherence to, and understanding of, the IRS’s guidelines for financial analysis generally leads to a number on which parties can agree.

As indicated above, the general analysis of how much a taxpayer can pay is based on equity in assets, and income less allowable expenses.  The IRS will also consider special circumstances where a taxpayer faces economic hardship or if there are special equity and/or public policy considerations.15

Determining Which Option Is Most Appropriate

We briefly introduced the three main types of collection alternatives above.  This section discusses the selection of a most appropriate collection alternative based on the taxpayer’s facts.  To make the analysis more specific, assume our client is a single taxpayer who owes the IRS $50,000. She is currently employed earning $36,000 per year.  She owns several assets, including a home worth $250,000 that is subject to a $210,000 mortgage, a 10-year-old car, savings and checking accounts worth just under $1,000, and an IRA worth $5,000.

Installment Agreements

The IRS offers several types of installment agreements to taxpayers who cannot pay the balance all at once.  Streamlined installment agreements anticipate a taxpayer will fully pay the liability over a period that may extend up to 72 months.  Here, our hypothetical client would have to pay at least $695 per month under such a plan to fully pay off the $50,000 tax debt within 6 years.  This would likely be too costly since the payment would equal 23% of her gross monthly income of $3,000.

Fortunately, the IRS permits partial payment installment agreements that require a taxpayer to pay any remaining monthly income after all necessary monthly expenses.  The taxpayer will be required to continue paying this amount until the collection statute of limitations runs.  At that point, the taxpayer will discontinue making payments, even though he or she will not have paid the full amount.  Here, we would need to add up the taxpayer’s monthly allowable expenses and subtract them from her gross income of $3,000.  Assuming she had $100 remaining each month, the IRS would expect her to set up a $100 monthly payment as a direct debit payment or pay by check or credit card each month.

The IRS will also accept “tiered” installment agreements where the taxpayer pays less in the first year, then more in the remaining years.  These are particularly well suited for taxpayers who must reduce their expenses to better align with what the IRS deems “necessary” and allowable.

Installment agreements primarily consider one’s remaining monthly income, rather than assets.  The IRS may require, however, that a taxpayer remit the equity in assets before allowing an installment agreement.16  The IRS may require the taxpayer to complete a Collection Information Statement (Form 433-A) to collect information about assets and remaining monthly income.  The 10-year collection statute of limitations is tolled while the IRS is evaluating an agreement. Interest and penalties also continue to accrue until the tax debt is paid.

Currently Not Collectible Status

The IRS will place taxpayers into CNC status when their monthly allowable living expenses exceed their monthly income.  CNC status effectively places collection of the tax debt on hold: the IRS will not levy the taxpayer’s income or accounts when the taxpayer is in CNC status.

For our hypothetical client, financial analysis may show that her monthly expenses exceed her income leaving her with no additional funds with which to pay the IRS.  We would need to identify all of her expenses for this analysis. In addition, we would want to consider whether she had medical expenses in excess of the current standard amount of $52 per month (or $114 if she is 65 or older), student loan payments, or any payment toward delinquent state tax debt.  The IRS would consider these allowable monthly expenses in determining our client’s ability to pay each month.

As with the installment agreement, a disadvantage of CNC status is that interest and penalties continue to accrue. Also, the IRS can remove the status in the event the taxpayer’s financial situation improves sufficiently to make payments.

A representative may request CNC status for a client either by mailing a completed Form 433-F, Collection Information Statement, to the IRS or by simply calling the IRS.17 The IRS typically insists that the taxpayer be current in all tax return filings, but full compliance is not absolutely required for CNC status. The IRS should still place delinquent accounts in CNC status when there are subsequent unfiled returns.18  It is generally helpful if taxpayers seeking CNC status file any unfiled returns before requesting CNC to avoid potential removal if it is later noted that they owe a balance for a year not initially included in the CNC status determination.

One of the main benefits of CNC status is that it does not add time to the 10-year collection statute of limitations.  Therefore, it may be a good option for a taxpayer with debt nearing the end of the statutory period.  It also works as a temporary solution for taxpayers whose cases are in collection, and who ultimately plan to submit an OIC but need time to prepare it.  Another advantage of CNC is that the IRS will place a taxpayer in this status even if they have some equity in savings or in a retirement account.  For example, our client may still qualify for CNC status even though she has some equity in her home and an IRA worth $5,000.  Therefore, CNC may be preferable to the other collection alternatives for clients with limited savings that they are unable or unwilling to liquidate.

Offer in Compromise - Doubt As To Collectability

The third collection alternative is an OIC for doubt as to collectability, which is a settlement initiated by a taxpayer based on a snapshot of the taxpayer’s financial situation.  In many cases, taxpayers can settle large tax debts for significantly less than they owe.19  The chart below shows acceptance rates for OICs in select years beginning with 1999.

Acceptance Rates by Fiscal Year:20

1999:                32%
2003:               18%
2005-2007:   26%
2009:               21%
2012:                34%
2013:                42%
2014:                43%
2015:                44%
2016:                43%
2017:                 40%

Before submitting an OIC for a client, a representative should review how the IRS completes its financial analysis.21  This allows the representative to determine an appropriate amount to offer and will remove much of the surprise for the client. 

The IRS will consider a client’s RCP, including equity in assets after factoring in exemptions and income less allowable living expenses each month.  The IRS would expect the client to pay over the remaining monthly income multiplied by either 12 or 24, depending on how quickly the taxpayer will pay the offer amount.

Going back to our client’s facts, the IRS would first consider the equity in her assets, which include her home, vehicle, and IRA.  Generally, the equity amount equals 80% of the fair market value of any assets less encumbrances.  If her home were valued at $250,000, 80% of this would be $200,000.  A mortgage balance of $210,000 would result in no equity in the home for purposes of calculating the RCP.  The IRS provides exemptions for vehicles and bank accounts, which may result in finding no equity for these assets.  Clients are often surprised to learn that 80% of the retirement account value will be included in the RCP.  If our client’s IRA had a fair market value of $5,000, the IRS would consider $4,000 as equity for the RCP.

The IRS would also consider remaining monthly income in calculating the future income amount.  The future income amount adds to the equity in assets to determine RCP.  Assuming our client had $200 remaining per month, the minimum future income amount the IRS would accept would be $2,400 ($200 x 12).  While many taxpayers want to pay the offer amount as quickly as possible to put their debts behind them, our client could elect a longer payment term–up to 24 months.22

For our client, assume the $4,000 from her IRA was her only equity in assets and that she had future income of $2,400.  Her offer amount would be the sum of these two items, or $6,400, a good deal to satisfy a $50,000 tax liability.

The advantage of this alternative is that the remainder of the tax debt is forgiven, and once the negotiated terms are satisfied, any liens that may have been filed on a taxpayer’s property are released within 30 days. The disadvantages include adhering to certain compliance requirements for five years after acceptance, such as filing all required returns and paying all taxes due by the filing deadline each year, and forfeiture of any refunds for a period of time. For some taxpayers, these disadvantages will outweigh the fresh start created by the elimination of the excess tax debt.

An OIC proposing to pay less than the amount owed can be requested by completing Form 656-B. The offer form must be accompanied by substantiation of the income received, certain expenses paid, and liabilities owed on noncash assets such as real estate and vehicles–showing the taxpayer has an inability to pay the full balance owed. An application fee and initial payment must also be included with the completed offer, unless the client’s income meets the “Low Income Certification” amount defined in the offer forms.

Effective Tax Administration Offers in Compromise

Changing our client’s facts slightly, let’s assume she owns her house outright without a mortgage, and she is elderly and receiving only Social Security income. She could sell her home to pay the $50,000 tax debt but doing so would likely render her homeless because it would be too expensive for her to afford a comparable living situation. In this case, the IRS would generally be willing to consider an Effective Tax Administration (ETA) OIC on grounds that it would create a significant economic hardship for our client to have to pay the tax liability.23

A representative would complete the same forms as for the Doubt as to Collectability offer defined above. The representative would indicate that the basis of the offer is ETA and would include a detailed narrative explaining the economic hardship that would result from the client’s having to sell her real estate.

The IRS will also consider ETA OICs on the basis of public policy or equity considerations identified by the taxpayer.  Such considerations provide a sufficient basis “only where, due to exceptional circumstances, collection in full would undermine public confidence that the tax laws are being administered in a fair and equitable manner.”24 For example, the IRS may consider an ETA offer where a taxpayer owes tax because of circumstances outside the taxpayer’s control, such as where a criminal or fraudulent act of a third party is directly responsible for the tax liability.25

What Can Be Done by Representatives and the IRS?

Whether your clients have been ignoring IRS notices regarding previous years’ taxes or they weren’t expecting to have to write checks when they filed last year’s returns, it’s time to take action.  The IRS may have an undeserved reputation for being difficult to deal with: as noted above, IRS agents can be quite understanding when individuals are open about their financial situations and any special circumstances they face, and are willing to pay what they can on their tax liabilities.

While taxpayers and their representatives must be proactive, there is also room for IRS improvement.  It could do more to take into account situations where the collections guidelines lead to inequitable results.  It should also expand the listing of allowable expenses and exemptions or be more willing to consider each taxpayer’s unique situation.

The calculations currently cap the amount allowed for certain reasonable living expenses based on national and local trends. These tend to be overly broad.  For example, if our hypothetical client lived in the District of Columbia, the cap for her housing and utility expenses in 2018 would be $2,211.  Within this area, rent prices vary greatly.  Also, many low-to moderate-income taxpayers have fewer cost-effective options for rental properties and can be forced into more expensive arrangements because of low credit scores.  In addition, a professional in this area may have higher expenses for professional clothing.  Furthermore, the caps reflect what taxpayers actually pay, rather than expenditures that would be required to maintain a healthy lifestyle.  Many taxpayers have expenses that are not clearly included, such as education costs for dependent children or for themselves.  Exemptions should also be allowed for additional categories of expenses such as retirement accounts, to protect at least a portion of a taxpayer’s retirement savings, as this could decrease their likelihood of needing public assistance.

The worst thing your clients can do is be nonresponsive. Contact the IRS to resolve their issues or refer those who cannot afford to pay you to your local Low Income Taxpayer Clinic–there’s at least one in most states.26 Take advantage of one of these alternatives and help your clients work toward resolving their issues.  They will come out better in the long run. ■

  1.                  In FY 2017, the IRS selected 933,785 individual income tax returns for examination and recommended assessing over $9 billion in additional tax on these returns.  See IRS Fiscal Year 2017 Data Book, Table 9a, pages 23-24.
  2.                  I.R.C. § 6020(b) confers this authority.
  3.                  I.R.C. § 6502.  Certain events add time to the collection statute, including bankruptcy filings, the period during which the IRS reviews an offer in compromise or installment agreement (including appeals), and the period during which any collection due process hearings are pending.
  4.                  See e.g., IR-News Rel. 2011-20 (Feb. 24, 2011).
  5.                  I.R.C. § 6320; see also I.R.C. § 6323(j).
  6.                  I.R.C. § 6330.
  7.                  I.R.C. § 6331(h).
  8.                  I.R.C. §§ 6331(b) and 6331(j); see also IRS Notice 99-27.
  9.                  I.R.C. § 7345.  The inflation-adjusted amount is currently $51,000.
  10.                  I.R.C. § 7122; see also Internal Revenue Manual § 5.8.5, Financial Analysis.
  11.                  Internal Revenue Manual § 5.15.1 contains the “Financial Analysis Handbook” and Section 5.8.5 contains the financial analysis applicable to making an OIC.
  12.                  Taxpayers often come to advisors with unrealistic expectations, e.g., believing that the IRS will accept 10% of the total tax owed, or some set dollar amount.  Such offers seldom work unless backed up by financial analysis.
  13.                  Internal Revenue Manual § 5.8.5; The equity is calculated by subtracting the quick sale value (80% of the current market value) minus any outstanding loans against the asset.  In addition, exemptions are provided for a reasonable amount of equity in bank accounts and vehicles.
  14.                  I.R.C. § 61; In addition to those items of income listed in § 61, the IRS will consider money contributed to support the household by non-liable taxpayers, net rental income, and child support. 
  15.                  Internal Revenue Manual §
  16.                  Melasky v. Commissioner, 151 T.C. No. 9 (2018).
  17.                  Generally, the taxpayer or a representative would want to contact the Automated Collection System at (800) 829-7650 and request that the client’s accounts be placed in CNC status. The request will take 7-14 days to appear on the taxpayer’s account.  This is the same number one should use in order to request an installment agreement.
  18.                  Viniateri v. Commissioner, 133 T.C. 392 (2009); see also Internal Revenue Manual §
  19.                  The authors have on numerous occasions been able to compromise clients’ liabilities of more than $50,000 for single offer payments of $10.
  20.                  See IRS Data Book for the applicable fiscal year. 
  21.                  Internal Revenue Manual § 5.8.5 contains detailed guidance for financial analysis for offers in compromise. 
  22.                  Internal Revenue Manual §; Note that this would increase the offer amount because the IRS would expect her to pay $200 per month for 24 months, therefore resulting in an offer of $4,800.
  23.                  Internal Revenue Manual §
  24.                  Internal Revenue Manual §, para. 2
  25.                  Internal Revenue Manual §
  26.                  See IRS Publication 3134.