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New Standards for Paying Off Tax Liabilities
New Standards for Paying Off Tax Liabilities
The IRS has released its 2012 Collection Financial Standards, which it applies to taxpayers' costs for food and clothing, out-of-pocket health care expenses, housing and utilities, and transportation when calculating a taxpayer’s ability to pay delinquent taxes.
With the April 17 individual income tax deadline for the 2012 filing season just behind us, taxpayers should have already determined their tax liability and filed a return, unless they requested an automatic six-month filing extension to October 15. Taxpayers generally should strive to file their return on time (including an extension), whether or not the taxpayer can pay taxes on time. The IRS can assess a penalty for failure to file a timely return in the amount of 5 percent of the taxes owed per month, up to a maximum of 25 percent. There is no penalty if the taxpayer is entitled to a refund or has reasonable cause for failing to file.
April 17, 2012, was also the deadline for paying taxes. Ordinarily, there is no extension for paying taxes after the April 17 deadline, even if the taxpayer obtained an extension to file. Any payment made after April 17 is considered late, and the IRS will generally charge interest. Interest runs until the tax is paid. The IRS cannot waive the interest, which is calculated for each quarter (three months) of the year.
The IRS may impose a penalty of 0.5 percent of the unpaid tax for each month the tax is unpaid, up to a maximum of 25 percent of the total liability. Because the IRS may apply interest and penalties to unpaid taxes, it says that taxpayers should pay what they can by the filing deadline to reduce these charges, even if the taxpayer cannot pay the full amount.
Some payment alternatives
Taxpayers can make monthly payments through an installment agreement. However, the IRS cautions that taxpayers can reduce interest and penalties and avoid the installment agreement fees by paying their tax debt in full. The IRS suggests taking out a loan (such as a home equity loan) or using a credit card to pay tax liabilities, because borrowing from a third party (rather than the IRS), or using restricted funds (i.e. an IRA) "may be cheaper."
Taxpayers can also avoid an installment agreement if they can pay the full amount of their taxes within 120 days. In this case, taxpayers should call 1-800-829-1040 and request a short-term agreement. The IRS does not charge a fee, and may not impose any penalties if full payment is made, although interest will accrue.
A taxpayer who cannot pay a tax liability without hardship can apply for an extension on Form 1127, Application for Extension of Time for Payment of Tax Due to Undue Hardship. For current taxes, the taxpayer can request a six-month extension. For a deficiency, the taxpayer can request an 18-month extension, plus another 12 months in exceptional circumstances. Form 1127 requires the taxpayer to submit a detailed explanation of the reason for the request. Taxpayers must also submit a statement of assets and liabilities, and an itemized list of income and expenses, for each of the last three months, although the form and instructions do not specify the submission of Form 433-F.
If the taxpayer owes $50,000 or less in income taxes, interest, and penalties, he or she can apply online for an installment agreement known as an online payment agreement (formerly, this threshold was $25,000). The taxpayer can also request an installment agreement by submitting Form 9465-FS, Installment Agreement Request, either separately or with an income tax return. The taxpayer should specify the monthly payment.
A taxpayer must have filed all required returns. An online payment agreement generally can be obtained without the IRS conducting a detailed financial analysis. A taxpayer who owes more than $25,000, but not more than $50,000, must provide some financial information on Part II of Form 9465-FS. A standard agreement costs $105. A direct debit agreement costs $52. If income is at or below 250 percent of the federal poverty level, the IRS may only charge $43.
If the taxpayer owes more than $50,000, he or she will also need to complete Form 433-F, Collection Information Statement, and the IRS will conduct a financial analysis. Collection Financial Standards are used in cases requiring financial analysis to determine a taxpayer's ability to pay. At the same time, the vast majority of installment agreements granted by the IRS are streamlined agreements that require little or no financial analysis, and no substantiation of expenses.
Offers in compromise (OIC)
In an OIC, the IRS agrees to settle the taxpayer's liability for less than the full amount if the taxpayer pays a reasonable collection potential. This is based not only on assets and liabilities, but anticipated future income, less basic living expenses.
The process of resolving an offer in compromise can sometimes take up to two years. The IRS has established a streamlined process available to wage earners and the self-employed with incomes of $100,000 or less and liabilities of no more than $50,000. A March 30, 2012, report from the Treasury Inspector General for Tax Administration found that more than 67 percent of the streamlined offers were resolved in less than six months.
Collection Financial Standards
The Collection Financial Standards determine the amounts that taxpayers may claim as basic, necessary living expenses when they claim that paying their taxes will cause an undue hardship. The IRS also applies the standards when taxpayers ask for an extension of time to pay the tax shown on their return.
Food and clothing
The new national standards specify monthly dollar figures for the amount of necessary food, clothing, housekeeping supplies, and miscellaneous expenses that may be taken into account while determining a taxpayer's ability to pay delinquent taxes. Taxpayers are allowed the total national standard amount, even if it is higher than the amount actually spent.
The national standards for food, clothing, and other related items range from $565 per month for one, to $1,450 per month for a family of four (up from $535 to $1,377 in 2011). For each additional person above four, taxpayers may add $281 to the four-person allowance (up from $262 in 2011).
Taxpayers must provide documentation to substantiate expenses exceeding the national standard amount. For miscellaneous expenses, the taxpayer must use the standard amount. In general, the number of people used to arrive at the correct national standard should be the same number of exemptions claimed on a taxpayer's most recent tax return.
With respect to food expenses, the IRS has clarified that:
- Food includes food at home and food away from home
- Food at home refers to the total expenditures for food from grocery stores or other food stores, but excludes the purchase of nonfood items
- Food away from home includes all meals and snacks, including tips, at fast-food, take-out, delivery, and full-service restaurants
Comment: Other expenses included in this category, and subject to the national standards, are: housekeeping supplies (i.e., laundry, cleaning, stationery, and lawn and garden products); apparel and services clothing (i.e., clothes, shoes, material, clothing rental, dry cleaning, and jewelry); and personal care products (i.e., hair, oral hygiene, shaving needs, and cosmetics).
Out-of-pocket health care expenses
The national standard for out-of-pocket health care costs is unchanged from 2011. The standard amount remains $60 per month for individuals under age 65, and $144 per month for individuals age 65 and older.
Out-of-pocket health care expenses include medical services, prescription drugs, and medical supplies. Health insurance premiums are excluded from this category. Taxpayers and their dependents are allowed the standard amount monthly on a per-person basis, without questioning the amounts they actually spend.
Housing and utilities
The housing and utilities standards include mortgage or rent, property taxes, and maintenance, along with gas, electric, water, heating oil, garbage collection, telephone service, cell phone service, cable television, and Internet service. The standard amount for housing and utilities is computed based on the state and county where the taxpayer resides, and the taxpayer's family size. For example, a family of five residing in Washington, DC, would have a standard amount of $2,913 (or the actual amount of housing and utility costs, if less than $2,913). A family of five residing in Buffalo County, South Dakota, would have a standard amount of $1,369.
Comment: National standards are provided for Puerto Rico.
The transportation standards for taxpayers with a vehicle take into account monthly loan or lease payments and monthly operating costs. The IRS uses a single, nationwide allowance for public transportation. If a taxpayer owns a vehicle and uses public transportation, expenses may be allowed for both, subject to certain rules. The 2012 nationwide allowance for public transportation expenses is $182 per month, per household.
The allowance for car ownership is $517 per month for one car, and $1,034 per month for two cars. A single taxpayer generally is allowed an allowance for one automobile. If a taxpayer's monthly lease or loan payment is less than the ownership cost allowance, the taxpayer must use that lesser amount. If a taxpayer has no lease or car loan payment, the allowance for ownership costs is $0.
For car owners, the national standards provide different standard allowances for operating costs, depending on what region of the United States the taxpayer resides in. Operating costs include expenses for maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking, and tolls. They do not include personal property taxes.
Taxpayers who are faced with making a late payment of taxes may incur interest and penalties, but there are alternatives available. For some of these alternatives, the IRS will look at the taxpayer's financial situation, and it may apply its Collection Financial Standards to determine what taxpayer expenses are justified and what the taxpayer can reasonably pay to the IRS.
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