Coping with the new IRS collection rules.

Delinquent taxpayers may find themselves on a government-imposed budget.

The Internal Revenue Service tax collection rules that went into effect in September 1995 have had a dramatic impact on individual taxpayers who owe $10,000 or more in unpaid taxes. The new rules impose expense limits for housing, transportation and "national standard expenses" (food, housekeeping supplies, apparel, personal care products and services and miscellaneous items). Delinquent taxpayers have one year to "adjust their lifestyles" (slash expenses and sell assets) or face enforced collection action, such as wage levies and asset seizures, if they are unable to pay their taxes in full in three years or pay on installments using the IRS's mandated expense limits. Many taxpayers faced with spending limits will look to their CPAs for guidance on handling unpaid taxes.

ENFORCED BUDGET

Although the three-year rule cited above seems to permit taxpayers to avoid the IRS expense limits if they can pay the balance in full within three years, the practical effect of the new rules has been to place all delinquent taxpayers on a budget. The reason for this is that IRS field personnel use the expense limits as a starting point in computing what taxpayers can afford to pay. The IRS completes the revised Form 433-A, "Collection Information Statement" (section V of which--"Monthly Income and Expense Analysis"--is shown in exhibit 1, page 44) using national and local standards.

The tax collection rules--contained in section 5323 of the Internal Revenue Manual--work as follows:

1. The IRS determines whether a taxpayer has assets that can be liquidated to pay the tax or some part of it. For example, a taxpayer can be asked to borrow against a home or cash in an individual retirement account.

2. If there are no readily available assets, the taxpayer's monthly gross income less necessary living expenses will be calculated to yield the minimum acceptable installment amount.

Expenses are either necessary or conditional. Necessary expenses are those required for health and welfare or for the production of income, such as food, housing, taxes, health care and transportation. All other expenses are conditional, meaning they are not allowed if a taxpayer cannot pay in full in three years. Examples are private school or college tuition, repayment of student loans, voluntary contributions to retirement plans and credit card payments. National standard expenses are based on family size and income, as shown in exhibit 2, page 44. Housing expense limits are set on a county-by-county basis. Transportation expenses are set on a regional and metropolitan basis.

PRACTICAL RULES FOR CPAs

Internal Revenue Manual exhibit 5300 contains elaborate charts and lists of questions and answers concerning the new collection standards. Some practical rules for CPAs:

1. Do not let clients submit the financial information on their own to the IRS collection division. Practitioners should carefully go over a taxpayer's assets, liabilities, income and expenses, looking for items that will deviate from the guidelines. For example, a taxpayer with a special medical diet--properly documented--can receive a higher food allowance. A taxpayer with high unreimbursed employee expenses or who is making court-ordered payments (such as child support) should document them as well.

2. Some clients may be able to delay imposition of expense limits. A taxpayer with sufficient assets to fully pay the liability if penalties can be abated or--in the case of nonfilers--if the proper returns are filed and the amount due is adjusted, should be advised to ask for a delay to accomplish the abatement or file the returns.

3. Always look for ways to help clients justify an expense as necessary for the production of income or for the taxpayer's health and welfare. For example, the Internal Revenue Manual says a self-employed taxpayer will be allowed to make minimum credit card and bank loan payments if these unsecured debts are used to pay suppliers and other business expenses. Similarly, a taxpayer who is a real estate agent in an affluent suburb can, according to the manual, justify a luxury car for business use.

FEW EXCEPTIONS

The new IRS tax collection rules have introduced uniformity and tight budgets into the system. Offers in compromise--in which the IRS accepts a smaller amount to ensure payment--are now more difficult to obtain. CPAs must study the rules and learn the exceptions so they can derive the maximum benefit for their clients.

EXECUTIVE SUMMARY

* NEW IRS TAX collection rules have had a dramatic impact on taxpayers whose unpaid taxes total more than $10,000, because they impose expense limits for housing, transportation, food, housekeeping supplies, clothing and personal care products.

* WHILE TAXPAYERS should be able to avoid an enforced budget if they can pay the balance due within three years, the practical effect has been to put all delinquent taxpayers on a budget. The IRS uses form 433-A to analyze their monthly income and expenses.

* CPAs SHOULD NOT LET clients submit information to the IRS collection division on their own. Some taxpayers should be advised to ask for a delay in expense limits to request tax abatements and file missing returns.

Exhibit 2: National Standard Expenses

Total gross                 Number of persons in household

monthly income     One      Two     Three     Four   Over four

Less than $830     $315     $509     $553     $714     +$120
$830 to $1,249     $383     $517     $624     $723     +$130
$1,250 to $1,669   $448     $569     $670     $803     +$140
$1,670 to $2,499   $511     $651     $731     $839     +$150
$2,500 to $3,329   $551     $707     $809     $905     +$160
$3,330 to $4,169   $590     $840     $948   $1,053     +$170
$4,170 to $5,829   $665     $913   $1,019   $1,177     +$180
$5,830 and over    $923   $1,179   $1,329   $1,397     +$190

Expenses include housekeeping supplies, clothing and clothing services, personal care products and services, food and miscellaneous. To find the amount allowed, read down the total gross monthly income column until you find the taxpayer's income, then read across to the column for the number of family members.

If there are more than four persons in the family, multiply the number of additional persons by the amount in the over four column and add the result to the amount in the four column. (For example, total monthly income of $830 to $1,249 for six persons would equal a monthly national standard of $723+$130+ $130, or $983.) Normally, expenses should be allowed only for persons who can be claimed as exemptions on the client's income tax return.

Dollar amounts are derived from Bureau of Labor Statistics Consumer Expenditure Survey, 1992 to 1993, tables 1, 3, 4, and 5.

National Standard Expenses

A tax-delinquent three-person household with total monthly income of $3,500 would be permitted to spend only $948 a month on housekeeping supplies, clothing, personal care products and food.

Source: Internal Revenue Manual

HARRY CHARLES, CPA, JD, LLM, is a tax lawyer in St. Louis, where he limits his practice to tax collection and audit representation.