Negotiating installment agreements with the IRS Collection Division.

A task frequently faced in representing clients before the IRS Collection Division is negotiating an installment agreement, under which monthly payments are made against an accrued tax liability, free of the threat of levies and seizures. Despite the Service's more mechanical application of national and local standards for "allowable" personal living expenses, there is still room for effective advocacy. In addition, the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98) made changes to the negotiation and legal consequences of installment agreements, and places greater emphasis on their use.

Identifying the Objective

Except for certain limited cases involving small balances, the IRS Collection Division will not accept a monthly payment agreement unless there is no alternative. In these cases, the task becomes getting the best possible deal, which requires an understanding of the client's objectives.

For some, the goal is full payment of the accrued liabilities as quickly as possible (to minimize interest and late payment penalties). Others, however, have created tax debts so large that full payment is just not possible; these taxpayers must look to the expiration of the statute of limitations (SOL) on collection, an offer in compromise or bankruptcy. For them, an installment agreement is an interim solution, and the objective is negotiating the smallest monthly payment the Service will accept. The [RS simply wants the largest payment the taxpayer can afford.

Current Compliance

A prerequisite to any installment agreement is "current compliance." This means that all required returns must be filed, and the taxpayer has rejoined the "pay-as-you-go" system. For business taxpayers, the Service will demand proof that current payroll taxes are being deposited on a timely basis. For individuals, there must be evidence of adequate withholding or estimated tax payments for the current tax year.

A taxpayer who is piling new liabilities on top of old ones is "pyramiding" in IRS-speak. For business taxpayers, the pyramiding of withholding taxes may reduce the chances for relief from levies or seizures.

Collection Information Statement

For installment agreements, the key IRS forms are Form 433-A, Collection Information Statement for Individuals, and Form 433-13, Collection Information Statement for Businesses; self-employed taxpayers must use both forms. The best way to help a client with a tax collection problem is to assist in completing these forms accurately, and with complete supporting documentation. Every entry must be correct and substantiated, not only because the form is signed under penalties of perjury, but also because an incomplete or inaccurate form may damage the practitioner's credibility with the Revenue Officer.

Sources of Information

For new clients, it is helpful to obtain copies of any collection information statements previously filed from the Revenue Officer handling the case. If no Revenue Officer has been assigned, the practitioner should consider filing a request with the District Disclosure Officer under the Freedom of Information Act.

Also, in all new cases, the practitioner should ask the Service for complete account transcripts for all relevant taxes and tax periods. These will provide details of all IRS transactions for each tax period, including assessments, penalties, interest, payments, refunds and offsets, lien filing dates, SOL and a host of other valuable information.

Assets

Forms 433-A and 433-B include balance sheets, requiring a taxpayer to list all assets, regardless of their nature or where they may be located. (If a practitioner believes a given asset is beyond the Service's legal reach, has no value or is subject to some prior encumbrance, the asset should be listed and information supporting this position should be provided.) Before discussing monthly payments, the Revenue Officer will first address selling or borrowing against assets. Generally, an installment agreement is allowed only if there is no ability to liquidate or borrow against assets to pay or reduce the tax debt. The IRS's Collecting Contact Handbook gives explicit instructions to Revenue Officers about how to approach these issues:

* If the taxpayer has cash equal to the tax liability, demand immediate payment.

* Consider other assets that may be pledged or readily converted to cash.

* Consider unencumbered assets, equity in encumbered assets, interests in estates and trusts, lines of credit from which money may be borrowed and the taxpayer's ability to get an unsecured loan.

* If there are assets with value and a taxpayer is unwilling to raise money from them, consider enforcement.

* If there appears to be no borrowing ability, ask the taxpayer to defer payment of other debts to pay the tax. By being aware of what the Service may do, a practitioner can be prepared to meet these questions and demands in a manner designed to achieve the most favorable result for the client.

For assets, there are two critical issues: ownership and valuation. The form of ownership is particularly important when assets are jointly held but only one spouse is liable for the tax. Many states offer a high degree of protection for "tenants by the entirety" property. In such states, no creditor (including the IRS) can generally reach such property to satisfy a spouse's separate debt.

Determining valuation offers many opportunities for vigorous advocacy. It is important that the Form 433-A or 433-B and accompanying materials adequately and fairly present the net amount that may be realized from a sale of a client's assets with proper allowance for expenses of sale, taxes and other costs. For example, the sale of securities may result in a current-period income tax, which would reduce the net after-tax proceeds. A premature withdrawal from an IRA or qualified pension plan may result in a penalty, in addition to a current-period tax. The sale of a client's house could require closing and brokerage costs, again reducing the net realizable value. (The costs attendant to moving and securing new housing are also relevant in presenting the net amount a client may actually realize from the sale of a house.)

Income and Expenses

Having demonstrated that a client is in current compliance and having addressed the issue of selling or borrowing against assets, the practitioner can next address the client's monthly income and expenses to arrive at an appropriate monthly installment payment. This discussion will be limited by the standardized expenditure allowances that the Service has developed to obtain more uniformity in collection cases. The IRS essentially divides expenditures into "necessary expenses" and "conditional expenses." The IRS publishes tables, based on income level and family size, for three categories of necessary expenditures: "national standard" expenses, housing and utilities expenses and transportation expenses. The Service's Collecting Contact Handbook contains the following description of these expense categories:

* Necessary expenses. These must meet the necessary expense test: provide for a taxpayer's and his family's health and welfare and/or the production of income. The expenses must be reasonable. The total necessary expenses establish the minimum a taxpayer and family need to live. Three types of necessary expenses are:

National Standards. These establish standards for reasonable amounts for five necessary expenses. Four of them come from the Labor Department's Bureau of Labor Statistics Consumer Expenditure Survey: food, housekeeping supplies, apparel and services, and personal care products and services. The IRS has established standards for the fifth category, "Miscellaneous"

Local Standards. These establish standards for two necessary expenses: housing and transportation. Utilities are included in housing.

Other. Other expenses may be allowed if they meet the necessary expense test They must be reasonable in amount. Since there are no nationally or locally established standards for determining reasonable amounts, the practitioner should assist in determining whether the expense is necessary and the amount is reasonable.

* Conditional expenses. These expenses do not meet the necessary expense test. However, they are allowable if the tax liability, including projected accruals, can be fully paid within three years.

In computing ability to pay, necessary expenses are allowed whether or not the proposed agreement would result in full payment in three years. Conditional expenses, however, are allowed only if the tax liability can be paid in full within three years.

Although it is easier to rigidly adhere to the national and local standards, Revenue Officers may allow excess necessary or conditional expenses for the first year of an agreement. This permits a reasonable "adjustment period" to bring expenses within the standards. Revenue Officers will seldom volunteer this one-year relief period. It is incumbent on the practitioner to argue for the application of this rule if it can benefit the client.

Many expenses are "necessary," even though they may fall outside the lists of expenditures covered by the IRS's standards. While the standards are designed to achieve more uniformity, they do not impose a rigid, mechanical cap; "excess" expenses may be allowed if the taxpayer can provide substantiation and justification. Examples of necessary expenditures that fall outside of the national and local standards include:

* Child care.

* Dependent care for the elderly, invalid or disabled.

* Taxes.

* Health care.

* Court-ordered payments.

* Involuntary deductions.

* Secured or legally perfected debts (minimum payments).

* Life insurance (term only).

* Charitable contributions (if necessary for health and welfare or required as a condition of employment).

* Education (for handicapped dependent if services are not provided by public schools or if required as condition of employment).

* Disability insurance (for self-employed individuals).

* Union dues.

* Professional association dues.

* Accounting and legal fees (for representation before the Service and other fees for health and welfare and/or production of income).

* Optional phone services (call waiting, caller ID, etc., or long distance, if for health and welfare and/or production of income).

Form 433-A has lines labeled for some of these items, but others might easily be overlooked if the practitioner simply follows the form without checking the IRS's pronouncements.

Finally, practitioners should be aware of the fact that the national and local standards change periodically. Merely following the instructions issued with Form 433-A does not guarantee the latest numbers. The most recent standards can be downloaded from the Service's Website (www.irs.ustreas.gov/prod/ ind_info/coll_stds).

Impact of IRSRRA '98 on Agreements

The IRSRRA '98 included several provisions that have already had an impact on the negotiation and use of installment agreements. Perhaps the most important change is a greatly expanded right to appeal threatened collection actions, thereby providing an administrative forum in which to argue that an installment agreement should be used as an alternative to enforced collection action.

Availability of Installment Agreements in Small Cases

The IRSRRA '98 required the IRS to expand its previously existing program of granting simplified installment agreements for small cases. There are now two kinds of simplified agreements: the "guaranteed" agreement and the "streamlined" agreement.

The "guaranteed agreement" is the Service's response to Sec. 6159(c). The IRS will grant a guaranteed installment payment agreement if (and only if) the taxpayer:

* Owes income tax (exclusive of penalties and interest) of $10,000 or less;

* Has filed and paid all tax returns during the five years prior to the year of the liability;

* Cannot pay the tax immediately;

* Agrees to fully pay the tax liability (including projected statutory additions) within three years;

* Files and pays all tax returns during the term of the agreement; and

* Did not have an installment agreement during the prior five-year period.

Such a guaranteed agreement can be obtained by contacting the Service or by filing a Form 9465, Installment Agreement Request. The IRS has also adopted an "interactive installment payment process" under which guaranteed installment agreements in small cases can be implemented directly over the Internet through the Service's Website; see www.irs.ustreas.gov/ind_info/ coll_stds/who_can_use.html.

The "streamlined" installment agreement is an expanded version of an IRS policy that was in place prior to the IRSRRA '98. Such agreements may be approved if:

* The unpaid balance of assessments is $;25,000 or less (including tax, assessed penalties and interest, but excluding accrued penalties and interest).

* The agreement will be fully paid in 60 months or prior to the collection statute expiration date, whichever comes first.

The taxpayer must otherwise be in current compliance. In addition, streamlined agreements are not available if the liabilities in question are withholding taxes for a business taxpayer still in business. A streamlined agreement can be obtained by telephone, by correspondence or through the Revenue Officer assigned to the case.

Reduction in Late Payment Penalty

The IRSRRA '98 also reduced the Sec. 6651 late payment penalty while a taxpayer is under an installment agreement. Clients are often shocked to find that the Service continues to assess interest and the one-half of one percent-per-month late payment penalty, even after they have entered into an installment agreement. Instead of eliminating the penalty, however, Congress chose to reduce it to one-quarter of one percent for any month during which an installment agreement is in place. This modest penalty relief applies only to individuals, and only if the original tax return was filed on time.

SOL Extensions

The IRSRRA '98 makes changes concerning extensions of the SOL on collection. Previously, entering into an installment agreement did not automatically extend the 10-year SOL on collection. However, the Revenue Officer often demanded that the taxpayer "voluntarily" extend the SOL to a date far in the future before an agreement would be granted. In general, the IRSRRA '98 eliminates the IRS's ability to demand such voluntary extensions. For an installment agreement, however, the Service retains the right to ask for an extension for the time it would take to achieve full payment beyond the normal 10-year SOL expiration date, plus 90 days.

Administrative Appeal of Proposed Collection Action

Although the procedural changes described above are helpful, the greatest impact of the IRSRRA '98 on the use of installment agreements is the opportunity the new law provides to appeal proposed collection actions. (This provision has already had the desired effect of forcing the Service to abandon more aggressive collection techniques in favor of installment agreements.)

Under the IRSRRA '98, the IRS cannot levy against property unless it has first provided the taxpayer with a "Notice of Intent to Levy," similar to that which was previously required by Sec. 6331(d). Subject to certain exceptions, no levy can occur until 30 days after issuance of such a notice. During the 30-day period, the taxpayer may demand a pre-levy "Collection Due Process" (CDP) hearing before the IRS Appeals Office. Sec. 6330 lists issues that may be raised at this hearing:

* Appropriate spousal defenses;

* Challenges to the appropriateness of collection actions; and

* Offers of collection alternatives, which may include the posting of a bond, substitution of other assets, installment agreements or offers-in-compromise.

Given the ability to more easily appeal threatened levy actions, many more taxpayers are taking their cases to Appeals. And at those hearings, taxpayers' representatives understandably argue that installment agreements provide an effective, reasonable and appropriate alternative to the seizure of their clients' assets.

The expanded right to appeal proposed collection actions also applies to the threatened termination of an installment agreement. The Service may terminate an agreement when it finds that a taxpayer has failed to pay an installment payment when due, failed to pay another tax liability when due, failed to provide updated financial information on request or secured the agreement by providing information that was inaccurate or incomplete. (Generally, installment agreements will not be defaulted for a taxpayer's failure to make estimated tax payments or tax deposits, or a failure to file another return when due.)

A taxpayer must be given 30-days' notice in writing before an installment agreement is terminated, and no levies may be served until 90 days after the notice is provided. Within the 30-day period, the agreement can be reinstated if the taxpayer cures the default. A new collection information statement may be required (unless the case meets the criteria for "guaranteed" or "streamlined" agreements previously discussed). In addition, taxpayers may appeal defaults and terminations of installment agreements. No levy action may be taken while the taxpayer's case is awaiting consideration before Appeals.

Conclusion

Unfortunately, many taxpayers are simply unable to pay their taxes in full, even by selling or borrowing against their assets. These taxpayers are forced to look to future cashflow to resolve their tax problems. With knowledgeable and creative representation, practitioners can help such clients to address their tax responsibilities through reasonable and appropriate monthly payment agreements.

FROM BURTON J. HAYNES, J.D., MBA, CPA, BURTON J. HAYNES, P.C., BURKE, VA, AND MARRY LOU GERVIE, CPA, CFE, WATKINS, MEEGAN, DRURY & COMPANY, L.L.C., BETHESDA, MD