What expenses will the IRS allow when determining ability to pay delinquent tax debts? The IRS has established expense standards for several categories of expenses. In order to claim an expense, taxpayers must show the expense meets the “necessary expense test.” The necessary expense test is defined as expenses that are necessary to provide for a taxpayer’s (and his or her family’s) health, welfare and/or production of income.
In order to help ensure taxpayers have adequate means of providing for basic living expenses, the IRS has developed national and local expense standards. These standards aid the IRS in evaluating a taxpayer’s ability to pay on back taxes. A national standard is one that is the same for everyone regardless of where they live. A local standard will vary with location due to regional cost differences.
National standards include:
1. Food, clothing and other items
This category of expenses includes five specific types of expenses. The categories are food, housekeeping supplies, clothing and clothing services, personal care products and services, and miscellaneous items. Each of the individual categories has their own standard defined.
2. Out of pocket medical
Out of pocket medical expenses include: prescriptions, medical and dental co-pays, and medical or dental bills. The IRS generally allows a set amount for each person in the household and the amount can vary based on age of the individuals that comprise the household. The IRS will frequently allow expense amounts that exceed the standard for this category with proper documentation.
Local standards include:
1. Housing and utilities
Housing and utilities include mortgage or rent, property taxes, homeowners or renters insurance, electricity, heat, water, sewer, garbage, phone, etc. Unfortunately, the IRS standard is not realistic. Many households will exceed the expense standard for this category resulting in some taxpayers having an artificially inflated ability to pay in the eyes of the IRS. While the IRS may allow expenses over the standard, the circumstances in which the IRS will do so are limited.
2. Vehicle ownership
IRS will allow vehicle loan or lease payments up to a set amount per vehicle. The IRS generally does not allow individuals to claim, as an expense, payments for extra vehicles such as a family’s third car driven by a child of driving age. Vehicles used in business require a bit more analysis determine how the vehicle expense should be treated. Although the vehicle ownership expense is the same regardless of location, it is still considered a local standard by the IRS.
4. Public transportation
Taxpayers that do not own a vehicle do not have the costs associated with operating a vehicle; therefore, the IRS will not allow a vehicle operating expense. The IRS does recognize that taxpayers without a vehicle must still get to work, the grocery store, the doctor’s, office, etc. The public transportation allowance is granted to acknowledge this expense. In some cases, taxpayer’s with a vehicle may also be entitled to the public transportation expense. For example, a taxpayer with impaired vision may be able to drive during the day, but is prohibited from driving in low light. Thus, the taxpayer relies on public transportation when driving conditions are not ideal. In this situation the IRS will generally allow the public transportation in addition to the vehicle operating with proper documentation of the reason why public transportation is actually used in addition to the operation of a vehicle. Like the vehicle ownership expense, the IRS considers public transportation to be a local standard even though it is the same amount for all taxpayers regardless of location.
5. Transportation operating
Transportation operating expense is the expense a taxpayer spends to operate their vehicle and includes expense items such as fuel, insurance and maintenance.
Some standards are governed by household size. For example, the expense standards for food, clothing, etc. and housing expenses are set based on household size. When determining household size, the IRS often looks to a taxpyers income tax return and the number of exemptions claimed to help determine the proper number of persons in a household.
Other expenses are those expenses that meet the necessary expense test and are therefore allowed expenses. Other expenses commonly include, health insurance, court ordered payments, term life insurance, union dues, mandatory retirement. Other expenses generally require documentation before the IRS will agree to allow them as an expense in order to offset income.
Conditional expenses do not meet the necessary expense test. Generally, the IRS will not allow a conditional expense. Common expenses considered to be conditional expenses are credit card payments, tuition, and charitable contributions. However, the IRS may allow these expenses if tax debts, including projected accruals, can be fully paid within six years. Additionally, the IRS may allow up to one year to adjust conditional expenses in some cases.
Taxpayers are only allowed expenses they are required to pay. A non-liable party is a person that lives in the same household with a taxpayer responsible for a delinquent tax debt. When this is the case, the IRS will generally look at the income of both the liable party and the non-liable party and may allocate some expenses according to the percentage of income each brings into the household. This is called prorating expenses or a proration analysis.