In the context of tax debt, the IRS offers taxpayers the option of submitting installment agreement requests to pay off their debts over time. However, the IRS also calculates a taxpayer’s “reasonable collection potential” to determine the amount that the taxpayer can reasonably pay toward their tax debt.
If the IRS determines that the proposed monthly payment does not accurately reflect the taxpayer’s reasonable collection potential, they may reject the installment agreement request. But what happens if a taxpayer submits an installment agreement request that fully pays the liability? Can the IRS still reject the request as the payment amount is too high? The court addresses this question in Lites v. Commissioner, T.C. Memo. 2005-206.
Facts & Procedural History
The taxpayers were a husband and wife, and the husband was a financial products salesman and the primary breadwinner for their family of four. However, the husband underwent a number of employment changes due to a downturn in the financial markets and a heart condition.
The taxpayers filed their federal income tax returns late, with their 1999 and 2000 returns being eight days late and their 2001 return being twenty-nine days late. Additionally, they failed to make a tax payment of approximately $66,000 and did not comply with an installment agreement after making only around $3,000 in payments.
The IRS issued a notice of levy to the taxpayers, and they requested a collections due process hearing. It does not appear that the IRS filed a lien notice and the taxpayers did not use the online installment agreement process. During the hearing, they proposed an installment agreement to pay off their tax debt. However, the IRS rejected the proposed agreement, stating that the taxpayers could afford more than the payment they had offered.
Over the course of a year, the taxpayers ended up making three such proposals: one for $750 per month, one for $1,000 per month, and one for $1,200 per month. In support of these offers the taxpayers asserted that they had $888 of monthly excess income. The IRS collection function and the IRS Appeals Office rejected the taxpayers’ offers, arguing that the taxpayers had $2,732 of monthly excess income and that that amount should be paid to the IRS on a monthly basis. Because the taxpayers had filed a collection due process hearing request, they were able to have the U.S. Tax Court consider the case.
Overview of the IRS’s Installment Agreement Program
The IRS’s Installment Agreement program allows taxpayers to pay their tax debt in monthly installments if they cannot afford to pay the full amount owed upfront. To submit an installment agreement request, a taxpayer must meet certain requirements, including having filed all required tax returns and making all estimated tax payments for the current year.
The IRS determines how much a taxpayer can pay based on their “reasonable collection potential.” The IRS considers several factors when calculating a person’s reasonable collection potential, including their income, expenses, assets, and liabilities. The calculation can also consider other factors, such as the taxpayer’s earning potential, health, and ability to pay.
The IRS’s determination of the reasonable collection potential can have a significant impact on a taxpayer’s ability to pay their tax debt through an installment agreement.
The IRS Changes Course at Trial
In court, the taxpayers argued that the IRS erred in rejecting their installment agreement request. They requested an installment agreement whereby they would pay $1,200 per month in full discharge of their tax liabilities.
The law at the time provided that “except in instances when a reasonable extension of the statutory period for collection will allow an agreement to be accepted.” The collection statute was 10 years. Extensions were limited to no more than 5 years, plus up to 1 year to account for changes in the agreement (such as payment skips, interest rate changes, etc.).
At trial, the IRS conceded that the taxpayers had $888 of excess income each month. But instead of conceding the case, the IRS took the position that it was correct in denying the taxpayers’ offers because the offers exceeded what the taxpayers could afford to pay. Note that the IRS had originally rejected the taxpayers’ offers because they were too low. Now at trial, the IRS argued that it was entitled to reject the taxpayers’ offers because the offers were too high.
The court correctly noted that there is no such law that permits the IRS to reject offers because they were too high. The court even cited the IRS policy manual saying that it “does not appear to contemplate rejecting an installment agreement merely because the taxpayer has offered more than the Commissioner believes the taxpayer can afford.”
The court stated that it was confused and perplexed by the IRS’s position. The court went on to say that the IRS could not have it both ways, i.e., reject the installment agreement for being too low and then prevail at trial based on the installment agreement being too high. So the court remanded the case back to the IRS for reconsideration.
Taxpayers generally should request the lowest monthly payment that the IRS will accept. This is true even if the taxpayer can pay the full balance by the time the statute for collecting expires. In the event that the taxpayer makes an offer that will fully pay their balance, the IRS should accept the offer. It almost always does. But in the event that the IRS does not, taxpayers can apparently use the collection due process hearing and court review to force the IRS to accept such an offer.