Chapter 11

How the IRS Conducts Financial Analysis

If you are trying to work with the IRS on an installment payment agreement of your tax debt, you may be wondering exactly how they determine who gets approved and who does not. It probably feels like, “which way is the wind blowing that day?”

Fortunately, the process is a little more objective than that. The IRS has a complex system of tables and guidelines that they use to determine what the standard of living is for your particular region. That information is used to set the bar for what they consider to be “reasonable expenses” that you can claim when applying for a payment agreement plan. 

The IRS will also look at your assets both personal and related to your business. There also is a little leeway for special circumstances, such as additional expenses you need to take care of your family or run your business.

In this chapter, I will explain to you how the IRS conducts financial analysis; what they take into consideration and how they compare it to national standards. I will also discuss how the IRS will apply local standards to your specific case. If you have questions about how to quantify your living and business expenses, reach out to me. I have helped my clients in these types of situations to present their financial picture in the most favorable light to have their repayment agreement requests approved by the IRS.

 

IRS Financial Analysis

IRS financial analysis is conducted by the IRS in order to both analyze and verify financial information. When conducting an IRS financial analysis, the IRS evaluates the income and expenses of the taxpayer to calculate for disposable income. 

Disposable income is defined as gross income less all allowable expenses. 

During their IRS financial analysis, the IRS also analyzes assets to resolve balance due accounts. To do this, the IRS will request that the taxpayer makes full, immediate payment if their cash on hand is equal to the total liability. 

In addition, the IRS will identify key sources of funds, “liquid assets which can be pledged as security or readily converted to cash” (IRS.gov, “Part 5. Collecting Process, Chapter 15. Financial Analysis, Section 1. Financial Analysis Handbook,” 8/24/2013).

Identification of key sources of funds is also extended to considering unencumbered assets, interests in estates and trusts, and lines of credit (“Section 1. Financial Analysis Handbook”). When analyzing assets to resolve balance due accounts, the IRS will also determine the priority of the Notice of Federal Tax Lien.

Under this category, the taxpayer may qualify for the six-year rule. This rule is most applicable to taxpayers unable to pay in full their federal tax liability. It also applies to those taxpayers who do not qualify for a streamlined installment agreement. 

Within this context, taxpayers must provide financial information but do not have to substantiate reasonable expenses. “All expenses may be allowed if the taxpayer establishes that he or she can stay current with all paying and filing requirements, the tax liability . . . can be fully paid within six years and within the CSED, and expense amounts are reasonable” (“Section1. Financial Analysis Handbook”).

The six-year rule is not applicable to corporations, partnerships, LLCs, and business expenses.

As part of the IRS financial analysis process, the IRS will also verify financial information by conducting interviews, asking pertinent questions and documenting the results. The IRS will ask questions with regard to the generation of income, the nature of the business process, the main products and services, major suppliers, assets held in the name of the taxpayer, and type of internet presence. 

The IRS will also “observe and document the physical layout of the business, the number of employees, the type and location of equipment, machinery, vehicles and inventory” (“Section 1. Financial Analysis Handbook”). The IRS will also verify previous collection issues addressed by field personnel to determine if reinvestigation is absolutely necessary.

Want To Save This Guide For Later?

No problem! Just enter your email address and we'll send you the PDF of this guide for free.

IRS National Standards

The IRS has developed IRS national standards as guides for taxpayers responsible for resolving their tax liabilities. The IRS national standards (or IRS Collection Financial Standards) are defined as five categories of necessary expenses developed and used by the IRS to calculate a taxpayer’s payment potential. 

The standards are used for the purpose of calculating repayment of federal tax liability. “IRS National Standards have been established for five necessary expenses: food, housekeeping supplies, apparel and services, personal care products and services and miscellaneous” (IRS.gov, “IRSNational Standards: Food, Clothing and Other Items,” 8/25/2013). 

For example, under the category of food, the IRS allows for calculations of both 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 ...Food away from home includes all meals and snacks, including tips, at fast-food, take out, delivery and full-service restaurants” (“National Standards: Food, Clothing and Other Items”).

The IRS defines housekeeping supplies as those items necessary for carrying on daily life. They include “stationery supplies, postage, delivery services, miscellaneous household products and lawn and garden supplies” (“IRS National Standards: Food, Clothing and Other Items”). 

Apparel and services include clothing, footwear, watches and jewelry. They also include “material, patterns and notions for making clothes, alterations and repairs, [and] ... dry cleaning and sent-out laundry” (“IRS National Standards: Food, Clothing and Other Items”). 

Personal care products and services include a list of items used in the hair, oral hygiene products and shaving needs. They are also extended to cosmetic and bath products and related personal care products, which also include electronic personal care appliances. 

The miscellaneous allowance includes credit card payments, bank fees and charges, school supplies and reading material.

The IRS allows taxpayers to calculate their respective IRS national standards by family size. However, if the amount claimed is more than the total allowed by the National Standards for food, housekeeping supplies, apparel and services and personal care products and services, the taxpayer must provide documentation to substantiate that those expenses are necessary living expenses.

The total number of persons considered in terms of National Standards should figuratively represent the same number allowed as exemptions on the taxpayer’s income tax return (“National Standards: Food, Clothing and Other Items”).

 

IRS Local Standards

The IRS Collection Financial Standards are also extended to local territories. The IRS Local Standards provide guidelines regarding how to account for housing and utilities. Housing and utilities calculations are based upon state, county and family size.

In addition, IRS Local Standards also include transportation standards. For example, in terms of ownership costs, single taxpayers are allowed one automobile. Taxpayers are allowed operating costs by regional and metropolitan area. 

There is a single allowance for public transportation. The “single nationwide allowance for public transportation [is] based upon Bureau of Labor Statistics expenditure data for mass transit fares for a train, bus, taxi, ferry, etc. Taxpayers with no vehicle are allowed the standard amount monthly, per household, without questioning the amount actually spent” (IRS.gov, “Local Standards: Transportation,” 8/25/2013). 

In the case of taxpayers who use both their personal vehicles and public transportation, the IRS may allow expenses for both, provided that the need is for the health and welfare of the family and contributes to the production of income.

Specific costs and more information about IRS Local Standards can be found on the IRS website.

 

Conclusion

I hope that I have helped solve some of the mystery surrounding how the IRS determines what are acceptable expenses when you apply for an installment repayment agreement. Whether you agree with their assessment or not, at least you know what criteria they are using to base their decision on.

All of the information about national and local standards can be found on the IRS website, so that should give you some idea of how to present your case for getting an repayment installment agreement approved. If you have questions or need assistance in understanding how to apply these guidelines to your situation, reach out to me. I have helped many, many clients prepare their applications for repayment plans to the IRS with great success. I know I can help you, too.

Book an Action Plan CTA
Chapters