Don't Bet the Business

Part 1 of a 2-Part Series

In an earlier blog post, we discussed options available to taxpayers facing a tax balance with either the Internal Revenue Service (IRS) or one of the states. These options can be very confusing and difficult to understand for a taxpayer attempting to sort through which option is right for them based on their own unique circumstances.

This two-part series will describe in detail the two most common collection alternatives used by the IRS and the states when resolving taxpayers’ outstanding tax debts. In the first part of this series, we will discuss installment agreements and the various forms  installment agreements can take to allow taxpayers to pay down their tax debts over time.

What is an Installment Agreement?

In simple terms, an Installment Agreement (IA) is an agreement between the IRS or a state and a taxpayer that allows the taxpayer to pay down their tax balance in monthly payments. For many people, it is easiest to think about an installment agreement as a revolving debt like a credit card or car payment.  An installment agreement will have an outstanding balance, a monthly payment amount, and it will have a set amount of time by which payments must be made to resolve the outstanding tax debt.  The fact that installment agreements have these predictable terms and payment options make them very attractive for taxpayers because a monthly payment can be established to fit the taxpayer’s budget and still meet the payment requirements for the IRS or state. 

What is the Process for Establishing an Installment Agreement?

The IRS and state tax authorities establish an IA with two main goals in mind that are balanced to arrive at an agreement that works for everyone.  The first is that the IRS and state are in the business of collecting as much tax revenue as is possible from taxpayers.  Statistics show that many taxpayers will not complete an installment agreement.  It is for this reason that the IRS and state are motivated to front-load an installment agreement attempting to collect as much money up front.

The second goal is to arrive at a payment amount that is appropriately tailored to the taxpayer’s actual ability to make the payments.  If the monthly payment is too high, the IRS and state know that the taxpayer is at an elevated risk of default. To accomplish the goal of an appropriately sized payment, the IRS and state often require that the taxpayer complete a form that outlines their monthly income and expenses which will be used to determine a reasonable IA payment.

For example, a taxpayer has monthly income of $4,000 and monthly expenses of $3,500.  The taxing authorities will subtract the monthly expenses from monthly income to arrive at an amount available to contribute towards a monthly IA payment, in this example $500.  

Once a payment amount is agreed upon, the IRS or state will prepare a written agreement that outlines the terms of the IA. The forms needed to establish the IA are relatively straightforward.  They contain the taxpayer’s information, the tax years and balances that are covered by the agreement, and the dates of the first and last payments.  Depending on the type of IA, the IRS or state may also require that the taxpayer consent to allowing the payments to be automatically withdrawn from their bank account. 

Once the IA is established, the taxpayer must remain in compliance by filing their returns and paying their taxes on time.  Provided that there are no compliance issues, the IRS and state are generally content to collect the negotiated payments until the tax debt is resolved.

What are the Different Types of Installment Agreements?

Depending on the taxpayer’s goals, the amount of the tax owed and the time remaining for the IRS or state to collect the debt, there are several IA options available.  Each has different advantages, or disadvantages, to consider when choosing a plan to fit the taxpayer’s goals and ability to pay.

Short Term Installment Agreement

A short-term installment agreement is an option for a taxpayer who can pay the tax debt within 180-days.  This type of IA is often suitable for a taxpayer who has filed their annual income tax return and simply needs additional time to pay the tax due.   Since the balance due is divided into six monthly payments, there is no need for any financial disclosures.  A short-term IA can be established simply by calling the IRS and setting it up over the phone.

Guaranteed Installment Agreement

A guaranteed IA is a payment option with unique terms that are tailored to a very specific taxpayer.  If the taxpayer meets the terms, acceptance by the IRS is guaranteed.  A taxpayer will be able to qualify for this IA if they owe less than $10,000 and:

• Have not owed any tax or had another installment agreement in the previous five-years; and
• Agree to pay the full amount owed within three-years.

Provided that the taxpayer meets these terms, a guaranteed IA also can be established through a phone call to the IRS.  Like the short-term IA, there is no need to provide any financial information to qualify for a guaranteed IA.

Streamlined Installment

There are two slightly different versions of streamlined IA available depending on whether the taxpayer is an individual or a business.

Individual Streamlined Installment Agreement

A streamlined IA Is very similar to the guaranteed IA except that the terms under which a taxpayer can qualify are more permissive.  A taxpayer can qualify for an individual streamlined IA if they meet the following criteria:

• The taxpayer owes less than $50,000;
• The taxpayer has not had a back tax debt or an installment agreement in the previous five-years; and
• The taxpayer agrees to fully pay the tax liability the earliest of 72 months or before the expiration of the collection statue, which is 10-years from the date of assessment.

Like a guaranteed IA, no financial information is required to establish this type of agreement which can be accomplished by a phone call to the IRS.

Business Streamlined Installment Agreement

The business variation of a streamlined IA is available when taxpayer owes no more than $25,000, and agrees to pay the tax debt over 24-months. Like the individual version, if the business meets the qualification requirements, no financial disclosures are necessary to establish the IA.

Regular Installment Agreement

When a taxpayer cannot meet the specific requirements of the previous three IA types, the IRS will require that they submit a Collection Information Statement that itemizes the taxpayer’s income and expenses. They will set up an IA based on the cash remaining at the end of the month after all allowable expenses are deducted from income. If the resulting monthly payment is sufficient to fully pay the tax balance on or before the 10-year collection statute, the IA will be classified as a regular installment agreement.

The benefit of this type of IA is that if the taxpayer makes the required monthly payments and otherwise remains in tax compliance, they will never need to revisit their payment plan again.  

Conversely, if the financial health of a taxpayer ever gets worse, they can always contact the IRS or state to have their payment adjusted to reflect their new financial reality.  The option to renegotiate the payment amount during challenging financial periods without the need to adjust the payment during positive financial periods is a powerful feature of a regular IA. An experienced tax practitioner can help a taxpayer navigate their current and future financial health to establish an IA that best meets their needs. 

Partial Pay Installment Agreement

A partial pay IA, or PPIA, is very similar to a regular IA in that both begin by submitting financial information to the IRS to determine the ability to pay.

The key difference between these two IA types is that the payment for a PPIA will not be enough to fully pay the tax balance before the applicable collection statute expires. The IRS may choose to accept a lesser amount because it prefers to collect some amount based on what the taxpayer can afford.

In exchange for accepting this lesser payment amount, the IRS will revisit the taxpayer’s financial condition every 18-months or so to determine if improved conditions mean that the taxpayer’s monthly payment can be increased. A PPIA can be helpful to the taxpayer with a small amount of disposable income each month and who does not expect that their financial situation will change.

The One Year Rule

For many taxpayers who begin a new IA, absorbing the new payment can be a shock to their monthly budget.  They may need time to adjust their monthly expenses to accommodate the new payment.  To help taxpayers adjust, the IRS will allow a taxpayer to use their actual expenses for the first year of a regular IA or PPIA. Normally, the IRS limits certain expenses based on national standards that it uses to determine what it believes are appropriate expense levels based on the region or city where a taxpayer resides.

When using these national standards, the IRS will use the lesser of the national standard or the taxpayer’s actual expenses to determine the payment amount.  By using actual expenses for the first year, the initial monthly payment will be lower than it will be over the remaining life of the IA.  The lower monthly payment in the first year gives taxpayers time to adjust their budgets to incorporate the new monthly payment over the life of the IA.

The Six Year Rule is part of the IRS's efforts to accommodate taxpayers who are unable to pay their tax debt in full immediately but can commit to resolving their debt within a reasonable period. This approach allows for more flexibility in managing one's financial situation while ensuring compliance with tax obligations.

Conclusion

An IA can be a useful tool to pay an outstanding tax balance.  Many are guaranteed to be accepted if the qualifying criteria are met.  Other IAs can be tailored to allow for payments based on what the taxpayer can afford.  

The next part of this series will cover the second most popular collection alternative to permanently settle large tax balances with the IRS or state. This is called an Offer in Compromise.