Most legal aid clients will be candidates for “Currently Not Collectible” (CNC) status. A taxpayer may be placed in CNC status if collection would cause undue hardship by leaving the taxpayer unable to meet necessary living expenses.1 A levy on wages must be immediately lifted if the taxpayer is placed CNC status.2 A taxpayer may receive CNC status even if there are unfiled tax returns.3

• 1I.R.M. 5.16.1.1, .2.9.
• 2I.R.C. § 6343(e); I.R.M. 5.16.1.2.9(7).
• 3Vinatieri v. Comm’r, 133 T.C. 392 (2009); I.R.M. 5.16.1.2.9, 8.22.7.7(4).

A taxpayer is eligible for CNC if collection would make the taxpayer unable to meet necessary living expenses, thereby causing undue hardship. The individual taxpayer’s financial information generally must be compiled on a Form 433-A.1 If the taxpayer has assets that can easily be liquidated to pay the liability, the IRS may deny the request for CNC status. Such assets can include whole life insurance policies, retirement accounts, extra vehicles, boats, or campers.

To be “necessary” expenses must be “necessary to provide for a taxpayer’s and his or her family’s health and welfare or production of income.”2 The IRS uses various standards to determine the allowable amount of these expenses. Expenses for clothing, food, housekeeping, personal care, and out-of-pocket health care automatically use the national standard. A taxpayer who claims more than the amount set in the national standard must substantiate and justify each separate expense of the total national standard.3 For housing and transportation, taxpayers are allowed the lesser of the local standard or the amount actually paid.4 The current national and local standards can be found on the IRS website and in I.R.M. 5.15.1.2. “Other expenses” may be considered if they meet the necessary-expense test.5 Examples of “other expenses” found necessary by the IRS include taxes, secured debt, and court-ordered payments.6

It is generally a good practice tip to ask your client to give you at least 3 months of complete bank statements to support your request for CNC status. These statements can usually be accessed online. Modern electronic banking has resulted in most income being deposited into, and expenses directly paid from, bank accounts. These statements can give you a clear picture of your client’s current financial situation. If there are any unexplained deposits or withdrawals, you should consult with your client about these items. You may find that a low-income client is sharing an account with children or other family members or is receiving one-time gifts to pay bills. 

• 1I.R.M. 5.16.1.2.9.
• 2I.R.M. 5.15.1.8.
• 3Id.
• 4I.R.M. 5.15.1.9.
• 5I.R.M. 5.15.1.10.
• 6Id.

CNC status suspends collection but does not forgive or compromise the tax or release liens. As a result, interest and penalties continue to accrue. The IRS will also continue to offset future tax refunds. However, because CNC status does not toll the collection limitation period, the 10-year statute of limitation for collection continues to run.

A taxpayer who is not financially able to pay a tax debt immediately may make monthly payments through an installment agreement. The IRS generally will not take collection actions while an installment agreement is being considered, in effect, or on appeal.

The minimum monthly payment on an installment agreement is $25. The time period for installment agreements varies. Generally, the installment agreement should not extend beyond the time remaining on the collection statute of limitation. Low-income taxpayers who pay a small monthly payment may not be reducing their principal tax debt given the interest rates charged on the taxes owed. The fees for setting up installment agreements also vary. Most low-income taxpayers will qualify for a reduced $43 set-up fee; apply for this reduced fee using Form 13844.

Taxpayers who owe less than $50,000 may apply for a guaranteed or streamlined installment agreement by several methods: (1) apply online (2) call the phone number on the IRS notice or bill or (3) complete and mail a Form 9465, Installment Agreement Request. A taxpayer who owes more than $50,000 will have provide additional financial information on a Form 433-F.

A taxpayer who can pay the full amount owed within 120 days may want to apply for a 120-day suspension of collection activity to provide time to gather the funds.1 In cases of financial hardship, a longer suspension of collection activity may be possible.2 This procedure allows the taxpayer to avoid the fees for setting up an installment agreement.

• 1I.R.M. 5.14.5.5.
• 2I.R.C. § 6161(a)(1); 26 C.F.R. § 1.6161-1(a).

The IRS will always want the liability to be paid off before the Collection Statute Expiration Date (CSED). If the CSED is near, the monthly payments needed to pay the liability may be higher than the taxpayer can afford. Partial installment agreements are now authorized.1 This is appropriate when the taxpayer can afford to make a monthly payment, but the amount will not pay off the entire liability before the CSED. Taxpayers who request partial installment agreements will have to show that they cannot pay more each month after paying basic expenses and that they do not have any assets that can be liquidated to pay off the entire liability. If the partial installment agreement is accepted, the taxpayer will make the required payments until the CSED at which point the liability will be extinguished. The advantage of a partial installment agreement is that the IRS will not take other collection actions while the monthly payments are being made.

• 1I.R.C. § 6159; I.R.M. 5.14.2.1.

A taxpayer will qualify for a “guaranteed” installment agreement without a financial analysis if the taxpayer owes less than $10,000, has been in tax compliance for the 5 prior years, and can fully pay the tax within 3 years.

An individual taxpayer may apply for a streamlined installment agreement if the aggregate unpaid balance is less than $50,000 and can be fully paid within 72 months.1 Full compliance (including filing of tax returns) is required for a streamlined installment agreement. A streamlined installment agreement can be granted without submission of a collection information statement or financial documents to the IRS. Most installment agreements obtained for taxpayers fall in this category.

• 1Memorandum SBSE 05-0112-013 (Jan. 20, 2012); see also I.R.M. 5.14.5, .10 (providing I.R.M. implementation rules).

A taxpayer who does not qualify for a guaranteed or streamlined installment agreement will have to apply for a regular installment agreement. This procedure requires completion of a Form 9465-FS and a Form 433-F collection information statement. Form 433-F is used to analyze the taxpayer’s ability to pay based on IRS collection financial standards. The IRS generally does not grant regular installment agreements if the taxpayer can fully pay the liability from assets and disposable income. In general, the IRS will usually grant an installment agreement if the liability will be paid within 6 years or before the CSED, even without financial documentation.

Taxpayers may pay installment agreements by check, money order, direct debit from a checking account (Form 433-D), payroll deduction (Form 2159), Electronic Federal Tax Payment system, or credit card. A direct debit installment agreement may qualify a taxpayer for withdrawal of a lien after 3 months of probation.1 The set-up fee for the installment agreement will also be lower for those who choose direct debit.

• 1I.R.C. § 6323(j)(2)(B); Memorandum No. SBSE-05-0411-036 (April 7, 2011).

Once the installment agreement is approved, the IRS and the taxpayer are bound by the agreement unless the taxpayer misses a payment, fails to file tax returns, provided inaccurate information during the negotiations, or has a changed financial condition. Denials or terminations of installment agreements may be appealed using Form 9423 and later reviewed in Tax Court under the abuse of discretion standard. The IRS will reinstate an installment agreement one time upon payment of a reinstatement fee. A taxpayer who is in danger of default on an installment agreement should contact the IRS. It is possible to get a temporary hold on payments.

You have heard TV ads about settling IRS debt for pennies on the dollars? These tax debt settlement firms are peddling help with filing an “Offer in Compromise” (OIC).  An Offer in Compromise (OIC) is a settlement in which the taxpayer offers to pay less than the amount owed. An OIC can provide substantial relief to a qualified taxpayer. Indigent and disabled taxpayers, with no assets, can settle tax debt for very small amounts. The analysis is similar to requesting CNC status, but the attorney will have to argue that the taxpayer’s inability to pay the full liability is permanent.

Tax lawyers at legal aid programs help taxpayers with OIC applications for free. Some private firms scam taxpayers by taking fees as high as $3,000 and then doing very little to get the IRS to approve the OIC. These firms often fail to provide the back-up documents and focused negotiation required for a successful OIC. Some firms also take fees from taxpayers who have no chance of getting an OIC such as taxpayers with substantial retirement accounts or real estate holdings.

An OIC may be submitted on the basis of doubt as to collectability, doubt as to liability, or effective tax administration.1 Most offers are submitted for doubt as to collectability. This generally requires a showing that the taxpayer cannot afford to pay the liability and does not have assets that can easily be liquidated to pay the liability and that this situation is permanent. Many elderly and disabled persons with limited income are eligible to receive an OIC on this basis. 

• 1I.R.C. § 7122.

An OIC is initiated by filing a Form 656, which requires information and supporting documentation of the taxpayer’s income, assets, and expenses. The filing fee is a non-refundable $186. However, the fee may be waived for a taxpayer whose income is below 250% of the poverty line.1 A taxpayer must file all required tax returns in order for an OIC to be considered. This may lead to the taxpayer incurring more liability before all of the liability can all be settled with an OIC. You may need to request CNC status for your client while the tax returns are being processed or the OIC is being prepared. Collection actions are suspended while the OIC is being processed by the IRS. 

The purpose of the Offer in Compromise program is to settle tax debts for the maximum amount that the taxpayer can pay from net current assets and future income potential. The amount of the offer is computed as the sum of net realizable assets2 and gross income minus necessary living expenses. Even if the computed “offer” amount is zero, the taxpayer must still offer at least $1. The Internal Revenue Manual has extensive rules on how the maximum collection potential is determined.3 After the filing of the Offer, an attorney will often need to advocate with the IRS for the proposed offer amount. The Internal Revenue Manual rules are useful in this advocacy since the IRS is supposed to follow them.4 IRS requests for additional information should be timely responded to.

The IRS may allow the taxpayer to pay off the debt in a lump sum payment or in installments over a period of time, usually between 6 months and 2 years.5  In the latter case, the taxpayer will be given a fixed monthly payment amount. Be sure to structure a realistic compromise that provides the taxpayer with adequate means for basic living expenses.

If an OIC is accepted, a taxpayer must file tax returns and pay taxes owed for the next 5 years. Non-compliance could result in a default and enforcement of the compromised taxes by the IRS. Be sure to advise your client of the duty to file and pay taxes per the OIC agreement. Document your advice in writing.

Levy is suspended while an OIC is pending or in effect.6 The IRS is not required to release a prior levy upon the taxpayer’s filing of an OIC. However, it will usually release the levy if the taxpayer shows economic hardship. 

A “rejection” of an OIC may be appealed to the IRS Appeals Office.7 The rejection notice should state specific reasons why the OIC was not accepted so the taxpayer can respond in an appeal. Levy is suspended pending an appeal.8 If the OIC was submitted as part of a collection due process hearing, the rejection may be appealed to Tax Court under an abuse of discretion standard.9

If an OIC is “returned”, this means that the OIC was incomplete and that the OIC agent attempted to contact the taxpayer and/or the representative but did not get a response. The IRS takes the position that a “returned” OIC cannot be appealed and that the only remedy is to submit a new OIC. Some OIC agents seem to quickly return an Offer without giving adequate time to respond or even ignore phone messages or faxes sent by the taxpayer. If this is the case, the matter should be appealed to the OIC agent’s supervisor and possibly IRS Appeals. 

• 1Use Form 656A for waiver of the fee.
• 2“Net realizable assets” equals the Quick Sale Value of an asset (generally 80% of fair market value) minus the first encumbrance, fix-up costs, broker fees, etc.
• 3I.R.M. 5.8.5; 5.15.
• 4Fairlamb v. Comm’r, T.C. Memo 2010-22.
• 5I.R.M. 5.8.1.10.4.
• 6I.R.C. § 6331(k).
• 7I.R.C. § 7122(e); see I.R.C. §§ 6320, 6330; Rev. Proc. 2003-71 (Collection Appeals Program). Returns of Offers for additional information are not “rejections.”
• 8I.R.C. § 6331(k).
• 9See, e.g., Blosser v. Comm’r, T.C. Memo 2007-323; Samuel v. Comm’r, T.C. Memo 2007-312.

Taxpayers who own their own homes may have equity. Although the IRS will generally not require a taxpayer to sell the home, the agency may require a taxpayer to obtain a bank letter denying a mortgage on the home. Thus, a client who has equity in a home but whose income is too limited to get a mortgage may still be eligible for an OIC. 

The IRS will generally allow a taxpayer to have one vehicle for personal use unless it is an especially valuable vehicle with a lot of equity. 

A taxpayer may also have whole life insurance, savings, or a pension that could satisfy the tax liability. If the attorney can show that these funds are needed to pay future living expenses, the taxpayer may be able to keep these assets and still be approved for an OIC. The attorney will have to show that the taxpayer’s income is insufficient to pay for basic expenses, that this situation is permanent, and that the asset is needed to offset the negative income for the remainder of the taxpayer’s life. Use the Social Security life expectancy charts when making this argument. These charts can be found online at the Social Security website. 

Possible disadvantages to an OIC include an extension of the 10-year statute of limitation by the pendency of the offer plus 1 year, forfeiture of certain tax refunds, filing of tax liens to protect the IRS’s interests, adverse impact on bankruptcy options, and, if the taxpayer defaults on the offer, reinstatement of the full debt plus penalties and interest.1 An OIC will also preclude a subsequent innocent spouse claim for a tax year covered by the OIC.2 Until recently, even when an OIC was accepted, the IRS could still seize the next year’s tax refund. This policy has now been changed so that no new seizures will occur after the OIC is accepted. 

• 1The IRS will not process an Offer in Compromise for a taxpayer who is in bankruptcy. See Rev. Proc. 2003-71; I.R.B. 2003-36.
• 2I.R.M. 25.15.5.15.