When taxpayers fall behind on their federal taxes, the Internal Revenue Service (IRS) has a range of collection tools at its disposal. To resolve these debts, two of the most common options are an Offer in Compromise (OIC), where you settle your tax liability for less than the full amount owed, or an Installment Agreement, where you pay your balance in monthly installments over time.
In the OIC program and with certain installment agreements, the IRS applies strict financial guidelines to determine how much you can afford to pay. Central to this calculation are the National and Local Expense Standards, which are tables of allowable living expenses the IRS uses when evaluating your financial situation.
Understanding how these standards work can mean the difference between approval and rejection of your OIC or installment agreement request.
Allowable living expenses include those that meet 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 and welfare and/or income production. The IRS uses these standards when reviewing your financial information included on Form 433-A (OIC), Form 433-A, or Form 433-F.
National Standards for food, clothing, and other items apply nationwide. Taxpayers are allowed to claim the total National Standards amount based on their family size, without being required to provide details about their actual expenditures.
National Standards have been established for minimum allowances for out-of-pocket health care expenses. Taxpayers and their dependents are permitted to claim a standard amount for each person, without needing to provide proof of the actual expenditures.
Maximum allowances for housing, utilities, and transportation, referred to as Local Standards, differ by location. Typically, taxpayers can claim the lesser of their actual expenses or the local standard.
Generally, the total number of persons allowed for necessary living expenses should be the same as those allowed as exemptions on the taxpayer’s most recent year’s income tax return. However, the IRS does grant exceptions.
If the IRS finds that a taxpayer’s situation demonstrates that the standards are insufficient to cover basic living expenses, it may permit actual expenses. Taxpayers must provide documentation to show that national and local expense standards do not adequately cover their basic living expenses.
National Standards: Food, Clothing, and Other Items
National Standards have been established for five essential expenses: food, housekeeping supplies, apparel and services, personal care items and services, and miscellaneous expenses. The standards originate from the Bureau of Labor Statistics (BLS) Consumer Expenditure Survey (CES), which gathers data from households and families across the nation regarding their spending habits, income, and household characteristics.
National Standards: Out-of-Pocket Health Care Expenses
Standards for out-of-pocket healthcare expenses include medical services, prescription drugs, and medical supplies like eyeglasses and contact lenses.
The table for health care allowances is based on data from the Medical Expenditure Panel Survey. It uses an average amount per person for taxpayers and their dependents under 65, as well as for those aged 65 and older. Additionally, the out-of-pocket health care standard amount can be claimed in addition to the amount that taxpayers pay for health insurance.
Local Standards: Housing and Utilities
The housing and utilities standards are derived from U.S. Census Bureau, American Community Survey, and BLS data, and are provided by state down to the county level. The standard for a specific county and family size encompasses housing and utility costs allowed for a taxpayer’s primary residence. These housing and utility standards include expenses such as mortgage or rent, property taxes, interest, insurance, maintenance, repairs, gas, electricity, water, heating oil, garbage collection, residential telephone service, cell phone service, cable television, and internet service. The guidelines provide five categories for households based on the number of persons: one, two, three, four, or five or more.
Local Standards: Transportation
The transportation standards for taxpayers who own a vehicle are divided into two components. The first part includes nationwide figures for monthly loan or lease payments, known as ownership costs. The second part outlines additional monthly operating costs, which vary according to Census Region and Metropolitan Statistical Area (MSA). A conversion chart is provided by the IRS listing the states that make up each Census Region, along with the counties and cities included in each MSA. The cost of ownership in transportation standards is nationwide, yet it remains part of the Local Standards.
The ownership costs provide maximum allowances for the lease or purchase of up to two automobiles if allowed as a necessary expense. A single taxpayer is usually allowed one automobile.
Operating costs include maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking, and tolls.
If a taxpayer has a car payment, the allowable ownership cost, when added to the allowable operating cost, equals the allowable transportation expense. If a taxpayer has a car, but no car payment, only the operating costs portion of the transportation standard is used to figure the allowable transportation expense. In both of these cases, the taxpayer is allowed the amount actually spent, or the standard, whichever is less.
There is a nationwide allowance for public transportation based on BLS expenditure data for mass transit fares, including trains, buses, taxis, ferries, and other modes of transportation. Taxpayers without vehicles are allowed the standard amount per household without questioning the actual amount spent.
If a taxpayer owns a vehicle and utilizes public transportation, expenses for both may be allowed if they are necessary for the taxpayer’s or their family’s health and welfare, or for producing income. However, the expenses allowed would be actual expenses incurred for ownership costs, operating costs, and public transportation, or the standard amounts, whichever is less.
Other Allowable Expenses
In addition to the national and local expense standards, the IRS may allow other expenses that are deemed necessary for a taxpayer’s health, welfare, or ability to produce income. This could include court-ordered payments, childcare costs, term life insurance, union dues, and certain secured debts.
Get Help with IRS Expense Standards
For taxpayers facing IRS collection actions, understanding and utilizing the Collection Financial Standards to your advantage can mean the difference between achieving financial relief and experiencing ongoing hardship. These standards will shape the outcome of your request for a payment plan, hardship status, or settlement.
If you are having difficulties with the IRS collection process, consider consulting a tax professional who can assist you in effectively presenting your financial information. With the right approach, you can protect your income, negotiate better terms, and find a path forward. Call East Coast Tax Consulting Group today for a FREE consultation.
Frequently Asked Questions
What happens if my actual expenses are higher than the IRS standards?
You can request that the IRS consider your actual expenses, but you’ll need strong documentation to prove that the higher costs are necessary and unavoidable.
Do these standards change every year?
Yes. The IRS updates National and Local Standards annually to reflect inflation and cost-of-living changes.
Where can I find the most up-to-date IRS Collection Financial Standards?
The IRS publishes updated National and Local Standards annually on its official website. Using the most recent figures is necessary when preparing Forms 433-A, 433-F, or 433-OIC.
Why are these standards important in an Offer in Compromise?
Because the IRS calculates your “reasonable collection potential” using these numbers. If your expenses exceed the standards without justification, your OIC is likely to be rejected.
Do the IRS standards account for childcare or dependent care costs?
Yes, but only if they are necessary for you to work or to provide for the welfare of your family. You’ll need to provide documentation for expenses related to daycare, babysitting, or eldercare services.