The IRS will allow “other expenses” if they meet the necessary expense test which is whether the expense is necessary in the production of income or to provide for the health and welfare of the taxpayer’s family. “Other expenses” include current taxes, child support payments, legal and professional fees, student loan payments, term life insurance, credit card debt, etc.) However, the IRS will only allow a reasonable amount. The question arises, what does the IRS consider to be reasonable? Unfortunately, the answer can vary from one IRS representative to another.
If a taxpayer is a wage-earner and has taxes (federal withholdings, social security, Medicare, and state withholdings) deducted from his/her paycheck every pay period, the IRS will allow it as a necessary expense. If a taxpayer is self-employed, estimated tax payments must be allowed as a necessary expense. The total amount of estimated tax payments will be averaged over a specified period of time. However, if the taxpayer is not making any estimated tax payments, even though they are required to so to prevent from incurring a new tax liability, the IRS will disallow it.
If a taxpayer pays for child support and has a copy of the child support order, the expense will be allowed. The easiest way to prove involuntary child support payments is to provide paystubs to show that the child support payments are deducted (garnished) from a taxpayer’s pay check. However, if payments are being voluntarily made without a court order the IRS will disallow the expense.
Legal and Professional Fees:
If a taxpayer pays for legal and professional fees, the expense should be allowed, but once the payment ends, the IRS will expect the amount that was being paid for legal fees is now available to pay the IRS tax debt. For example, if a taxpayer pays $500 for legal fees, but only has two months of payments before the debt is paid in full, the IRS will expect the $500 to be paid to them, on top of the monthly disposable income.
Student Loan Payments:
If a taxpayer is paying back their federally funded student loans, the IRS will allow them if the taxpayer can provide proof that he or she is making monthly payments. If the taxpayer took out a personal loan, the loan payment will not be allowed because the IRS takes the position that taxes have priority over personal loans payments. If a taxpayer is paying for their child’s college education, the payments may not be allowed, but it may depend on the IRS representative reviewing the taxpayer’s financial information. Unfortunately, the IRS takes the position that a college education does not qualify as a necessary living expense.
If a taxpayer has whole life insurance, the IRS will consider it as an asset and any premium payments will not be allowed as a necessary living expense. In fact, if the life insurance policy has a cash value, the IRS will prefer the taxpayer to cash it out. If, however, the taxpayer has term life insurance, the IRS will allow the payments as long as it is reasonable. Based on experience, usually any amount less than $100 per month will be allowed, provided that the taxpayer can provide proof of monthly payments.
Credit Card Debt:
The IRS considers credit cards as a way to pay the IRS, not as a necessary living expense. The IRS inquires on whether a taxpayer has any available credit to see if the taxpayer can borrow against any available credit. The IRS’s position is that credit card debt is unsecured and does not take priority over tax debt.
When providing financial information to the IRS, taxpayers must keep in mind the purpose behind it. The Collection Information Statements help the IRS determine how much they can collect while allowing the taxpayer just enough to pay for their basic living expenses.