The Basics of IRS Payment Plans or Installment Agreements
IRS installment agreements, also called IRS payment plans, are offered to taxpayers looking for a way to pay their tax to the government in monthly amounts. Installment agreements are among the most popular programs requested by clients at our Atlanta CPA firm.
There are several variations of installment agreements:
CPA Tax Planning Tip: It is important to know that installment agreements are available as a tax relief solution only if the taxpayer’s returns have been filed. The IRS will be looking for the last six years of returns. If returns are missing, then they need to be filed as soon as possible. At that point we can propose an installment agreement to the IRS for the tax due.
Automatic Installment Agreements
The automatic installment agreement is for situations when the tax debt is less than $10,000.
To qualify, the taxpayer must not have owed back taxes or had an installment agreement in the last five years. The full amount of the tax must be paid in monthly installments within three years.
The application process is straightforward and financial information is not required to be submitted.
Streamlined Installment Agreements
The streamlined installment agreement is for situations when the tax debt is less than $50,000. As with an automatic installment agreement, the application process for a streamlined agreement is straightforward and submission of financial information on Form 433 is not required.
To qualify, the taxpayer must not have owed back taxes or had an installment agreement in the last five years. The full amount of the tax must be paid in monthly installments within 72 months (six years).
IRS 84 Month Installment Agreement
In 2018, the automated collection system (“ACS”) branch of the IRS started to approve streamlined installment agreements up to $100,000, with payment times of 84 months. This does not apply to all branches of the IRS.
CPA Tax Planning Tip: Consider using assets to pay off part of the tax, so it is below the threshold for a streamlined agreement. This strategy means that the IRS will not require the taxpayer to disclose and liquidate all their assets to pay the tax in full.
IRS Installment Agreement Coronavirus
As a result of COVID, the limit for a streamline installment agreement was increased in 2020 to $250,000, payable over the months remaining on the statute of limitations.
This only applies to IRS tax debts processed through automated collection system of the IRS.
Regular Installment Agreement
The regular payment plan is for those who do not qualify for the automatic or the streamlined installment agreement. This is commonly for tax debts over $50,000.
The application process is far more complicated, including the preparation of Form 433, which requires detailed financial information.
IRS Payment Plan Calculator
The monthly payment under a regular IRS installment agreement or payment plan is based on a formula called Reasonable Collection Potential. This formula is calculated on IRS Form 433. The intention of the formula is to determine what the taxpayer can afford to pay monthly.
First, the IRS looks at the taxpayer’s gross monthly income. All sources of income are considered, including wages, business income, child support, disability income and social security. It does not matter whether the income is taxable or not.
Then, “allowable expenses” are subtracted from gross monthly income. Only certain expenses, but not all, will be allowed. Depending on the type of expense, allowable expenses are based on national or local standards, rather than actual amounts.
Finally, the IRS will also look at the taxpayer’s net equity in assets. The IRS will discount the fair market value of the assets based on an 80% Quick Sale Value. The IRS may require the taxpayer to liquidate certain assets to pay off the tax, before the monthly installment agreement amount is calculated.
The sum of these calculations (net income, plus net equity in assets) will determine what the the taxpayer can afford as a monthly payment to the IRS to pay the tax debt.
The IRS will require that the monthly payments be sufficient to pay off the tax debt in full within the time remaining on the 10-year IRS statute of limitations for collections (also knows as the CSED).
CPA Tax Planning Tip: The IRS will allow the taxpayer to pay a lower monthly installment amount for one year based on actual expenses, rather than the IRS allowable expenses, provided that the tax will be paid in full by the end of the 10-year IRS statute of limitations. This “one year rule” gives the taxpayer a year to adjust their standard of living in order to afford a higher monthly payment after the first year.
CPA Tax Planning Tip: The IRS will also allow the taxpayer to pay a lower monthly installment amount for six years, based on actual expenses, if the tax will be paid in full within the six year period. The is called the “six year rule.” It is very helpful for the taxpayer looking for a payment plan that is easier to live with.
Partial-Pay Installment Agreements
The partial-pay installment agreement (PPIA) or payment plan is for those who are unable to pay off their tax debt in full within the time remaining on the 10-year IRS statute of limitations for collections (CSED).
The application process for a partial-pay installment agreement also requires the submission of Form 433, with full financial information.
The monthly payment amount will be based on the taxpayer’s ability to pay.
The taxpayer may be asked to use the available equity in assets to pay down the tax before the amount of the monthly payment is computed. If the equity in assets is significant, the IRS may seize or levy the property. However, this can be avoided if the taxpayer can demonstrate a hardship.
The monthly amount will be reviewed by the IRS, usually every two years, to see see if the taxpayer can afford to increase their monthly payments.
Setting up an IRS Payment Plan
The installment agreement is one of the most popular tools in our accounting firm to resolve tax debts. The other solutions are offer-in-compromise, uncollectable status (hardship) and bankruptcy.
The first step in the process is a careful analysis of the taxpayer’s IRS tax transcripts. This is necessary in order to know what the IRS has in its records that could impact qualification under the various tax resolution provisions. At our CPA firm, we analyze IRS transcripts to double check the statute of limitations as calculated by the IRS. This has a direct bearing on installment agreement calculations.
Also, we make sure that there are no unfiled tax returns for the prior six years, which could make it impossible to set up a payment plan. If returns are missing, we get them filed ASAP. If the return is tied to a business, we also get the QuickBooks caught up, so the returns can be fled.
Defaulting on an IRS Installment Agreement
Three actions will trigger a default of an installment agreement:
- Incurring a new tax debt or penalty
- Failing to file a tax return on time
- Failing to make installment payments
If a taxpayer defaults, the IRS will terminate the agreement. In such case, the taxpayer will have to pay the balance of the tax in full. Alternatively, the taxpayer may request an Appeal or attempt to negotiate a new installment agreement with the government.
CPA Tax Planning Tip: We strongly recommend that taxpayers use an automated direct debit arrangement for their installment agreements in order to avoid an inadvertent default.
Short-Term Extension of Time to Pay
A short-term payment plan is a good option for those who can afford the monthly payments. The period of payment is between 10 days and 180 days (about 6 months). Since the payment term is shorter, interest and penalties will be less, although they do continue to accrue.
The IRS will usually not impose a tax lien or levy while a taxpayer is under a short-term extension of time to pay.
IRS Interest Rate on Installment Agreements
Interest will continue to accrue while the installment agreement is in place. The interest rate is adjusted quarterly. As an example, the IRS increased the interest rate on underpayments for the fourth quarter of 2022 to 6%, for most taxpayers.
The IRS will not agree to forgive interest payments.
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Massey and Company CPA is a boutique tax and accounting firm serving individuals and small businesses in Atlanta, Chicago and throughout the country. Our services include tax return preparation, tax planning for businesses and individuals, IRS tax problem resolution, IRS audits, sales tax, and small business accounting and bookkeeping.