If you have a tax debt and you think you might qualify for relief because you cannot afford to repay your tax debt, here’s a list of “allowable” expenses that the IRS will take into account in collections context. The collection context is you having a chat with an IRS representative about your bills and why you can’t pay.
A word or two about “disposable income”. If you owe and can’t pay you must prove it to the IRS. The IRS has your income information from your tax return or W2 and will compare those income (and expense) figures to national, regional and local standards for things like housing and utilities, food, clothing and other items and transportation – the operation and maintenance of your vehicles(s). When that calculation is complete, if there’s any money left over, that’s called your disposable income (DI).
Here’s a list of expenses (and other hacks) that can be used to reduce that DI.
- Term life insurance – Term life insurance is the type of life insurance with no attached saving account. You are basically renting the insurance. It only pays a death benefit if you die within agreed term. If you survive, the money you paid into the policy is gone forever. The IRS allows this expense and it can reduce your disposable income accordingly. If they allow it, you’re basically getting life insurance before paying back taxes! This is a great deal! Also, as you get older, the cost of life insurance goes up – this means if you are older, a term life insurance policy can take a big bite out of your disposable income.
- Health Insurance – same idea here. Health insurance seems controversial because of the baggage associated with the Affordable Care Act but if you don’t have health insurance and you have to pay back taxes, you can pay for health insurance before paying for back taxes.
- Regular monthly medical bills – If you have medical or dental debt you are regularly paying on, same thing applies. You can pay for it before repaying back taxes. You’ll notice I bolded and italicized “regular” – if your payments are not regular the IRS will disallow.
- Court ordered Child support or Alimony – Divorces are one of the most common causes of tax debt. These payments are allowed in a collections context. Alimony is deductible, child support is not.
- Regular payments to student loans – If you have student loans, the IRS will allow you to make your payment before repaying back tax.
- Estimated tax payments or additional withholding – If you are self-employed or not having enough tax withheld as an employee, the IRS will allow you pay this money before repaying back tax. One of most important rules about fixing a tax debt is you must not owe again in the future.
- 401(k) Loan repayments – If you have borrowed money from your retirement plan like a 401(k), the IRS must allow this as well.
- Hack 1: Have another child. This is a not a hack in the traditional sense but if you are planning to have a child or another child, it can affect your disposable income figures. A larger household size increases allowable food, clothing and miscellaneous expenses as well as those for housing and utilities.
- Hack 2: Move somewhere more “expensive” – Part of the standards are based on census data at the county level. If you’re not living in one of the top 250 most expensive counties in the US and would like to live there, then that can have an outsized effect on your disposable income.
- Hack 3: Upgrade your car(s), get a second car. Can we just agree right now the United States is the most car obsessed country in the world? A tax benefit for having a car payment – come on! The national standard for a car payment is about $500 so if you want to drive a nicer, newer car (or two) before repaying your tax debt – this is possible.
The above list is a compilation of hard-won lessons in negotiating thousands of cases before the IRS. The team of tax professionals with whom I’ve worked has used some or all of these items to get our clients the best outcome they qualify for. Using the above information is constrained by the experience of the IRS representative you reach but if you are trying to fix this on your own – good luck. You can always email me or someone on my team here: firstname.lastname@example.org.