Tax Notes logo

Affordable Living Expense Standard

Posted on Aug. 23, 2017

In the National Taxpayer Advocate’s Fiscal Year 2018 Objectives Report to Congress, she identifies the affordable living expense standards as most serious problem #13.  These standards now provide critical information for almost all collection cases and deserve attention.  She seeks to move the IRS to a different way of calculating the living expenses based on need rather than on expenditures by individuals without enough money.  If she succeeds, it could make a difference for numerous individuals seeking to compromise their tax liability, to obtain an installment agreement, or to move into currently not collectible status.

The affordable living expense standards have been around for two decades.  The NTA’s report cites to IRC 7122(d)(2)(A) as the legal mandate to the IRS to develop such standards for offer in compromise cases; however, as with many of the provisions enacted into law in the legislative actions in 1988, 1996 and 1998 labeled Taxpayer Bill of Rights I, II and III, Congress codified something that the IRS had already done.  As I have discussed before, the IRS abandoned about 130 years of ignoring the offer in compromise provisions in the early 1990s when under pressure from Congress to reduce its accounts receivable and after Congress, with no prompting from the IRS or Treasury, increased the statute of limitations on collections from six years to ten thinking it would produce more revenue.  The IRS knew the change in the statute of limitations would produce little revenue but would approximately double the size of its accounts receivable, making it look even worse.  Casting about for ways to avoid looking bad, it settled upon an offer in compromise program as a possible way to write debt off its books before the end of the 10-year period.

When the IRS jumped into accepting offers in compromise (OIC), it did so with very little thought regarding standards.  Revenue Officers, who handled OICs for the first several years of the program before most offers were centralized in Brookhaven and Memphis, received very little direction on what to allow.  Some were overly stingy while others were overly generous.  Most had a good sense of reasonable expenses but all were flying by the seat of their pants.  Because IRC 7122 at that time required that all offers in which the taxpayer owed more than $500 must be reviewed by Chief Counsel’s office, my office reviewed all of the offers in Virginia and, for a time, West Virginia.  Reviewing the offers with no standards on expenses was difficult.  So, I set some standards for vehicles and life insurance in an effort to bring order to the process.  The IRS headquarters heard many complaints about the lack of standards from without and within, and established standards by 1996 using Bureau of Labor Statistics data for expense standards and exemptions from levy for asset standards.

Since the beginning of the adoption of standards, taxpayers have complained about them.  The IRS has responded to some of the complaints adjusting and tweaking the formula occasionally.  Some of the biggest adjustments came in 2008, 2011 and 2012 with the adoption of the Freshstart Initiative.   The NTA writes her most serious problem report in this background and brings up some good points which the IRS might consider as it continues to adjust the living standards which have now become such an important part of the IRS collection process and which Congress adopted for use in bankruptcy cases in Bankruptcy Code 707(b)(2)(A)(ii) as part of the 2005 amendments.

The NTA points out that the IRS relies heavily on the Consumer Expenditure Survey (CES).  This survey measures what people spend and not what goods and services actually cost.  Because of the way it is designed, the survey will fail to recognize even necessary expenditures of taxpayers who must cut out such expenditures because of lack of funds.  She points out that the survey does not take into account the high percentage of a low income taxpayer’s funds that must be spent on housing and that the survey is out of date in many areas such as child care, technology, or retirement savings.  She proposes that the IRS develop alternate measures that better capture the true costs of living.

The IRS responded that it strives to make the allowable expenses up to date pointing to the many updates it has made over the years.  The IRS expressed concerns that the standards sought by the NTA do not meet “standards of accuracy or cover sufficient geographic area; they are also not collected regularly or generally accepted as a reliable data source.”  The IRS further replied that the allowable standards “are not based on the official poverty level or the average expenditures of poor households.  They are based on average expenditures for all income groups combined,” and that 10 years ago the IRS removed income based ranges at the suggestion of the NTA.

The NTA responds that the IRS is using data that measures expenditures and not what it actually costs to live.  The debate in which the NTA seeks to engage the IRS is an important debate.  Since moving to Boston, I find myself in a very high cost of housing area.  I have clients making $40,000 who are essentially homeless and couch-surfing to find a roof over their head.  Boston is not the only place where housing located near reasonable public transportation options forces residents to make tough choices.  Those choices can include many alternate living situations in order to make ends meet.  Do we want the standards to reflect what people spend when their ability to spend is limited by available funds or do we want the standards to reflect what they should be allowed to spend in order to live with what we as a society see as basic necessities?

The IRS is probably right that the survey data out there does not do a good job of capturing what should be allowed because there are so many ways to make ends meet.  Someone with access to housing in Boston because of family and friends will have a much easier time making ends meet than someone trying to find housing without those connections.  Housing is not the only area where these cost issues exist.  I applaud the NTA for seeking to engage in the discussion.  I do not expect the answers to come easily.  Should my very frugal clients who somehow make ends meet by cutting back on what many would consider to be life’s essentials be required to pay more than my more extravagant clients?  This is a question that comes up repeatedly.  I know of no easy answers but I hope we keep asking the questions.

Subject Areas / Tax Topics
Copy RID