In this and next week’s blog, I will discuss my recent Most Serious Problem on Installment Agreements (IAs) and the corresponding Research Study that was published in my 2016 Annual Report to Congress. Today I will focus my concerns on IAs and discuss the results of the study; in next week’s posting, I’ll review the recommendations my office made to address the problems identified in the study and the IRS’s response to our recommendations.
Most taxpayers want to comply with the tax code and voluntarily pay their taxes. The IRS collects 98 percent of taxes from timely and voluntary tax payments and only two percent through enforced collection. However, there are times when taxpayers find themselves unable to pay their taxes. I recently blogged about Allowable Living Expenses (ALEs) – it’s difficult to talk about IAs without also talking about ALEs, as you will read with my concerns about IAs – and a court case (Leago v. Commissioner) where the taxpayer was behind on his taxes and needed life-saving brain surgery. The IRS did not want to allow the expense because the taxpayer was not currently paying for the surgery. Here is a situation – a choice between life (or at the very least, a life without serious disability) and paying taxes – that a taxpayer should never face.
When a taxpayer cannot timely and fully pay their taxes, several options exist to assist the taxpayer. Among possible collection alternatives are offers in compromise (OICs), IAs, or placing a taxpayer in currently not collectible status (CNC). Collection alternatives should be designed to set a taxpayer up for success in meeting tax obligations. When a taxpayer is placed in a collection alternative that is inappropriate for the taxpayer’s individual facts and circumstances, the IRS violates taxpayer rights, and wastes its resources as a result of associated rework.
As noted earlier, ALEs and IAs go hand in hand. ALEs are used to calculate a taxpayer’s ability to make IA payments. However, as discussed in my recent blog on ALEs, I have many concerns about ALEs and I do not think they adequately capture all necessary expenses. Further, and borne out by the data uncovered by my research staff, taxpayers are routinely entering into and making payments on IAs despite having monthly income lower than their ALEs.
Taxpayers enter into more than 3,000,000 IAs per year, making IAs the most common collection alternative for taxpayers who find themselves unable to meet their full tax obligation. Offering IAs that are affordable is necessary for promoting future compliance. Offering IAs that disregard the taxpayer’s ability to pay and meet his or her basic living expenses would set up such IA for failure, jeopardize the taxpayer’s Right to Privacy and his or her Right to a Fair and Just Tax System, in addition to creating compliance rework for the IRS.
For the study, TAS looked at the more than 3.4 million taxpayers who entered IAs in calendar year (CY) 2014. TAS selected CY 2014 to be able to see the picture of the future compliance behavior of these taxpayers. The study focused on the following questions:
TAS used information already available to the IRS, through its own databases, to answer the study questions. For the first question, through IRS databases we could identify taxpayers who entered into IAs in CY 2014, the taxpayers’ total income from their 2014 tax returns, and the ALEs permitted by the IRS for that period.
While answering the questions above, our research revealed much information about taxpayers who enter IAs. One of the most concerning results focused on taxpayers entering IAs that they cannot afford, by the IRS’s own formula. I previously discussed ALEs in another blog. The IRS uses ALEs to determine how much a taxpayer can pay to the IRS via an IA after meeting their basic living needs. However the most frequently used form of installment agreements is the “streamlined” installment agreement. In Fiscal Year (FY) 2014, 2,857,043 out of 3,011,636 IAs (94.9 percent) were streamlined IAs; for FY 2016, 84.4 percent of the 3,115,404 IAs the IRS entered into were streamlined. With streamlined IAs, there is no financial analysis and no application of the ALEs. The IRS simply divides the balance due by 72 or even 84 months. The resulting required monthly payment bears no relationship to what the taxpayer can actually afford to pay.
The IRS likes streamlined IAs because they are easier to implement than a financial analysis and application of the ALEs to the taxpayer. Moreover, because no complicated financial analysis is required, lower graded Customer Service Representatives (CSRs), who have limited training on financial statements, are able to place taxpayers into streamlined IAs, “saving” the IRS resources. In FY 2016, nearly one-third of all streamlined IAs were entered into by Toll-free CSRs. Taxpayers also like streamlined IAs because they are quick to enter into. But the long-term effects of taxpayers agreeing to streamline IAs are very disturbing.
TAS research found that almost 40 percent of all individual taxpayers who entered IAs in 2014 had income levels below their ALEs. For taxpayers, this means they could not meet their basic living expenses as determined by the IRS before paying the IRS, yet these taxpayers still entered IAs.
Further, TAS research discovered that not only are these taxpayers entering IAs they cannot afford; they are making payments on their IAs. Over 400,000 taxpayer accounts identified in the study would qualify for CNC status, meaning these taxpayers have income and assets that do not allow them to make payments to the IRS at this time without creating economic hardship for the taxpayers. Yet, of these accounts, 69 percent were resolved by the taxpayers actively making payments, not through passive collection such as refund offsets. What basic living expenses (utilities, food, and a place to live) are these taxpayers foregoing to pay the IRS?
To answer the second study question, TAS research compared two taxpayer populations: those whose IA was established concurrently with a TAS IA case closed in CY 2010 (TAS customers) and those who entered into an IA in CY 2010 without TAS involvement (non-TAS taxpayers). To eliminate factors that may have led to selection bias in the taxpayer comparison groups, such as prior compliance history, TAS selected groups of TAS customers and non-TAS taxpayers who were identical in income level, age, prior year compliance, tax balance due, and additional factors.
Our research found that in the first two years after TAS service, TAS customers were less likely to incur subsequent liabilities after their IAs were initiated. In tax year (TY) one after service, TAS customers were more than eight percent less likely to incur a further liability and in TY two TAS customers were nearly seven percent less likely to incur a further balance due. These results are statistically significant. This suggests that TAS service positively influences future compliance for the first two years following that service.
The study also found a difference in compliance with the IAs granted for the TAS customer group versus the non-TAS taxpayer group. We looked at default rates on IAs by year for the TAS customers and the non-TAS taxpayers. TAS customers had lower default rates on their IAs in all years and a statistically lower default rates in the second, third, and fourth years after the IA was established. For instance, TAS customers defaulted at a rate of 5.4 percent less than the non-TAS taxpayer group.
What is the explanation for these results? First, even if a taxpayer qualifies for a streamlined IA, TAS employees are required to review the taxpayer’s financial data to ensure the taxpayer can actually afford the monthly payment per the streamlined IA rules without foregoing basic living expenses (ALEs). Second, TAS advocates educate taxpayers on their responsibilities to continue making IA payments and the responsibility to pay their current tax obligations. Third, our advocates also ensure that wage earners have sufficient withholding and that self-employed taxpayers have income sufficient to maintain their estimated tax payments.
In the study and the associated Most Serious Problem I have made recommendations to the IRS to help reduce the default rates of IAs and ensure that taxpayers are entering IAs that they can afford. In my next blog, I will explore the recommendations and the IRS’s response to my recommendations.
The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.
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