Usually, the largest single expense a taxpayer or family incurs on a monthly basis is their housing expense. That encompasses for renters:
- monthly rent or lease payment
- monthly utility costs (e.g., electricity, gas, water, waste disposal)
- monthly average of other rental expenses, such as renter’s insurance, telephone service (landline and cell), internet and television services.
For taxpayers who own their home, the housing expense would be the total of the following:
- monthly mortgage payment(s)
- monthly average of utility costs
- monthly average of the property taxes (annual tax divided by 12)
- monthly average of homeowner’s insurance (annual divided by 12)
- monthly average of repairs and any other housing expenses (see examples above)
The total house expense calculated above is then compared with the housing expense standard for (a) the county in which the property is located, and (b) the number of persons living in the household.
Besides a spouse, the only other individuals that are considered by the IRS as family members for the purpose of this table are those who qualified for a dependency exemption on the taxpayer’s most recently filed tax return. Of course, if a new dependent exists for the current year (as an example – the taxpayers have a new baby born in the current year), the taxpayers should be allowed that additional family member for the purpose of calculating the maximum allowable housing expense amount.
To illustrate, assume our taxpayers (husband and wife, and their three school-age children) live in Burbank, CA, in an apartment. Their monthly rent, including utilities, renter’s insurance, telephones (landline and cells), cable TV and internet is $3,000 a month. Burbank is in Los Angeles County. So, we go to the table for CALIFORNIA, then find LOS ANGELES COUNTY. We go over to the column for 5 family members, and the allowable amount is $3,009. Since their total housing cost ($3,000) is less than the standard amount ($3,009), they will be allowed the entire $3,000 as a qualified housing expense in determining their net disposable income. They will need to provide a copy of their lease or rental agreement, evidence of the rent payments (usually the IRS wants the last three months), and copies of their utility and other bills to prove their average utilities and other listed expenses.
Let us change this example and instead consider the same couple, but this time with only one (1) child instead of three. The standard for Los Angeles County for a family of 3 is $2,656. That is LESS than the $3,000 the taxpayers are currently paying. The IRS will compute net disposable income using $2,656 since it is LESS than their actual expense.
What will this affect? If the taxpayers opt to continue living in their present housing, they are going to be really stretched thin because of the excess amount they have to spend for housing over what was allowed. What options do they have?
- They can do nothing and stay in this apartment in Burbank, CA and figure out how to cut somewhere else to be able to make the required IRS monthly installment payment and still be able to pay for their existing housing
- They can ask for a short (certainly 90 days is reasonable) period for making a transition to less costly housing in Burbank or some other city. In this circumstance, the IRS will generally calculate the monthly payment for the first three months using the taxpayers’ current housing expense, and then the monthly payment would adjust upward in month four by the difference between the standard and current housing expense.
- The taxpayers can look for additional sources of income to enable them to stay in their current housing. However, unless the installment agreement was a full-pay agreement, it will be reviewed usually every two years. At the time of the next review, if the taxpayers still have the increased income, the monthly payment would be adjusted upward and they will find themselves back into the same problem.
Shared living scenario with only one of the taxpayers having a tax liability
There is a unique problem when you have a situation where more than one person lives in the housing unit, but only one has the tax liability. This is actually quite common – and that is why I am addressing it here.
Consider a couple – a man and his girlfriend in this example – living together in a rented apartment. Only the man has a liability, and he is seeking an installment agreement. What will the IRS allow for the housing expense since part of it certainly pertains to the non-liable taxpayer (his girl friend)?
The IRS will typically calculate all of the costs for the housing as described above. Then, they will compare the total income of all members of the household (yes – the girl friend will have to cooperate and provide her monthly income even though she is not liable for the tax). In our example, the man averages $4000 a month, and his girl friend makes $2000 a month. Of the total household income. the man earns 2/3 and the girl friend 1/3. If the total housing expense is $3000 a month, then the IRS will allocate $2,000 (2/3 ) to the man. That amount is compared to the standard for one person (we assume the girl friend does NOT qualify as a dependent). The man will be allowed the lesser of the 2/3 of his allocated share of expense or the standard for one person. If this apartment were in Burbank CA, the standard for one person in Los Angeles County would be $2,146. So, in this example, he would be allowed the full $2,000 allocated to him.
This blog is not the forum for me to discuss all of the atypical scenarios that can arise in the calculation of the allowable housing expense for purpose of an installment agreement or offer in compromise. This determination is made on a case-by-case basis. It can get more complicated. Just as an example, if the taxpayer has an office in the home out of which he runs his business, then part of the residence is actually a business asset – nor residential. So, we now get into doing a further allocation to remove the business portion out of this computation. This is fun stuff (not!).
For many taxpayers seeking installment agreements, offers in compromise, or even a CNC determination, having professional representation can make a significant difference in the outcome as taxpayers generally would be unfamiliar with all of the nuances (and opportunities for a more favorable outcome) involved in this whole process.
Hopefully, you now have a better understanding of just how the housing expense table gets applied, and what happens when housing is shared and the other party is not liable for the tax debt.