Handbook 5.15
Financial Analysis Handbook - (prior version)


Chapter 1
Analyzing Financial Information

Contents

• [5.15] 1.1 Overview

• [5.15] 1.2 Analyzing and Verifying Financial Information
  • [5.15] 1.2.1 Sources of Information
  • [5.15] 1.2.2 Determining Maximum Collectibility
  • [5.15] 1.2.3 Analysis, Substantiation, and Verification of Income and Expenses

• [5.15] 1.3 Definitions
  • [5.15] 1.3.1 Allowable Expenses
  • [5.15] 1.3.2 Necessary Expenses
    • [5.15] 1.3.2.1 Necessary Expenses: National Standards
    • [5.15] 1.3.2.2 Necessary Expenses: Local Standards
    • [5.15] 1.3.2.3 Necessary Expenses: Other
    • [5.15] 1.3.2.4 Necessary Expenses: Other -- Unsecured Debts
  • [5.15] 1.3.3 Conditional Expenses
    • [5.15] 1.3.3.1 Conditional Expenses: Five-Year Rule for Full Payment
    • [5.15] 1.3.3.2 Conditional Expenses: Unsecured Debts
    • [5.15] 1.3.3.3 One-Year Rule for Eliminating Excessive Necessary and Not-Allowable Conditional Expenses

• [5.15] 1.4 Making The Collection Decision
  • [5.15] 1.4.1 Installment Agreement
  • [5.15] 1.4.2 Enforced Collection
  • [5.15] 1.4.3 Offer-in-Compromise
  • [5.15] 1.4.4 Currently Not Collectible
  • Exhibit [5.15] 1-1 Using the Tiered Interview With Allowable Expenses
  • Exhibit [5.15] 1-2 Financial Analysis -- Expenses (Reference: Section 5.15.1.3)
  • Exhibit [5.15] 1-3 Questions and Answers to Assist in Financial Analysis (Reference: Section 5.15.1.3)
  • Exhibit [5.15] 1-4 Financial Analysis: Total Monthly National Standards -- Except Alaska and Hawaii; Reference 5.15.1.1(6) (Effective 10-01-1999)
  • Exhibit [5.15] 1-5 Financial Analysis: Monthly National Standards -- Itemized -- Except Alaska and Hawaii (Effective 10-01-1999) Reference 5.15.1.1(6)
  • Exhibit [5.15] 1-6 Financial Analysis: Total Monthly National Standards for Alaska (Effective 10-01-1999) Reference 5.15.1.1(6)
  • Exhibit [5.15] 1-7 Financial Analysis: Monthly National Standards for Alaska -- Itemized (Effective 10-01-1999) Reference 5.15.1.1(6)
  • Exhibit [5.15] 1-8 Financial Analysis: Total Monthly National Standards for Hawaii (Effective 10-01-1999) Reference 5.15.1.1(6)
  • Exhibit [5.15] 1-9 Financial Analysis: Monthly National Standards for Hawaii -- Itemized (Effective 10-01-1999) Reference 5.15.1.1(6)
  • Exhibit [5.15] 1-10 Financial Analysis -- Local Standards: Housing and Utilities (Effective 10-01-2000) Reference 5.15.1.1(6)
  • Exhibit [5.15] 1-11 Financial Analysis -- Local Standards: Transportation *
    (Effective 10-01-2000) Reference 5.15.1.1(6)

[5.15] 1.1  (11-15-2000)
Overview

1. An interest based interview (IRM 5.14.1.4) should be conducted in order to determine the appropriate form of case resolution.
2. If the taxpayer states he or she cannot fully pay the liability, the following case decisions should be considered:
   • Allow an extension of time to full pay (IRM 5.14.2.4)
   • Grant a guaranteed or streamlined installment agreement (IRM 5.14.2.2 and IRM 5.14.2.3) if the taxpayer qualifies for these options
   • Explore possibilities of deferring other debts, or borrowing on or selling assets to pay in a short time
3. If the taxpayer is unable to meet any of the conditions in (2) above, financial analysis is necessary. Financial information may be secured on:
   • The ACS financial information screen (FIN)
   • Form 433-A, Collection Information Statement for Individuals
   • Form 433-B, Collection Information Statement for Businesses
   • Form 433-F, Collection Information Statement (CIS) (can substitute for Form 433-A for individuals owing less than $100,000)
   • The taxpayer's own financial statement
4. Analysis of a taxpayer's financial condition provides you with a basis to make one or more of the following case decisions:
   1. Make an installment agreement
   2. File a Notice of Federal Tax Lien.
   3. Explain an offer in compromise.
   4. Report the account currently not collectible.
   5. Recommend or initiate enforcement action if assets are available to pay taxes and a taxpayer is unwilling to convert the assets to cash, and no reasonable alternative for collection exists (see IRM 5.10.1.3.2 for information on conducting a risk analysis
5. Installment payments may be used for collection of the tax. Such payments are based on the taxpayer's ability to pay, which is determined by the excess of monthly income over allowable expenses. This chapter will assist you in determining the amount of allowable expenses.
6. See the following exhibits:
   • Exhibit 1-2, Financial Analysis -- Expenses. An alphabetic listing and discussion of major expenses
   • Exhibit 1-3, Questions and Answers to Assist in Financial Analysis
   • Exhibit 1-4, Collection Financial Analysis: Total Monthly National Standards
   • Exhibit 1-5, Collection Financial Analysis: Monthly National Standards -- Itemized
   • Exhibit 1-6, Collection Financial Analysis: Total Monthly National Standards for Alaska
   • Exhibit 1-7, Collection Financial Analysis: Monthly National Standards for Alaska -- Itemized
   • Exhibit 1-8, Collection Financial Analysis: Total Monthly National Standards for Hawaii
   • Exhibit 1-9, Collection Financial Analysis: Monthly National Standards for Hawaii -- Itemized
   • Exhibit 1-10, Collection Financial Analysis: Local Standards: Housing and Utilities
   • Exhibit 1-11, Collection Financial Analysis: Local Standards: Transportation

[5.15] 1.2  (11-15-2000)
Analyzing and Verifying Financial Information

1. Analyze the income and expenses to determine the amount of disposable income (gross income less allowable expenses) available to apply to the tax liability.

[5.15] 1.2.1  (11-15-2000)
Sources of Information

1. The following sources may be used to secure finacial information:
   • Information received from the taxpayer.
   • Corporate Files On-Line (CFOL) command codes (IRPTR or RTVUE).
2. When analyzing a taxpayer's financial situation, compare information on the FIN screen or CIS with CFOL commands or other sources.
   1. If there are significant discrepancies, discuss them with the taxpayer. If substantiation is needed, ask the taxpayer to provide it.
   2. Note discrepancies and their resolution in Comments or history and make necessary corrections to the FIN screen or CIS.

[5.15] 1.2.2  (11-15-2000)
Determining Maximum Collectibility

1. Analyze income and assets to determine ways of resolving the account. Follow the steps in 5.15.1.1 in order to determine the most appropriate course of action.

[5.15] 1.2.3  (11-15-2000)
Analysis, Substantiation, and Verification of Income and Expenses

1. Expenses must be reasonable for the size of the family, the geographic location, and any unique individual circumstances. You may allow more than a reasonable amount for an expense if the tax liability including projected accruals can be fully paid within five years. See Section 5.15.1.3.3.1.
2. A taxpayer is not required to substantiate expenses which are categorized as National Standards unless they exceed the standards.
3. A taxpayer may be required to substantiate expenses which are categorized as Local Standards or Other Necessary Expenses.
4. Substantiation of expense amounts could include items like bank statements, credit card vouchers, rent/lease receipts and leases, payment coupons, court orders, contracts, and canceled checks. Taxpayers who own homes should provide documents showing the monthly payment amount, purchase price, date of purchase, and the principal amount due. When obtaining documents for substantiation, ask the taxpayer for copies, not original documents. If necessary, secure telephone numbers and contact names of creditors. These can be used if verification is necessary.
5. When analyzing expenses for a business taxpayer, make sure that business expenses are not also included under personal expenses. Also, depreciation is not a cash expense for determining disposable income.
6. Compare income to expenses. If expenses exceed income, ask the taxpayer for an explanation. Look at the last filed return using CFOL cc RTVUE to see if an understatement of income is also present there. If so, consider referral to Examination.
7. For installment agreement or currently not collectible dispositions, consider future expenses; for example, the birth of a child or need to replace a car.

[5.15] 1.3  (11-15-2000)
Definitions

1. Allowable expenses . There are two types: necessary and conditional.
2. Necessary expenses . These must meet the necessary expense test: they must provide for a taxpayer's and his or her family's health and welfare and/or the production of income. The expenses must be reasonable. The total necessary expenses establish the minimum a taxpayer and family need to live. Three types of necessary expenses are:
   1. National Standards. These establish standards for reasonable amounts for five necessary expenses. Four of them come from the Bureau of Labor Statistics (BLS) Consumer Expenditure Survey: food, housekeeping supplies, apparel and services, and personal care products and services. The Service has established standards for the fifth category, Miscellaneous.
   2. Local Standards. These establish standards for two necessary expenses: housing and transportation. Utilities are included in housing.
   3. Other. Other expenses may be allowed if they meet the necessary expense test and they must be reasonable in amount. Since there are no nationally or locally established standards for determining reasonable amounts, you must determine whether the expense is necessary and the amount is reasonable.
3. Conditional Expenses. These expenses do not meet the necessary expense test. However, they are allowable if the tax liability, including projected accruals, can be fully paid within five years.
4. Five-year rule. Excessive necessary and conditional expenses may be allowed if the tax liability including projected accruals will be fully paid within five years. Use IDRS cc ICOMP to calculate accruals.
5. One-year rule. A taxpayer may have up to one year to modify or eliminate excessive necessary or not-allowable conditional expenses if the tax liability including projected accruals cannot be fully paid within five years.
6. Reasonable amount. For specified expenses, the reasonable amounts are provided by the National and Local Standards. For other expenses you must determine if the amount claimed is reasonable. If the tax liability including accruals can be fully paid within five years, allow the taxpayer's claimed expenses.
7. Disposable income. This is the amount of income that remains after allowable expenses are deducted from gross income, including deductions required by law to be withheld, or any child support or alimony payments that are made under a court order or legally enforceable written agreement. Amounts required by law to be withheld include, but are not limited to, Federal and State taxes, FICA contributions, Medicare contributions, and wage garnishment payments. Disposable income is the amount available to apply to the tax liability.
8. Substantiation and verification. A taxpayer substantiates by providing proof of expenses. The Service verifies by checking on information provided by the taxpayer and by obtaining information from internal and external sources.
   1. Substantiation. A taxpayer is required to provide evidence and justification for claimed expenses, except National Standards. See LEM 5.3.1.
   2. Verification. In some cases, it may be necessary to obtain additional information about a taxpayer's financial condition using third party data.

[5.15] 1.3.1  (11-15-2000)
Allowable Expenses

1. Allowable expenses include:
   1. Necessary expenses -- if reasonable are always allowed. A case would be closed as currently not collectible if there is no disposable income beyond necessary expenses.
   2. Conditional expenses -- are allowable if a tax liability can be fully paid within five years through an installment agreement.
2. A list of typical necessary and conditional expenses appears in Exhibit 5.15.1-2. This exhibit includes discussions of expense types and conditions which determine whether an expense is allowable.
3. In discussing expenses with taxpayers, emphasize how much we expect from them rather than how we expect them to spend their money. For example, if the taxpayer has excessive necessary or not-allowable conditional expenses:
   1. Do not tell the taxpayer that he or she cannot own, for example, a boat or summer cabin.
   2. Tell the taxpayer that we expect an amount equal to that going to excessive necessary or not-allowable conditional expenses.
   3. Tell the taxpayer that he or she is responsible for determining what modifications or eliminations must be made to expenses to pay the tax.

[5.15] 1.3.2  (11-15-2000)
Necessary Expenses

1. Necessary expenses are those used for taxpayers and their families for:
   1. Their health and welfare.
   2. The production of income.
2. Unless the Service receives full payment within five years (see Section 5.15.1.3.3.1), necessary expenses must be reasonable. The total necessary expenses establish the minimum a taxpayer and family need to live.
3. Accounts closed as currently not collectible, offer in compromise, and as installment agreements requiring more than five years will be allowed only necessary expenses. For installment agreements which require more than five years, you may grant up to a year to eliminate excessive necessary and not allowable conditional expenses.

[5.15] 1.3.2.1  (11-15-2000)
Necessary Expenses: National Standards

1. A number of necessary expenses are categorized as National Standards. They are: housekeeping supplies, apparel and services, personal care products and services, food, and miscellaneous.
   1. Except for "miscellaneous," the National Standards are derived from Tables 1, 3, 4, and 5 of the Bureau of Labor Statistics (BLS) Consumer Expenditure Survey. These expenses are stratified by income level; as income levels increase, the percentage of income provided for these expenses decreases. They will be updated yearly as the information becomes available through BLS. The miscellaneous expense is a discretionary amount established by the Service. It is $100 for one person and $25 for each additional person in a taxpayer's household.
   2. The total monthly National Standards appear in Exhibit 5.15.1-4. This exhibit provides the total amount allowed a taxpayer, by gross income level and by number of persons in the household.
   3. The monthly National Standards, by type of expense and by totals, appear in Exhibit 5.15.1-5.
   4. The total monthly National Standards for Alaska appear in Exhibit 5.15.1-6.
   5. The monthly National Standards for Alaska appear in Exhibit 5.15.1-7.
   6. The total monthly National Standards for Hawaii appear in Exhibit 5.15.1-8.
   7. The monthly National Standards for Hawaii appear in Exhibit 5.15.1-9.
2. National Standards eliminate the need to require justification or substantiation for a number of recurring expenses.
   1. Allow taxpayers the total National Standards amount for their income level. Taxpayers making more than the highest income level shown in the National Standards will be limited to the maximum amount allowed by the National Standards unless they can substantiate and justify a larger amount.
   2. How the amount allowed for National Standards is spent is up to taxpayers. For example, they may spend less for clothing and more for entertainment (including cable T\/V); or they may decide to apply part of the amount to conditional unsecured debts.
   3. A taxpayer who claims more than the total allowed by the National Standards must substantiate and justify as necessary each separate expense of the total.

   EXAMPLE:

   A taxpayer may claim much more for food than allowed if based on special prescribed or required dietary needs.

3. If a taxpayer can fully pay the tax liability including projected accruals within five years, he or she may be allowed more than the National Standards amount.

[5.15] 1.3.2.2  (11-15-2000)
Necessary Expenses: Local Standards

1. For some kinds of expenses, the National Standards are not feasible: for example, housing, utilities, and transportation (including car insurance and public transportation).
2. Local standards for housing and transportation have been developed. Utilities, including telephone, are covered under housing. Taxpayers will be allowed the local standard or the amount actually paid, whichever is less. See Exhibits 5.15.1-10 and 5.15.1-11.
   1. Housing. The housing standard provides the basis for determining whether a taxpayer will be required to pay the Service an amount equal to excessive or not-allowable housing expenses. Standards are established for each county within the district. When deciding whether a taxpayer should be required to pay the Service an amount equal to excessive or not-allowable housing expense, consider the cost of moving to a new residence, the increased cost of transportation to work and school which would result from moving to lower-cost housing, and the tax consequences of the loss of the interest deduction.
   2. Transportation. The transportation standard provides the basis for determining if the taxpayer will be required to pay the Service an amount equal to excessive or not-allowable transportation expenses. (1) As part of the standard, amounts are allowed for car purchase and lease, establishing different rates for a first car and, if allowed, a second or more cars. (2) Consider availability of public transportation if car payments (purchase or lease) will prevent the tax liability being paid in part or in full. Public transportation could be an option if it doesn't significantly increase commuting time and inconvenience the taxpayer.

[5.15] 1.3.2.3  (11-15-2000)
Necessary Expenses: Other

1. Depending upon individual circumstances, other expenses may meet the necessary expense test: they must provide for the health and welfare of the taxpayer and/or his or her family, or they must be for the production of income.
2. A taxpayer must substantiate the amounts and justify the expenses as necessary, unless the tax liability will be fully paid, including projected accruals, within five years. Other expenses which may meet the necessary expense test include, but are not limited to:
   1. Child care.
   2. Dependent care: elderly, invalid, or disabled.
   3. Taxes.
   4. Health care.
   5. Court-ordered payments.
   6. Involuntary deductions.
   7. Secured or legally perfected debts (minimum payments).
   8. Life insurance.
   9. Disability insurance for self-employed individual.
   10. Union dues.
   11. Professional association dues.
   12. Accounting and legal fees for representing a taxpayer before the Service, and other fees which meet the necessary expense test.
   13. Optional telephone service (call waiting, call identification, etc.), or long distance calls, if they meet the necessary expense test.
3. Charitable contributions. To be necessary, charitable contributions have to provide for a taxpayer's or his or her family's health and welfare or be a condition of employment. Otherwise, they are conditional and allowable only if the tax liability, including projected accruals, can be paid within five years.
4. Education. To be a necessary expense, a taxpayer must demonstrate that the expense is for a physically or mentally handicapped dependent and the education is not provided by public schools; or the expense must be a condition of employment.
5. The expenses listed in 5.15.1.3.2. do not exhaust the category of necessary expenses. Other expenses may be considered if they meet the necessary expense test; health and welfare and/or the production of income.
6. If other expenses are determined to be necessary and, therefore, allowable, document the reasons for the decision in the ACS Comments or case history.

[5.15] 1.3.2.4  (11-15-2000)
Necessary Expenses: Other -- Unsecured Debts

1. Payments on unsecured debts may also be necessary. Allow minimum payments if a taxpayer substantiates and justifies the expense as necessary for either the health and welfare of the taxpayer and/or his or her family or for the production of income. Unsecured debts are rarely necessary expenses. Examples of unsecured debts which may be necessary expenses include:
   1. Payments required for the production of income; for example, payments to suppliers and payments on lines of credit needed for business;
   2. Payment of debts incurred, except to friends and relatives, to pay a federal tax liability.
2. Except for payments required for production of income, don't allow payments on unsecured debts if the tax can be paid in full within 90 days.

[5.15] 1.3.3  (11-15-2000)
Conditional Expenses

1. Conditional expenses are those that may be allowed if certain requirements are met.

[5.15] 1.3.3.1  (11-15-2000)
Conditional Expenses: Five-Year Rule for Full Payment

1. If taxpayers establish they can stay current in all tax requirements and that the tax liability including projected accruals can be paid within five years, all expenses may be allowed, if amounts are reasonable.
2. Although five years are allowed, base agreements on the taxpayer's actual ability to pay. Don't automatically allow agreements for the five-year maximum if the excess of income less expenses would allow them to pay in a shorter period of time. See IRM 5.14. for Installment Agreement procedures.
3. Taxpayers may have incurred excessive necessary and not-allowable conditional expenses after the assessment of the tax liability. These expenses are not covered by the five-year rule. If you feel the taxpayer has incurred them to reduce the ability to pay, enforcement against the post-assessment assets or not allowing the expenses in an installment agreement may be appropriate.
4. In unusual circumstances, it may be appropriate to allow conditional expenses even if the liability, including projected accruals, cannot be paid within five years. The basis for the exception must be fully explained in the case history, and expenses must be substantiated.

[5.15] 1.3.3.2  (11-15-2000)
Conditional Expenses: Unsecured Debts

1. Don't allow payments on unsecured debt, including credit or charge cards, if omitting them would permit a taxpayer to pay in full within 90 days.
2. Allow payments if the tax including projected accruals will be paid within five years. Note dates for final payments of the unsecured debts so additional funds can be applied to the tax. Include the increase in payments in installment agreements.
3. If the tax can not be paid within five years, tell the taxpayer that unsecured debts which are conditional expenses are not allowed, and he/she must pay an amount equal to the expense.

[5.15] 1.3.3.3  (11-15-2000)
One-Year Rule for Eliminating Excessive Necessary and Not-Allowable Conditional Expenses

1. Taxpayers who cannot full pay their accounts within five years may be given up to one year to modify or eliminate excessive necessary and/or not-allowable conditional expenses. By modifying or eliminating some conditional expenses, the taxpayer may be able to full pay the liability within the five-year limit. This would enable the taxpayer to retain some conditional expenses.
2. For the first year or part of the year, make an installment agreement for an amount, even if minimal, which can be paid until the date the excessive or not allowable expenses are to be modified or eliminated. See 5.14 for installment agreement instructions.
3. An installment agreement must include a payment increase at the date the taxpayer is expected to have modified or eliminated excessive necessary or not-allowable conditional expenses. Taxpayers are responsible for determining how best to adjust or eliminate expenses.
4. If a taxpayer proposes an installment agreement that does not meet these terms, the case must be referred to the Independent Reviewer. See IRM 5.14 for these procedures.
5. Excessive necessary expenses include, but are not limited to:
   1. Transportation. Car payments (purchase or lease) for luxury cars or for cars which do not meet the necessary expense test .
   2. Education. The taxpayer may be paying for a child's private school or university education. Tell the taxpayer that, unless it is determined to be a necessary expense, it will not be allowed beginning with the following school year, and we will expect an amount equal to the tuition. Taxpayers are responsible for deciding how to adjust or eliminate expenses.
   3. Housing. Taxpayers may be paying more than is warranted by their income level or may be paying more than is necessary for similar housing. Before determining if housing expenses are excessive, consider what is involved: leases, saving money for moving, loss of the interest deduction, and selling a house.
6. If at the end of the first year, or other determined period of time up to one year, the taxpayer has not modified or eliminated excessive necessary and/or not allowable conditional expenses, grant additional time to do so only in unusual circumstances. Document the basis for the exception.

[5.15] 1.4  (11-15-2000)
Making The Collection Decision

1. After the income and expense analysis has been completed, a collection decision can be made on the account.
2. Some of the alternative collection decisions include:
   • Installment Agreement
   • Enforced Collection
   • Offer-in-Compromise
   • Currently Not Collectible

[5.15] 1.4.1  (11-15-2000)
Installment Agreement

1. In some cases, payments on expense items are not due in regular monthly increments; for example, car insurance may be paid twice a year. Average expense items with varying monthly payments over twelve months unless the variation is excessive.
   1. In such instances, tell taxpayers they are responsible for putting enough money aside to ensure that tax payments are made during months that large payments on other liabilities must be made.
   2. If the installment agreement is for a year or less, it can be set up to reflect changes in payment. Document the expected increase or decrease in expenses, and adjust the installment payment amount accordingly.
2. In arriving at disposable income, analyze the taxpayer's payroll deductions to ensure they are reasonable and allowable. The only automatically allowable deductions from gross pay or income are federal, state, and local taxes (including FICA and Medicare).
3. Use locator number XX12 to establish installment agreements on cases involving non-allowable expenses which will be eliminated by the taxpayer, permitting an increase in payment. See IRM 5.14.
4. If an installment agreement is granted to a taxpayer who has defaulted on a past agreement, document in Comments or the case file the reason for granting another agreement.
5. If a taxpayer wishes to make payments but financial analysis shows that he or she lacks the resources to do so, the procedures in IRM 5.14.1.8(5) should be followed.

[5.15] 1.4.2  (11-15-2000)
Enforced Collection

1. After taxpayers have been given the opportunity to resolve their accounts and failed to do so, consider enforcing collection.
2. See Chapter 6 of IRM 5.14 for the procedures to follow for Independent Review prior to enforcing Collection if you are proposing the rejection of an installment agreement.

[5.15] 1.4.3  (11-15-2000)
Offer-in-Compromise

1. Consider advising the taxpayer to submit an offer in compromise if payment by installments will not satisfy the tax liability within the life of the CSED plus an allowable extension. See IRM 5.8.

[5.15] 1.4.4  (11-15-2000)
Currently Not Collectible

1. When financial analysis indicates no means of payment, see IRM 5.16, Currently Not Collectible (CNC) Handbook.
2. Don't report cases CNC when the taxpayer is allowed time to modify expenses.
3. Don't allow conditional expenses if a case is closed as CNC.