How the IRS views your cost of living

In general, the IRS appears to take a cynical view at people’s cost of living, and can be fairly judgmental about how we spend our money. This cynicism obviously increases dramatically the moment you have an outstanding tax debt.

Before delving into specifics, I’d like to make two points regarding the IRS personnel you’d normally be discussing your personal finances with. First, IRS field personnel such as Revenue Officers and Settlement (Appeals) Officers typically have higher salaries than the IRS National Standards for the areas in which they are assigned. In other words, even as public servants, they make more money than their own standards set for a middle class lifestyle.

Second, keep in mind that these people are public servants. In fact, most senior IRS personnel are lifetime bureaucrats, meaning that they have never had to work in the private sector. Some senior Revenue Officers, Revenue Agents (Auditors), and Settlement Officers have actually never worked a day in their lives outside of the government, and don’t even have finance or accounting backgrounds.

Combining these two things, you can see that it’s very possible that the IRS person you are explaining your finances to has an interesting view on the world: They’ve always made an above average salary, and lack any personal experience running a business or dealing with the reality of private sector employment. This skewed perspective becomes readily apparent in talking to senior IRS personnel if you’re a middle class taxpayer or “mom and pop” small business owner.

Now, with that said, let’s talk about the IRS National Standards. The government uses national and local cost of living data to establish norms for the cost of living across various categories. Some cost of living standards are the same for everybody, while others, such as housing and transportation, are adjusted by region.

These standards are based entirely on the government’s definition of a middle class existence. In other words, for purposes of determining how much of your income the IRS expects you to fork over in monthly payments on a tax debt, they only allow you to claim a middle class lifestyle.

It is not uncommon for me to have a conversation with a client where I’m explaining this, and they get frustrated. When you’re in IRS collections, they don’t like seeing that you’re making $1500 per month car payments on a Hummer and a Corvette, or have two people living in a 4200 square foot home. If you are used to a certain lifestyle, you may not quite understand why these things would piss off the government when you owe back taxes.

The main thing to remember is that the IRS National Standards are calculated from a middle class lifestyle standard. While you may consider yourself middle class, statistically you may in fact be upper-middle or even upper class. Keep in mind that the median household income in the US is about $52,000 per year. This means half of households make more, half of households make less. This number, by definition, represents middle class America, and is what the IRS National Standards are based on.

If you owe the IRS a substantial amount of money, and are living above the IRS National Standards, it is possible to negotiate up to a 12-month “stay of execution” against you with IRS Collections. This time period is designed to allow you to reduce your lifestyle to a middle class existence. This would include downsizing to a smaller home, selling cars, boats, and recreational vehicles, etc.

It wasn’t until March 2012 that the IRS finally allowed taxpayers to claim their minimum credit card and student loan payments as allowable expenses. At the same time, the IRS made a major change in how an Offer in Compromise is calculated, drastically reducing the amount they expect you to fork over in a reduced settlement situation. These changes have made literally hundreds of thousands of tax debtors now eligible for the OIC program that previously were not, so it’s worth looking into.

When it comes to discussing your standard of living and associated expenses with an IRS field agent, understand that you are both going to be frustrated, and for very different reasons. If you live a higher than middle class lifestyle, I would definitely suggest having a representative work on your behalf with the IRS, not only to avoid you frustration with these types of conversations, but also because a representative is going to be more knowledgeable regarding what expenses can be negotiated for inclusion with the IRS.