IRS Installment Agreements — Ramifications for the Factor Published October 1, 2009
As the economy worsened over the past two years, the number of businesses and individuals who “borrowed” money from the Internal Revenue Service (IRS) has increased. The IRS estimates that there was $345 billion in unpaid taxes in 2008. As a result, the number of IRS lien filings increased from 683,659 in 2007 to 768,168 in 2008. Therefore, it is likely that Factors will have to deal with many more clients with tax liabilities in the near future. The existence of a tax liability does not mean Factors must stop financing, but it does require that the Factor takes some additional steps to protect their investments and limit their exposure.
When confronted with a tax liability, many business owners ask how they can “settle” their liabilities with the IRS. There is only one program with the IRS that allows a taxpayer to “settle” the liability for less than what is owed – the Offer in Compromise. Generally, this program is not an available option to businesses. In 2008, the IRS accepted only 10,677 Offers (there are more than 2 million balance due accounts). Although businesses can submit requests for Offers in Compromise with the IRS, it is extremely rare for the IRS to accept an In Business Offer. As such, the vast majority of businesses must turn to the Installment Agreement to resolve their liabilities with the IRS. The IRS defines the Installment Agreement as an “arrangement by which the IRS allows taxpayers to pay liabilities over time.”
What many may not realize is that the Installment Agreement can come in many forms. For a Factor it is most important to understand the commonalities in almost every situation. Installment Agreements assist Factors by (1) significantly limiting the IRS’s ability to take enforced collection and (2) acting as a prerequisite to obtaining a Certificate of Subordination of Federal Tax Lien (Subordination). Initially, an Installment Agreement can be particularly helpful to the business taxpayer and the Factor in that it prevents the IRS from taking enforced collection, e.g., levies of accounts receivable. The IRS’s Internal Revenue Manual (IRM) indicates, “If the taxpayer makes an offer to pay a liability through installments, no levies can be served while the proposal is pending.” Additionally, the IRM clarifies that no levy may be served for 30 days after a proposal for an Installment Agreement is rejected, while the rejection is being appealed, while an agreement is in effect and in good standing, for 30 days after an agreement is terminated, and while termination (or proposed termination) of an agreement is being appealed. The IRS cannot levy receivables while a proposal is pending, while the agreement is in good standing, or for a minimum of thirty days after the agreements defaults. During this time, the Factor would be protected and could continue to advance funds on the receivables while finalizing negotiations for a Subordination.
The requirements for a “pending” proposal are relatively simple. The IRM indicates that to qualify for “pending” status, the taxpayer must (1) provide information sufficient to identify the taxpayer, (2) identify the tax liability to be covered by the agreement, (3) propose a monthly or other periodic payment of a specific amount, and (4) be in compliance with filing requirements. To satisfy the fourth requirement, the taxpayer must simply have all of the returns filed in order to achieve pending status. Importantly, there is no requirement to be current and compliant with the federal tax deposits (however, to actually formalize the agreement, the taxpayer must be making federal tax deposits).
The third requirement for a pending proposal – identifying a specific payment amount – may seem simple enough, but can be rather complicated. Many business owners ask, “What do we have to pay each month to make the IRS go away?” There is an assumption that the IRS is looking for an arbitrary (and sometimes substantial) figure. Although the question is certainly understandable given the circumstances, it focuses on the wrong notion entirely. Despite what many people think or may be told, the IRM indicates, “Installment [A]greements must reflect taxpayers’ ability to pay on a monthly basis throughout the duration of agreements.” Therefore, the monthly payment should not be based upon an arbitrary figure (though many are), but upon what the taxpayer can actually afford. Many agreements with the IRS default because businesses were set up for failure – the established monthly payment was too large for the business to remain current and compliant with its federal tax deposits and make the installment payments.
A taxpayer’s ability to pay is based upon its disposable or discretionary income – income minus allowable expenses. These figures are gleaned from two financial statements –Form 433-B, Collection Information Statement for Businesses and Form 433-A, Collection Information Statement for Individuals. Although the liability may have been generated solely by the business, there are potential personal liabilities that can be assessed and the IRS will frequently review personal financial statements as well, which requires the 433-A to be completed in addition to the 433-B. The proposed monthly payment should reflect the disposable income on the 433-B (and/or 433-A as well). If the monthly payment is less than the disposable income on the financial statements, the IRS will most likely reject the proposal on the basis the business can afford a larger payment. If the proposed monthly payment is more than the disposable income, the IRS will likely reject the proposal because it appears the business cannot afford the payment. The 433-B (and 433-A) is a basis for any proposal for an Installment Agreement.
In addition to providing protection to a business taxpayer (as well as the Factor) and a means to repay the liability over time, the Installment Agreement is an essential component to negotiating a Subordination. The Subordination is necessary for the Factor to regain priority over the receivables once the Factor has actual knowledge of the Federal Tax Lien or 45 days after the Federal Tax Lien is filed. In a November 2008 memo, the Director of Collection Policy at the IRS stated, “Since periodic payments are involved, a signed installment agreement…must be secured in conjunction with the subordination and will be subject to the normal termination and default provisions.” Because of the protection afforded by the Installment Agreement and its necessary inclusion as part of the Subordination process, a pending proposal for an Installment Agreement can bridge the gap and allow the Factor to continue funding receivables while the proposal and Subordination are being finalized.
Despite the efficacy of the pending proposal and Installment Agreements in general, there is an important new limitation to the “pending” proposal provisions in the IRM. The IRS recently included a “solely to delay” provision. Essentially, the IRS can deem certain proposals as “solely to delay” the IRS’s ability to collect the taxes. If a proposal is deemed “solely to delay,” the request will not be classified as “pending,” no rejection will be issued, and the IRS can begin or resume enforced collection, e.g., levies of receivables. There are a few specific circumstances when a proposal will be considered “solely to delay,” which includes a request made by a taxpayer that has defaulted prior Installment Agreements.” Therefore, it is imperative that proposals for Installment Agreements reflect the true ability to pay and once an agreement is formalized, everything is done to keep the agreement in good standing. In addition to the issues raised herein, there are several nuances and potential pitfalls to negotiating an Installment Agreement that have not been discussed. The information reviewed in this article provides a basic framework for understanding the most common resolution with the IRS. It is always important to monitor a business taxpayer’s compliance with the IRS. Yet, given the increase in the number of businesses with tax liabilities, the increase in the number of lien filings, the importance of the “pending” class – signification for a proposed Installment Agreement, and the “solely to delay” limitations, monitoring a business taxpayer’s status with IRS is now more important than ever.
Jason S. Peckham, Esq., is vice president of Resolutions for Tax Guard, Inc. Tax Guard monitors federal tax compliance, identifies risks before federal tax liens are filed and resolves federal and state tax liabilities. He can be reached at email@example.com or 303-953-6325.