So, what is “phantom cash flow”? And how does it affect an IRS Offer in Compromise? Well, I’m not talking about making money under the table. I am referring to the dreaded IRS “reasonable expense standards”. Basically, these are the Census Bureau median amounts for variety expense categories, including Housing and Utilities; Food, Clothing and Miscellaneous; Vehicle Ownership Cost (monthly car payments); Vehicle Operating Costs; Out of Pocket Health Costs, and so on.
The IRS uses these Census Bureau numbers based upon your household size to determine if your expenses are reasonable or not.
So how does this work out in real life when you owe the IRS? Here are a couple of case studies and they will apply not only to IRS Offers in Compromise but also Complex Installment Agreements in which you owe over $50,000.
Case Study 1: Mortgage Payment “Too High”
I received a call recently from a home contractor who owed $125,000 to the IRS in back taxes, and his monthly mortgage payment was $2,500 for his family of 3 (one minor child and a spouse). He was interested in entering into a payment plan (Installment Agreement), but the IRS was rejected the terms of his suggested payment. While he made a good income from his business, the IRS refused to allow him to deduct the entirety of his monthly mortgage payment. Their reason was that the IRS “standard” for housing and utilities in his County (outside of Pittsburgh) was $1,534 a month. While the IRS didn’t quite tell him to walk away from his house, they would only deduct $1,534 for all of his housing and utility bills. His real housing and utility costs were around $2,850 a month, but the IRS wanted to add on $1,316 per month to his suggested payment amount. Simply put, he couldn’t afford the higher payment.
His options were either to file a Chapter 13 bankruptcy in order to repay his tax debts, or to pay down on his tax debts. In Bankruptcy Court, the IRS is not permitted to implement its reasonable expense standards approach, and must instead follow Bankruptcy Court rules, which are more forgiving. The second option, to pay down on his tax debt, was too difficult, because he didn’t have enough funds ($25,000) to get his total debt under $100,000.
So, in his case, the sum of $1,316 per month, aka “phantom cash flow”, was undermining his payment plan approach.
Case Study 2: Car Loan “Too High”
Bill wanted to pursue an Offer in Compromise. He didn’t have a lot of assets, which was a good thing for his Offer amount. However, he had purchased a late model Chevy truck with a monthly payment of $825 a month. Yes, his truck had a lot of bells and whistles and he really liked it. His problem was that the IRS only permitted him to deduct $485 a month for a vehicle payment. The difference was $340 a month, and thus for his Offer in Compromise calculation, he was having to overpay $4,080 due to his truck being so expensive. With Offer calculations, you must multiply your remaining monthly expenses by 12 months. So, just for his truck payment along, the sum of $340 a month was considered phantom cash flow, and it was therefore increasing his Offer amount by $4,080 in full.