Dealing with tax liabilities can be stressful, but understanding what expenses the IRS considers allowable can help taxpayers manage their finances more effectively. In this third installment of our IRS Allowable Expenses series, we delve into important expenses the IRS recognizes when negotiating tax debt resolutions.
The Importance of Staying Current
One of the most critical aspects of managing tax debt is staying up to date on your current-year tax obligations. The IRS closely examines whether you are making estimated tax payments or have sufficient withholdings. If you continuously owe taxes year after year, the IRS is unlikely to offer any relief or resolution. Their rationale is straightforward: if you haven’t fixed the problem that caused your tax debt, you are likely to accumulate new debt even after reaching an agreement.
To avoid this, taxpayers should either increase their withholdings or make estimated tax payments. Failing to do so could result in penalties as high as 8% per year. The IRS operates on a pay-as-you-go system, meaning taxes should be paid throughout the year, not just in a lump sum at the end.
State and Local Taxes
The IRS considers state and local tax payments as allowable expenses. However, there is a hierarchy when paying off tax debt. Many tax professionals advise paying state taxes before IRS debts because state tax agencies often have stricter collection practices. States may impose wage garnishments and bank levies more aggressively than the IRS, making it essential to prioritize those obligations.
Other Recognized Allowable Expenses
Beyond current-year tax obligations, the IRS allows for several other necessary expenses, including:
1. Secured vs. Unsecured DebtsThe IRS gives priority to secured debts, such as mortgages, car loans, and judgments, over unsecured debts like credit cards and personal loans. If you have substantial credit card debt, it may not be in your best interest to pay it off before addressing your tax liability. The IRS may disallow payments toward unsecured debt when considering an installment agreement or offer in compromise.
2. Medical ExpensesMedical expenses, including health, dental, and vision insurance, are considered allowable if they are deemed reasonable and necessary. Elective procedures, such as cosmetic treatments, may not qualify. However, significant dental work, such as implants or reconstructive surgery, is often recognized as necessary and allowable.
3. Student LoansStudent loan payments are another category the IRS acknowledges. If you are a cosigner on a student loan for a child, you may still receive credit for making those payments, provided you are legally responsible for the debt.
4. Disability and Life InsuranceThe IRS considers long-term and short-term disability insurance payments as allowable expenses, as they fall under prudent financial planning. Term life insurance is also allowable, but whole life insurance policies are not, as they accumulate cash value that the IRS may require you to liquidate.
5. Childcare CostsFor taxpayers with dependents, the IRS allows childcare expenses—but only when necessary. If both parents work or one is unable to provide childcare, the costs are usually considered allowable. However, expenses for extracurricular activities such as soccer or day camps may not qualify unless directly tied to necessary childcare.
Planning for Long-Term Tax Compliance
A primary goal when working with tax professionals is to create a long-term plan that ensures compliance. If a taxpayer sets up an installment agreement or other tax resolution but continues to fall behind on tax payments, it can lead to defaults and further financial strain.
To maintain compliance, taxpayers should establish a habit of making regular payments, whether monthly or quarterly. This helps in building a history of compliance and makes it easier to negotiate favorable terms with the IRS.
Navigating IRS allowable expenses can be complex, but understanding which expenses qualify can help taxpayers create realistic financial plans. By ensuring current tax obligations are met, prioritizing secured debts over unsecured ones, and recognizing allowable expenses like medical bills, student loans, insurance, and childcare, taxpayers can better position themselves when negotiating with the IRS.
If you need assistance in understanding how these allowable expenses apply to your situation, consulting a tax professional can provide clarity and help prevent future tax issues. Taking a proactive approach to tax management is the best way to secure financial stability and avoid the stress of unexpected liabilities.
Book a free consultation with a Guardian Tax Professional today to get clear answers to your unique situation.
