Types of Expenses: Necessary and Conditional
The most detailed policy changes embodied in IRM §5323 relate to analysis of allowable expenses. Expenses are now divided into two categories; necessary and conditional. Necessary expenses are defined as those that are necessary to provide for the health and welfare of the taxpayer or family, or necessary for the production of income. There are three types of necessary expenses: national standards, local standards, and other.
Necessary Expenses: National Standards
National standards are established standards for reasonable amounts of five necessary expenses; food, housekeeping supplies, payroll and services, personal care products and services, and miscellaneous. The first four standards are derived from the Bureau of Labor Statistics Consumer Expenditure Survey 1992-1993. They are stratified by income so as income levels increase, the percentage of income provided for those expenses decreases. The miscellaneous allowable expense has been established by the Internal Revenue Service, and is $100.00 for the first person and $25.00 for every additional person in the household. (This is a decrease in the miscellaneous expense previously allowed under the local Buffalo District standards effective as of December 12,1994, which had provided an allowance for discretionary expenses in the amount of $100.00 per household member to a maximum of $400.00 total.) Necessary Expenses: Local Standards
Two necessary expenses will be determined by local standards. These two expenses are housing (including utilities) and transportation (including car insurance and public transportation). Local standards for housing and transportation have been developed with the assistance of the National Office Research and Analysis function and the District Office Research and Analysis sites. The allowable amount will be the lessor of the local standard or the amount actually paid by the taxpayer.
Necessary Expenses: Other
Other necessary expenses are those expenses which are not included in the national and local standards, but are nonetheless usually considered to be necessary. These other expenses are taxes, health care, court ordered payments, involuntary deductions, accounting and legal fees for representing a taxpayer before the Internal Revenue Service, and secured or legally perfected debts. (Only minimum payments will be allowable for expenses related to secured or legally perfected debts.) Accounting and legal fees, other than those for representing a taxpayer before the Service, may be allowable necessary expenses if they meet the necessary expense test of health and welfare and/or production of income.
Depending upon individual circumstances, additional expenses may meet the necessary expense test including, but not limited to, child care, dependent care (elderly, invalid, or disabled), life insurance, charitable deductions, education, disability insurance for a self-employed individual, union dues, professional association dues, and optional telephone services (call waiting, caller identification, etc.) or long distance calls. Donations to charitable organizations will only be allowed as necessary expenses if they provide for the health and welfare of a taxpayer or family, or are a condition of employment. For an education expense to be a necessary expense, the taxpayer must be able to demonstrate (1) that the education is for a physically or mentally handicapped dependent and (2) that such education is not otherwise provided by public schools, or that the education is a condition of employment.
Payments on unsecured debts may also be necessary expenses. If the taxpayer can demonstrate that payments on unsecured debts meet the necessary expense test, minimum payments should be allowed. However, except for payments required for the production of income, payments on unsecured debts will not be allowed if the tax liability, including projected accruals, can be paid in full within ninety days.
Conditional Expenses
Conditional expenses are those that are not required to provide for the health and welfare of the taxpayer or family, or for the production of income. Conditional expenses will be allowed if the taxpayer can establish that he/she can remain current in all future tax payments and can pay the outstanding tax liability, including projected accruals, within three years. This leads us to the Service’s two new rules regarding necessary and conditional expenses.
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