In the case of Mathews v. Commissioner, TC Memo 2015-225 the taxpayer protested that the IRS had abused its discretion by counting the taxpayer’s veterans’ disability payment as income in determining his ability to pay when deciding on the amount the taxpayer could pay under an installment agreement for unpaid taxes.

The taxpayer owed taxes from eight separate years running from 2000 to 2011. The IRS issued a notice of tax lien and the taxpayer for a collection due process hearing.

In computing the amount of an acceptable installment agreement the IRS counted the $3,309.00 per month the taxpayer received in veteran’s disability payments, an amount that the taxpayer argued was not subject to tax under §104(a) and, for purposes of the issue in this case, the IRS agreed to treat as not consisting of taxable income.

The taxpayer argued that this amount should not be considered when computing the amount the taxpayer could pay under an installment agreement.  If that income was removed, the taxpayer’s monthly income fell to $1,328.75 an amount that would end up being far less than allowable expenses—thus making a zero installment agreement acceptable.

The IRS disagreed, arguing that the question was his ability to pay and, in that case, the $3,309.00 represented funds that increased the taxpayer’s ability to pay—and thus increased the amount the IRS would demand to have an acceptable installment agreement.

The taxpayer argued that it was not properly includable because of the fact that it was not taxable under IRC §104(a) and because the benefits are in part not subject to levy by the IRS under §§6334(a)(6) and 6331(h).

On the issue of nontaxable income being excluded from an ability to pay calculation, the Tax Court sided with the IRS.  The question being addressed was ability to pay and not taxability.  As the Court noted:

Respondent maintains that petitioner's monthly veteran disability benefits are nonetheless properly included in determining the amount that petitioner would be able to pay each month to the IRS with respect to the unpaid liabilities at issue. Petitioner counters that the Internal Revenue Manual and Form 433-A use the label "income" to refer to various receipts that are required to be included in determining the amount that a taxpayer would be able to pay each month to the IRS with respect to an unpaid tax liability.

We understand, and are sympathetic to, the confusion that has resulted from the use of the label "income" in the Internal Revenue Manual and Form 433-A. However unfortunate the use of that label may be, it does not require us to conclude that it was an abuse of discretion for the second settlement officer to have included petitioner's monthly veteran disability benefits in determining the amount that petitioner would be able to pay each month to the IRS with respect to the unpaid liabilities at issue. Indeed, the Internal Revenue Manual identifies certain payments that a taxpayer receives which are required to be included in determining the amount that a taxpayer would be able to pay each month to the IRS with respect to an unpaid tax liability, even though those payments are excludible from gross income. By way of illustration, IRM pt. 5.15.1.11(2)(f) requires certain child support payments that a taxpayer receives to be included in determining the amount that a taxpayer would be able to pay each month to the IRS with respect to an unpaid tax liability, even though the taxpayer may exclude from gross income under section 71(c) child support payments described in that section.

We point out that, consistent with the requirement in the Internal Revenue Manual that amounts which a taxpayer receives and which are not includible in gross income be nonetheless included in determining the amount that a taxpayer would be able to pay each month to the IRS with respect to an unpaid tax liability, the Internal Revenue Manual requires certain personal expenditures to be included in that determination, even though those personal expenditures are not deductible for tax purposes. Indeed, petitioner reflected in petitioner's financial statement, and the second settlement officer allowed, certain nondeductible monthly expenditures of petitioner (e.g., "Trash Service", "Phone", and "Cable") to be included in determining the amount that petitioner would be able to pay each month to the IRS with respect to the unpaid liabilities at issue.

Similarly, whether an item is available to the IRS to levy against doesn’t impact an ability to pay calculation, addressing the taxpayer’s second complaint.  The Court notes:

We turn now to petitioner's second argument in support of his position that the second settlement office erred in including petitioner's monthly veteran disability benefits in determining the amount that he was able to pay each month to the IRS with respect to the unpaid liabilities at issue. Petitioner's second argument is that petitioner's monthly veteran disability benefits "qualify as service-connected disability payments under 26 U.S. Code Section 6334(a)(10) and should * * * not be included in any ability to pay calculation." We recently held in Ligman v. Commissioner, T.C. Memo. 2015-79, at *10, that it was not an abuse of discretion where a settlement officer included certain Railroad Retirement Board benefits that the taxpayer involved there had received in determining the amount that the taxpayer would be able to pay each month to the IRS with respect to an unpaid tax liability, even though those benefits were in part not subject to levy under sections 6334(a)(6) and 6331(h).

On the record before us, we find that the second settlement officer did not abuse his discretion in including petitioner's monthly veteran disability benefits in determining the amount that petitioner would be able to pay each month to the IRS with respect to the unpaid liabilities at issue.