Monthly disposable income (MDI) is a simple formula: average monthly income less average monthly allowable expenses.  The complexity in computing MDI is computing the “average” amount and determining what expenses are allowed.

Average monthly income:  average monthly income is usually the last three months of income for the taxpayer.  However, the IRS will usually use the last 12 months for taxpayers who are self-employed or who receive annual bonuses or other irregular income.

Average allowable monthly expenses:  these expenses include expenses that are necessary to provide for the health and welfare of the family (i.e. living expenses) plus any expenses to produce income.  These expenses must be paid by the taxpayer.  Expenses can be categorized into three areas:

  • Allowable necessary living expenses that are limited by IRS financial standards:  the IRS puts limitations on expenses for housing (includes mortgage/rent, utilities, property taxes, insurance, maintenance, etc.), transportation (ownership costs, operating costs, public transportation), and food/clothing and other miscellaneous expenses.  These expenses are determined based on the taxpayer’s location and/or size of family.  The IRS allows a flat amount for out-of-pocket medical costs based on the age of each member of the household.  For out-of-pocket medical expenses, taxpayers are allowed the greater of the paid medical expenses (not including health insurance) or the IRS standard amount allowed. 
  • Other necessary living expenses that are not limited by IRS financial standards:  these are necessary expenses for the household that are not limited by IRS expense standards.  Some examples of these expenses include health and term life insurance, taxes, dependent care expenses, and court-ordered payments such as alimony or child support.
  • Other conditional expenses:  expenses that do not meet the necessary living expense test but may be allowed based on the taxpayer’s circumstances.  These expenses, such as private school tuition and elective retirement contributions, are not allowed unless the taxpayer can pay the balance owed within 72 months, or before the collection statute expires, whichever is shorter.  Normally, conditional expenses are allowed in agreements where the taxpayer owes more than $50,000 (i.e. do not qualify for a streamlined installment agreement) and can pay within 72 months with their current actual household paid expenses.

The Food/clothing/other, transportation operating costs, and the out-of-pocket medical cost standards are allowable up to the standard amount, regardless if the taxpayer has paid these expenses. However, for all other expenses, the IRS will limit the expense allowed to the standard or paid amount, whichever is less – unless the taxpayer qualifies to use other conditional expenses.

The IRS allowable living expense standards are updated annually and are published on the IRS website.

An example

A taxpayer cannot pay with available equity in assets and does not qualify/cannot pay with a streamlined installment agreement.  To determine their installment agreement payment amount, they will need to determine their ability to pay with monthly payments – that is, what is their MDI.

The taxpayer is a wage-earner, age 35, and is single with no dependents.  The taxpayer lives in Charlotte, NC.  Over the past three months, their average gross income is $6,000 per month.

When computing expenses, the taxpayer has the following average actual paid expenses over the past three months:

  • Food, clothing, other household items:  $500 a month
  • Housing and utility costs (rent, renter’s insurance, utilities, cell phone):  $1,200 a month
  • Transportation ownership costs (car payment):  $700 a month
  • Transportation operating costs (fuel, insurance, repairs, etc.):  $200 a month
  • Health insurance:  $900 a month
  • Term life insurance:  $100 a month
  • Child-support payment: $500 a month
  • Out-of-pocket medical costs (doctors, prescriptions):  $150 a month
  • Taxes (federal and state income, FICA taxes):  $1,000 a month
  • Retirement contributions (voluntary 401K contributions):  $300 a month

The standards for Charlotte, NC, family of 1, age 35 are as follows:

  • Food, clothing, other:  $727 (family of 1).  Taxpayer is allowed the standard amount without providing proof of expenses paid.
  • Housing and utilities:  up to $1,461 (family of 1, Mecklenburg County, NC)
  • Transportation ownership costs:  up to $508 (one vehicle allowed)
  • Transportation operating costs:  $210 (South Region, one vehicle).   Taxpayer is allowed the standard amount without providing proof of expenses paid.
  • Out-of-pocket medical costs:  $55 (under age 65).  Taxpayer is allowed the higher of the standard or amount paid.

Health insurance, term life insurance, taxes, and child-support payments are other costs allowed and are not limited by IRS allowable living expense standards.  The retirement contributions are a conditional expense that will only be allowed if the taxpayer can pay within 72 months, or before the collection statute expires, whichever is shorter.

The taxpayer’s MDI is:

Average monthly gross income of $6,000 less, allowable monthly living expenses of $5,295, or $705.  The monthly living expenses were allowed as follows:

  • Food, clothing, other household items:  $727 (use the standard)
  • Housing and utility costs (rent, renter’s insurance, utilities, cell phone):  $1,200 (lesser of standard or actual expenses paid)
  • Transportation ownership costs (car payment):  $508 (lesser of standard or actual expenses paid)
  • Transportation operating costs (fuel, insurance, repairs, etc.):  $210 (use the standard)
  • Health insurance:  $900 (actual paid amounts allowed)
  • Term life insurance:  $100  (actual paid amounts allowed)
  • Child-support payment: $500 (actual paid amounts allowed)
  • Out-of-pocket medical costs (doctors, prescriptions):  $150 (higher of actual expenses paid or standard amount allowed)
  • Taxes:  $1,000 (amount paid)
  • Retirement contributions (voluntary 401K contributions):  $0 (can be allowed if the taxpayer pays the total balance owed within 72 months or the collection statute, whichever is earlier)

Note:  expenses allowed for purposes of computing the settlement amount for an offer in compromise differ slightly than the expenses allowed for a payment plan.  In fact, in determining the offer amount, taxpayers may actually be allowed additional expenses depending on their circumstances.

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