Each and every taxpayer is required to show his income to the IRS in the Collection Information Statement. This is used to calculate the Reasonable Collection Potential. This helps the IRS to figure out how much needs to be collected from the taxpayer. There are chances that the IRS and the taxpayer may dispute on the same figure if it not matches to their calculation.
If the income of the individual is not a fixed amount, then in that case, the IRS or the taxpayer can use an average income instead of the individual’s current wages.
Now the question is how will the IRS determine the time window to be used? The Internal Revenue Manual grants flexibility to the IRS representative. This means that the IRS representative can choose a window that is most beneficial to the IRS. On the other hand, the Manual dictates that the window should be correctly chosen to provide the most accurate results to apply to the Reasonable Collection Potential. The goal is to know the most likely income of the taxpayer and he may appeal to that directive in his/her argumentation for one time window over another.
Lets say, if a taxpayer has earned less money over the last year that what he had earned in the previous years, the IRS will average the taxpayer’s income over the three years prior to get a correct calculation. The taxpayer on the other hand will request for a shorter time period as it will provide a more accurate income, indicating to a downward trend in his income that has yet to be straightened out.
Since the laws are so flexible, when an individual’s income fluctuates, a taxpayer must do a financial analysis on the income history. This way, he can figure out which will be the best tax resolution strategy, and pursue, lowest Reasonable Collection Potential with the IRS.
Helpful Resources: http://www.irs.gov/