There are several different federal, state, and local government agencies that can intercept your federal tax refund if you owe money to these agencies. This procedure is known as a tax offset. This article will look at which agencies can take your refund and how bankruptcy can help you with tax refund offsets.
Written by Lawyer John Coble.
Updated August 14, 2023
There are several different federal, state, and local government agencies that can intercept your federal tax refund if you owe money to these agencies. This procedure is known as a tax offset. This article will look at which agencies can take your refund and how bankruptcy can help you with tax refund offsets. It's important to know that while these agencies can take your tax refund, they can not take the economic stimulus payment created by the CARES Act in response to the COVID-19 pandemic.
What Is an IRS Setoff?
If you owe back taxes, you may ask yourself where is my refund? The Internal Revenue Service (IRS) can take the amount owed to it out of your federal income tax refund. This is known as an offset. For example, if you owe the IRS $1,300.00 and you have a tax refund of $3,000.00, the IRS may take the $1,300.00 you owe out of the tax refund, leaving you with a refund amount of $1,700.00. The money is withheld before you ever get the money from the IRS. In the same example, if you have $3,500.00 in back taxes due, the IRS would take your entire tax refund.
The Bureau of the Fiscal Service (BFS) is the federal agency that withholds this money from the tax refund. The BFS like the IRS is a part of the Treasury Department. The BFS will send you a letter explaining why they took part or all your refund. The letter will show the offset amount, and show any remaining balance owed. The BFS may apply the remaining balance against future tax refunds. When a tax refund offset isn’t enough to pay the full amount of the debt owed, the BFS will continue to take your tax refunds every year until the debt is paid in full. These offsets will not affect your eligibility for direct deposits. Any refund available after the offset will still be automatically deposited into your account.
The BFS collects debts for several government agencies by offsetting tax refunds. The BFS's Treasury Offset Program (TOP) can be used to take back taxes owed to the IRS out of your refund. You will receive a CP128 letter from the IRS if the IRS has used the BFS to offset a tax refund of yours.
If you expect a tax refund and haven't received it, you can use the "Where's My Refund" tool on the IRS website. You will need your social security number or IRS Individual Taxpayer Identification Number to use the "Where's My Refund" tool. It's important to know that the economic stimulus payment arising from the coronavirus is not subject to treasury offsets by the BFS. If you owe back taxes, don’t let the fear of an offset cause you to avoid getting your stimulus payment. By law, the IRS nor any other part of the government can offset this payment like it can with a regular tax refund.
Why Did the IRS Offset My Tax Refund?
The refund offset is a favorite collection method for the IRS. The IRS knows the amount of the money available and where it is. It is the easiest form of collection. But, if the IRS tries to seize the amount of money out of your bank account, they may find that there is no money in your bank account. Or, the IRS could find that your bank account is commingled with the money of another person who doesn't owe the IRS. These complications don’t exist with a tax refund offset. The problem with commingled money in a bank account with your spouse doesn't occur if you file a joint tax return with your spouse. The same treatment applies to a tax refund from a joint tax return. Even if one spouse doesn't owe back taxes, the IRS will take the entire refund. If you are a non-owing spouse and the IRS is collecting your spouse's tax debts from your part of the tax refund, you need to get an injured spouse allocation. A good accountant can help you to get this allocation. This allocation provides you with relief by allocating your portion of the refund to you without the offset. Do not confuse an injured spouse allocation with innocent spouse relief. Injured spouse allocations deal with tax refunds. Innocent spouse relief deals with relief from all collection activities against you caused by your spouse's tax debts.
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Other Reasons Your Tax Refund May Have Been Offset
It's not only back taxes that could cause you to ask, "Where's my refund?" The IRS isn't the only government agency that uses the Treasury Offset Program to take tax refunds. Other agencies that use this program include state income tax departments, state unemployment compensation offices, county and state child support offices, and the Department of Education.
State Tax Debts & Unemployment Compensation Debts
State governments use the offset program to collect back taxes and overpaid unemployment compensation.
Past Due Child Support
State and county child support offices use the program to collect back child support payments.
The Department of Education collects defaulted student loans through the offset programs. Federal student loans can use the offset program to get your tax refund. But, private student loans can’t use the offset program. Private student loans are loans that are not guaranteed by the government.
There have been cases of identity theft where the thief has used another person's social security number to have the other person's tax refund taken by an offset. Once you're able to confirm that you have been the victim of identity theft, it's important to file Form 14039 with the IRS. See irs.gov for more information on tax-related identity theft.
Timing a Bankruptcy Where There Is a Refund Offset
When you file bankruptcy, §362 of the Bankruptcy Code stops collection activity. §362(b)(26) of the Bankruptcy Code has an exception for tax refund offsets under certain circumstances. If there is a determination by a court finding that you don’t owe debts claimed by the tax authorities, the offset money must be returned. If you're challenging your tax liability, you need to claim any possible return of money as exempt. This will prevent the bankruptcy trustee from taking this money. One example of a challenge to the legality of the debt would be a proceeding to determine if a tax were dischargeable in bankruptcy.
For Chapter 13 bankruptcies, the automatic stay only allows an offset for the tax refunds from tax periods that ended before the filing of the bankruptcy. The back-taxes must also be from years before the filing of the bankruptcy. For example, if you filed a Chapter 13 bankruptcy in December of 2019, your tax refund in 2020 can't be offset. This is because the tax year of the refund offset (2019) ended after you filed. Both the refund year and the debt year need to have ended before you filed for an offset to occur after the filing of a Chapter 13 bankruptcy. But, if you file your bankruptcy on January 2, 2020, your tax refund for 2019 which you’d normally receive between February and May of 2020 will be offset by the IRS.
Even if you get your timing right regarding the offset, it's also important that you claim your tax refund as exempt on your bankruptcy petition, if possible. Otherwise, the bankruptcy trustee will take your tax refund.
Timing the Bankruptcy Filing to Stop Tax Setoff
If the IRS offsets your tax refund within ninety days before you filed bankruptcy, that is a preference. A preference is when you "prefer" one creditor over other creditors. It doesn't matter that you have no choice in the matter. When there is a preference due to an offset, the trustee can take the offset back from the IRS and distribute it among other creditors.
Why You Should Care if the Trustee Goes After the Tax Offset: Non-Dischargeable Debts
If the trustee takes the offset tax refund , you will have lost the money that would have been yours if the debt is dischargeable. Most of the debts that are eligible for the tax offset program are difficult if not impossible to discharge. These include debts such as child support arrearage. Yet, certain income taxes are dischargeable if certain criteria are met. As for the more common situation of the tax refund offset being for debt that you can't discharge, you want to make sure the trustee doesn't take this money and split it among creditors you wouldn’t otherwise have needed to pay. You want the tax offset to stay with the original creditor since you have to pay that creditor regardless of your bankruptcy. For this reason, consider delaying the filing of your bankruptcy until 90 days have passed since the offset. Waiting beyond 90 days will prevent the trustee from taking the offset.
Certain nondischargeable debts that can be offset are also priority debts. The trustee must pay these priority creditors in full before paying the other creditors. Other debts such as student loans are not priority debts. For this reason, the bankruptcy trustee can pay student loans pro-rata with other unsecured creditors. In this case, the offset amount will only partly go to the original offset creditor. If you have to pay the original offset creditor, you want the whole offset amount to go to that creditor. Consider what type of debt has been offset before making a decision about delaying your bankruptcy filing.
IRS offsets usually occur near the end of the tax season in April or May. In these tough economic times due to the coronavirus pandemic, not receiving your tax refund can be especially hard. Whether to wait until July or August to file a bankruptcy to avoid the 90-day preference rule may depend on the type of debt that the offset paid. As mentioned above, you want the nondischargeable debts to be paid in full as opposed to the money being paid pro-rata to the creditors and your trustee. You should also remember that the tax refund can't be offset for back-taxes if there is a challenge to the liability for the underlying debt. The IRS can still hold your refund until the liability dispute is resolved. If the underlying creditor realizes they are only going to get a pro-rata payment due to a preference, they may back off from the offset. It's important to be very careful when timing your bankruptcy filing in relation to tax debts and tax refund offsets for non-tax debts. It's a good idea to hire an experienced bankruptcy attorney before filing bankruptcy if you have tax issues or other nondischargeable debt issues.