As much as people relish getting a tax refund, many others just dread seeing that money disappear to cover a host of delinquent bills — such as old income tax bills.
“If you owe the IRS money, they’re obviously not going to issue you a refund without offsetting that first,” said Greg Rosica, tax partner at the EY Private Client Services in New York. “Certainly, the IRS has the first priority.”
The Treasury’s Bureau of the Fiscal Service also is able to immediately reduce your tax refund for specific past-due debts:
- State income taxes.
- Child support.
- Federal agency non-tax debts, including past-due federal student loans.
- Overpayment of unemployment compensation, say in the case of fraud.
Overall, the bureau’s program that reduces federal income tax refunds for unpaid debts claimed 4,564,980 in offsets for a total of $5.9 billion from 2018 tax returns filed last year, according to the Treasury’s Bureau of the Fiscal Service.
Typically, it’s not a surprise that you owe somebody money. But you might be shocked that your tax refund is about to be reduced by the government.
“My guess is if you owe child support, this is not the first time you will have heard about it,” Rosica said.
The good news, of sorts: A credit card issuer isn’t able to garnish your refund on the spot before you get your hands on it. If you deposit your tax refund in the bank, though, a private creditor could use a court judgment to gain access to the money.
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Jennifer Azevedo, financial coach for the Wayne Metropolitan Community Action Agency, said she’s worked with clients at the nonprofit group’s tax preparation sites who have seen their tax refunds garnished.
While it’s the one time of the year that many get a big chunk of money, she said, some understand that the tax refund does need to cover the debt when it’s garnished. They’re often living paycheck-to-paycheck and struggling to make payments otherwise.
“They don’t mind because it’s easier for them to pay the debt off,”
Sometimes, though, people who have old, now delinquent student loans are a bit shocked to see their tax refund go to pay down that debt. In some cases, she said, the borrowers ignored the student loan debt because it was just so overwhelming but they never realized the impact on a tax refund.
Tax filers get some explanation when a tax refund is garnished. The Bureau of Fiscal Service sends you notice to tell you the original refund amount, how much is being offset and who is getting the money.
The notice would include the address and phone number of the agency that is receiving the offset. If you believe you don’t owe the debt or if you’re disputing the amount taken from you, you need to contact the specific agency.
“For taxpayers who are not expecting an offset, it is quite upsetting,” said Andy Phillips, director of H&R Block’s Tax Institute.
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Some filers may lose the entire refund to past-due debt. Others, though, may receive a portion of the refund that remains after the offset payments are taken out.
If you don’t receive a notice, you should contact the bureau’s Treasury Offset Program call center at 800-304-3107 Monday through Friday from 7:30 a.m. to 5 p.m. central time.
State income tax refunds can also be subject to a tax refund offset. In Michigan, for example, the Michigan Department of Treasury withholds income tax refunds or credits for payment of certain debts, such as delinquent state taxes, state agency debts, garnishments, probate or child support orders, overpayment of unemployment benefits and IRS levies on individual income tax refunds.
Generally, for a non-governmental creditor, such as a credit card issuer, to garnish a state income tax refund in Michigan, a creditor must first win a judgment against the taxpayer. Then the creditor files a writ of garnishment, the Treasury issues a notice to the taxpayer and the taxpayer has a 14-day window to object to the writ of garnishment, according to H&R Block.
Here’s what else you need to know:
How college debt can reduce a tax refund
You’re not at risk if you’ve missed a student loan payment or two. Instead, you’d lose your tax refund if the federal student loan debt is in default — which typically occurs after 360 days of non-payment. You’re at risk of default if you do not make special arrangements with your lender to get a deferment or forbearance.
Lenders are able to garnish up to 15% of the borrower’s wages in that case without a court order, according to Mark Kantrowitz, publisher and vice president of research for Savingforcollege.com.
If you’re working a low-paying job, the amount can be smaller because borrowers must be left with 30 times the federal minimum wage per week — now $7.25 an hour — after wage garnishment. That would amount to $217.50 a week.
“Wage garnishment usually doesn’t occur until after the loan has been in default for at least a year and other attempts to collect the debt have failed,” Kantrowitz said.
But if someone is self-employed, they’re more likely to be affected by the offset of income tax refunds, Kantrowitz said.
“Borrowers seem to be more upset about intercepting income tax refunds,” he said.
The entire tax refund, of course, could be garnished depending on how much you owe.
Many consumers may desperately need the extra money from a tax refund check because they’re facing high heating bills or old holiday bills.
For some, it could be less shocking to see a a wage garnishment when a few dollars are dragged out of a paycheck each week instead of watching a $2,000 or $3,000 federal income tax refund vanish at once.
“The workaround for consumers is to fine-tune their withholding so that they aren’t left with a big income tax refund,” Kantrowitz said.
How one spouse can protect a tax refund
If you’re married and filing jointly, it is possible to get back your share of a tax refund if the refund has been reduced to apply to a debt owed by your spouse, not you.
Rosica, tax partner at EY in New York, said the form would work if it’s not a joint liability, say a delinquent student loan taken out by your spouse.
You’d need to file a Form 8379, the Injured Spouse Allocation. It only applies if you file a joint return.
An injured spouse form can be filed with a joint tax return, an amended joint tax return or afterward by itself.
“This is only available if the debt is the liability of only one of the spouses,” said Phillips, of H&R Block.
“And in this case, the taxpayers have to go through a process of determining how much of the refund belongs to each spouse.”
A couple would need to decide if they want to file Form 8379, he said, to get back part of the refund that would apply to only one spouse. Or perhaps the couple could decide that the debt needs to be paid off anyway and not file the injured spouse form.
If you’re concerned about a garnishment involving a state income tax refund, Michigan issues a Non-Obligated Spouse Form 743 to the taxpayers after the return is filed. The Form has a strict 30-day response date.
Some couples use different strategies.
Another option, Phillips said, is for the couple to file married filing separate returns if only one spouse is liable for a past due debt.
But there can be other negative consequences, perhaps losing out on some tax breaks, by using the married filing separate status. For example, if you opt to file married filing separately, you would not be able to reduce your taxable income by up to $2,500 through a special deduction that allows you to claim interest paid in 2019 on federal and private student loans. The student loan interest deduction can be taken on federal returns even if you do not itemize your deductions and choose to opt for the standard deduction.
“Taxpayers should run the numbers each way to determine which choice is best for them,” Phillips said.