Can Your Debt Cause You to Lose Your Tax Refund?

If you’re expecting a tax refund, you probably already know how you’re going to spend it. But there’s a chance your refund won’t hit your mailbox or your bank account at all if you’re behind on certain debts.

Through the Treasury Offset Program, the government can seize some or all of your tax refund if you’re behind on federal and state income taxes, federal student loans or certain other debts. If you open your snail mail regularly (which many of us don’t), the possibility that you won’t get your refund shouldn’t be a surprise. While it’s a nasty shock to lose your tax refund because of debt, the government will give you plenty of warning, said Michael Bovee, co-founder of Resolve and president of the Consumer Recovery Network.

“If you owe the government money, they’ll be really, really obvious about it. You’ll receive letter after letter with them saying, ‘Hey, pay your money.’ ‘Hey, pay us what you owe,’ ” he said.

What kind of debt?

The Department of Treasury’s Bureau of Fiscal Service runs the Treasury Offset Program. If it’s taking some or all of your tax refund, it will notify you before and after it happens. You’ll see how much is at stake and which agency gets the money.

You’ll also have a chance to dispute or pay the debt to prevent your refund from being seized. Also keep in mind that if you filed a joint return and your refund was offset for debt owed only by your spouse, you can file an Injured Spouse Allocation form to ask for your part of the refund back.

It’s not just the Internal Revenue Service that can get a crack at your tax refund, although it gets the first shot if you are behind on your federal taxes. The other reasons your tax refund can be garnished include:

State income taxes. The state government can request that your tax refund be garnished if you owe it money.

Federal student loans. If you default on a federal student loan — something you should do your absolute best to avoid, Bovee said — the IRS can withhold your tax refund. Depending on the type of federal student loan you have, it could take quite a while to go into default — sometimes as long as 270 days. And there are income based repayment plans available for federal student loans that can prevent you from ever going into default. You may even qualify to pay as little as $5 a month.

Child support. If you’re behind on paying court-ordered child support, the state’s child agency can ask the Treasury Department to withhold money from your tax refund.

Spousal support. If you are paying court-ordered spousal support, be aware that the situation is much like that with child support if you fall behind on payments.

State unemployment compensation. If the state suspects you collected more in unemployment money than you should have, either because of fraud or incorrectly reporting your earnings, it can ask for a tax refund offset to repay what you owe. (Need help with debt? Read our guide to debt management.)

Can you lose your tax refund to credit card debt?

Credit card companies and lenders can’t just reach out and grab your tax refund — not directly at least; that’s the province of Uncle Sam. But there is one way they can wind up with your refund money.

If a creditor, lender or debt collector sues you for your past-due debt and wins a judgment against you, it could include a levy on your bank account. In that case, if your tax refund is deposited into your bank account, the money could be sent to the judgment holder instead. “You can go to bed with $5,000 in your account and wake up to find $4,200 is gone,” Bovee said. “It’s awful.”

Incidentally, Bovee said, tax season can be an opportune time to pay off debt. “A lot of debt collectors run specials around tax refund time,” he said. “They’re proactively reaching out to consumers who owe them. You could end up getting rid of debt for less than half of what you owe.”

How can you avoid losing your tax refund?

The most obvious way to keep your tax refund is to pay your debts. But that’s not always possible.

If you’ve fallen behind on any of your debts, your first step should be to cut back on your spending, Bovee said. With federal taxes, if you owe less than $50,000 to the IRS, contact the agency and ask about a payment plan. It is usually willing to work with you, especially early on, Bovee said.

“Do not touch your 401(k) to pay off your taxes,” Bovee said. “It breaks my heart when people do that.”

Unlike your tax refund or your Social Security check, one thing the federal government can’t touch is your retirement accounts.

(Need help with debt settlement? Read our comprehensive guide.)

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