Tax refund offsets, part 1: When are they allowed?

If you got a tax refund this year, or are expecting one, the infusion of cash is surely welcome.

Sometimes, however, there are circumstances that can reduce your refund. This is called a refund offset.

When can the IRS offset a refund? And how might the IRS change its procedures for offsets, in light of a recent report from the Treasury Inspector General for Tax Administration (TIGTA). In this two-part post, we will address these questions.

First of all, a bit of terminology. Technically federal tax refunds are issued by the Bureau of the Fiscal Service (BFS), not the IRS itself. But like the IRS, the BFS is part of the Treasury Department, and the refund is an IRS refund. So for purposes of this post, we will simply say IRS, not BFS.

There are several scenarios in which the IRS can offset a refund.

Let’s start with federal tax debt. The Tax Code gives priority to individual federal tax debt. Once that debt has been satisfied, any amount of the refund that is left over can be applied to business tax liabilities for which that individual is responsible.

Small business owners who are sole proprietors have both individual and business taxes. So how these offsets are handled is important to those taxpayers.

Even if there is no federal tax debt, there are other potential offsets, such as non-tax debts to a federal agency. Other offsets include unpaid state taxes and unpaid child support.

The IRS is supposed to verify that federal tax debt is paid before applying any of these other offsets. In part two of this post, we will take note of what TIGTA found about how that process is working.