The topic of income tax refunds comes up periodically in New York bankruptcy. It’s important because in chapter 13 cases, New York trustees will demand the full refund to repay the creditors, and in chapter 7 it’s an asset that will be taken by the trustee if the debtor can’t protect it with an exemption. Income tax refunds also connect to household debts outside the context of bankruptcy. This would be “income tax refund offsets,” which are the mechanism the federal government uses to repay certain creditors out of money that would normally be refunded to the taxpayer.
According to the IRS, there are four types of debts that are subject to income tax refund offsets. They are:
(1) Past-due child and parent support,
(2) Federal agency non-tax debts,
(3) Unpaid state income taxes, and
(4) Unemployment compensation debts owed to a state.
Child and parent support debts speak for themselves; they’re much like domestic support obligations in bankruptcy. The same goes for state income taxes. Unemployment compensation debts are usually attributable to fraud on the unemployment system. Finally, federal agency non-tax debts are frequently student loans that are owed to or guaranteed by the Department of Education. In other words, when someone falls behind on a student loan, the government will offset an income tax refund to ensure the Education Department is paid.
Income tax refund offsets are managed by the Bureau of the Fiscal Service, a relatively new federal agency that’s part of the Treasury Department. (Offsets were formerly handled by the Fiscal Management Service.) Individuals can contact the government agencies to which they owe debts to see if their debts were submitted to the BFS.
For its part, the BFS sends individuals notices when it applies offsets to their income tax refunds. The notice will contain the following:
- The original refund amount,
- The offset amount,
- The agency receiving the payment, and
- That agency’s contact information.
Individuals can contact the BFS to dispute an offset. The IRS has a procedure for joint income tax filers who are not responsible for the debt causing the offset to receive their share of the income tax refund.
You can find the IRS’s discussion of income tax refund offsets here.
In most cases, the debts that can be subject to an income tax offset are priority claims that would be the first paid in a bankruptcy case. If you owe one of the four kinds of debts that can be offset by the BFS, it’s wise to discuss your situation with a New York bankruptcy lawyer.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced fair debt collection practices act Bruce Weiner for a free initial consultation.