With another Tax Day behind us, many Americans across the country eagerly await receiving their tax refunds. What many taxpayers might not be aware of, however, is that the government can garnish tax refunds for certain types of debt. While private creditors cannot seek repayment through tax refunds, government agencies do have the power to garnish federal and state tax refunds to recover any of the following types of debt, listed in order of which are paid off first: delinquent federal tax debts, child support, other non-tax federal debts, student loan payments, debts related to unemployment compensation, small business administration loan payments, housing and urban development (HUD) loan payments, and finally state tax debts. Notice that all federal debts are recovered before state debts, and this is true when either the federal or the state refund is garnished. If the IRS does reduce the refund to pay any of these debts, the taxpayer can expect to receive a notice from the IRS or the Department of the Treasury’s Financial Management Service (FMS) stating the original tax refund, the amount paid toward the debt, which agency they sent payment to, and the address and phone number of that agency.
What about when your spouse owes money but you don’t? For married couples who filed jointly, the spouse who is not responsible for the debt is entitled to a portion of the tax refund. The spouse will need to file IRS form 8379, Injured Spouse Allocation, to request his/her portion. This form can be attached to the tax return when originally filed, or it can be sent by itself once notified by the IRS of the tax refund reduction due to outstanding debts. For state refunds, the states treat joint returns in a similar fashion, where the non-debtor spouse’s portion of the state tax refund will not be reduced to pay the indebted spouse’s outstanding debt, although submitting a specific form is not required for state refunds.
Other recently passed legislation has added a few additional types of debts to the list. In addition to federal and state-level debts, parking violations, unpaid city fines and other fees and tickets owed to many localities like the City of Chicago can also offset state tax refunds. The penalty for going without health insurance was also recently added. Beginning in 2014, Americans nation-wide are required to have basic health insurance coverage to avoid a penalty for going without coverage. Unpaid penalties will reduce future federal tax refunds. The penalty increased substantially after the year of its inception. The penalty in 2014 was $95 per adult and $47.50 per child up to a maximum of $285, or a penalty of 1% of the taxpayer’s annual household income, whichever amount is higher. In 2015, the penalty rose to $325 per adult and $162.50 per child up to $975, or 2% of household income. In 2016, the penalty will rise as high as $695 per adult and $347.50 per child up to a maximum of $2,085, or 2.5% of household income. Each American must be insured for at least 9 months of the year to avoid the penalty. You can catch a break if uninsured for less than 3 months, but otherwise the penalty amount is one twelfth of the full penalty times the number of months uninsured. For low-income taxpayers who struggle to afford health insurance, there is an exemption from the penalty when insurance premiums exceed 8% of the household income.
Taxpayers can rest assured that private creditors cannot go after their tax refunds. But for those taxpayers who are delinquent on their taxes, child support payments, student loans, health insurance penalties, local parking violations, or have any other government agency related debts, the IRS and each state’s department of revenue do have the power to recover these debts directly through the refunds they issue.
If you receive correspondence from the Internal Revenue Service or any state taxing agency, please forward them to your contact here at ECS to make sure the information is correct and to adjust our records accordingly. Refunds carried forward to future years will likely change estimated tax payment calculations if the adjustment is significant, so we’ll want to evaluate the situation to make sure you are protected from future penalties.
2015 Tax Due Dates:
June 30th –
Monthly Illinois wage report for May due (employers with 25 or more employees)
July 31st –
2nd quarter 2015 employer payroll tax returns due
About The Author - Jay W. Dahl, CPA, CLFP, oversees ECS Financial Services’ tax practice and has been with ECS since 1984; a shareholder since 1990. Mr. Dahl’s areas of expertise include individual and corporate tax planning, research and tax return preparation; estate and trust planning and return preparation; profit-sharing and retirement plan consulting and design; litigation support; strategic business planning; financial statement compilation; management consulting and leasing company management for a variety of closely held businesses, individuals, trusts and estates. He is a Certified Public Accountant and a Certified Lease & Finance Professional, maintaining memberships in the American Institute of Certified Public Accountants, Illinois CPA Society, Equipment Leasing and Financing Association, Certified Lease & Finance Professional Foundation and National Equipment Finance Association.