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Note about changes due to COVID-19:
There have been changes to the federal student loan program as a part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) that passed in Congress on 3/27/2020 to help those affected by the Coronavirus.
Until September 30, 2021, borrowers have the option to suspend payments without penalty, if needed. Payments made on federal student loans during this time will first apply to unpaid interest accrued from before 3/13/2020, then directly towards the principal balance. In addition, no interest will accrue during this time—effectively setting the rate at 0%.
If you are pursuing Public Service Loan Forgiveness or forgiveness through an income-driven repayment plan, skipped payments will still count towards the monthly payments required to be eligible. The same is true for borrowers working to meeting student loan rehabilitation requirements.
Lastly, the government will not garnish tax refunds or money from other federal benefits of borrowers who are behind on student loan payments during this time.
Many of us look forward to tax refunds each year. A refund means you overpaid your taxes throughout the year, usually because of how your withholdings are set up. The IRS sends a refund to cover the overpayment.
However, in certain situations, such as defaulting on your student loans, your tax refund can be confiscated.
Why Can Your Refund Be Taken?
When you default on federal student loans, the U.S. Department of Education has the authority to garnish tax refunds based on the Treasury Offset Program. Default is defined as being behind on your payment by 270 days or more. The Offset Program authorizes federal payments to be garnished from tax refunds to pay debts owed to federal agencies. These payments can also include payments for Social Security, for example.
If you’re married and you file taxes jointly with your spouse, the IRS can also garnish both of your tax refunds, even if your spouse is not connected to your student loans.
For every year you’re in default, the IRS can continue to offset your taxes. There is no statute of limitations for federal loans.
Only federal student loans are subject to the Treasury Offset Program. For the U.S. government to take a tax refund, they have to do very little.
In contrast, lenders of private student loans must get court approval before taking action – like garnishing wages. Private lenders cannot seize refunds, although they can take collections actions sooner than the 270 days required in past due status before the federal government can. Some private lenders will start taking action after just one late payment.
If the IRS plans to take a tax refund, they will usually send a letter to the taxpayer notifying them of the garnishment and informing them about what steps they can take to avoid having their refund taken.
Can You Stop the IRS From Taking Your Refund?
If you’re in default on federal student loans, it’s unlikely that you can prevent the government from garnishing your tax refund. You can try to request a review to challenge the student loan tax offset, or you can agree to pay the debt.
If you request a review, you must prove your taxes shouldn’t be offset. Reasons you might think a hearing is the right option for you would be incorrect balances, you’re in a bankruptcy process, or your debt was discharged.
Another option is to pay the debt. This doesn’t necessarily mean that you have to pay a lump sum. You may be able to work out a payment plan with the U.S. Department of Education, such as an income-driven repayment plan or start student loan rehabilitation.
You can also try to refinance your student loans at a lower interest rate, though it is unlikely you will qualify if you’re already in default on your loans.
Deferment and forbearance are options available with federal loans in some cases. With these situations, borrowers may be able to stop making payments or have their payments reduced for a period. With a deferment, the interest is waived during the time payments aren’t being made.
In some cases even if a refund is taken, if the taxpayer can show financial hardship, they may get some of it back. Again, that’s rare.
Preventing Tax Offsets
If there is a possibility a federal student loan default could lead to a garnishment of a tax refund, the best thing to do is try to prevent it. You may be able to receive some money back through the student loan tax offset hardship refund.
First, you may want to adjust your tax withholdings. If you’re getting a large refund, you’re overpaying on your taxes throughout the year, and it’s a good idea to adjust your withholdings.
Beyond that, you’ll have to deal with the fact that you’ve defaulted on your loans.
Rather than waiting until a situation reaches a point where a tax refund is taken, borrowers should be proactive with their options like refinancing and enrolling in payment plans.
Author: Ashley Sutphin