Could Unpaid Debt Affect My Tax Refund?

Could unpaid debt affect my tax refund? Here are three reasons the federal government may hold onto your tax refund to cover unpaid debt.

With tax season upon us, many people may be looking forward to their refund as a way to pay down existing debts. However, certain existing debts could prevent you from seeing a refund at all.

Collections agencies to which you owe debts like a credit card balance or mortgage cannot intercept your refund, although they could seize it after it is deposited into your bank account.

The IRS can garnish your tax refund to cover debts you owe to a government agency, such as unpaid taxes or child support, says Bruce Caulk, a CPA with Naden/Lean LLC in Hunt Valley, Maryland.

At the federal level, the Bureau of Financial Services is legally obligated to notify you if your tax refund is being garnished, or withheld to cover existing debts. This notice will tell you what your refund would have been, how much has been offset, and where that offset is going.

Could Unpaid Debt Affect My Tax Refund?

Here are three reasons why the government may hold on to your refund:

1. Existing Tax Debts

If you owe the Internal Revenue Service for taxes you failed to pay in the past, you may not get a refund this year, Caulk says. The IRS could keep your refund to put it toward the debt, and it can also withhold the refund on behalf of your state government if you owe back taxes to your state.

If your tax debt is $25,000 or more, the IRS may place a lien on all of your assets, which can make it more difficult for you to get a mortgage or an auto loan, he says.

“That’s why remedying a tax liability is of the utmost importance, even if it’s just going on a payment plan,” Caulk says.

2. Child Support Debts

A taxpayer who fails to pay child support may also risk losing a tax refund, Caulk says. In addition to using your refund to pay such debts, some states impose other penalties until the debt is paid, such as suspending your driver’s license or preventing you from getting certain business licenses.

3. Nontax Federal Debts

Other debts owed to the federal government can also impact your tax refund. If you have defaulted on a federal student loan, your refund could be held to pay toward that debt.

If you’re unsure about whether an outstanding debt will impact your tax refund, contact the agency to which you owe money and discuss your situation, Caulk says. Many agencies may work with you to set up a payment plan.

“Step back and organize your finances and [develop] a plan of repayment,” Caulk says. It’s helpful to go to the agency with a proposed date for repayment.

If you don’t have assets with enough value to cover your debts, you may be able to come to an agreement with the agency to pay less than you owe.

“If you owe $50,000 and there’s no way you’ll ever be able to pay that off, you can offer to pay maybe 20 cents on the dollar and, as long as your financial situation supports that, [the government] may be able to accept that,” Caulk said. “You have to remain in compliance [with the payment plan] moving forward, but that’s one option for people who are truly financially distressed and only owe income taxes.”

Whatever you do, don’t ignore the debt, he says.

“Ignoring the issue is very foolish,” Caulk says. “It will never go away. There are mechanisms in place to collect that debt.”