Court Blesses Offset Before Pandemic When Later Filed Return Would Have Been Treated Differently

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In Seto v United States the Court of Federal Claims held that it was permissible to apply a taxpayer’s 2019 federal income tax refund to offset defaulted student loans dating back nearly 30 years. In the case, Seto argued that Treasury unlawfully offset the refund because if he had filed his 2019 return later in the filing season, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) financial relief provisions would have precluded offsets. The case offers a relatively rare judicial consideration of the Treasury Offset Program, and illustrates how some taxpayers who filed returns prior to the pandemic were left worse off than those who filed after Congress and federal agencies administering debts subject to offset provided financial relief.

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The opinion discusses how Seto had approximately $170,000 in student debt, with about $95,000 of that principal, stemming from loans that began in the early 1980’s. The opinion details Soto’s struggles to make payments, leading eventually to a default notice that identified the possibility that any future tax refunds would be applied or offset to the delinquent education debt. In late 2018, the Department of Education informed Soto that it had referred the delinquent debt to the Treasury’s Offset Program, which applies federal payments to differing debts owed to federal and state agencies, including delinquent student loan debt.

In January of 2020, Seto filed his 2019 tax return, and that return reflected an overpayment of $9,228, with almost $8,000 of that due to a claimed Investment Tax Credit for the purchase and installation of a solar energy system.

The IRS processed that return in mid-February 2020, BC (Before COVID).  After the IRS processed the return, it authorized the refund which passed through the IRS filters since Seto had no outstanding federal tax debt.  The refund then moved from the IRS to the Bureau of Fiscal Services for payment which required it go through the TOP filters prior to payment.  Because of the outstanding student loan on the books at TOP, Treasury (aka the Bureau of Fiscal Services) applied the refund to the delinquent student loan debt.

A month or so after, Congress passed CARES. CARES provided taxpayers relief from offsets of CARES payments other than those attributable to delinquent child support. The problem for Seto was that CARES did not go into effect until the President signed the bill into law on March 27, 2020, two months after he filed and about a month after the IRS processed his return.  He also had a problem that the offset by TOP resulted from a regular tax refund and not a CARES economic impact payment.  Nothing in the legislation protected regular tax refunds though neither Seto nor the court focused on this distinction.

Not surprisingly, when Seto heard about the CARES offset relief, he responded by asking for his money back. When that did not happen, he sued, claiming that the offset violated his due process rights. The Court of Federal Claims considered his pro se complaint as an illegal action case, as the due process clause is not money-mandating and thus is generally outside its jurisdiction.

Why was this not a refund suit? From a tax procedure standpoint, when IRS reviews a return and applies an overpayment, no basis exists for a refund suit.  Subsequent to the application, the IRS either applies the refund to a past due federal tax debt or approves the refund for payment causing it to go through the TOP filters where it is applied to the myriad other federal and state debts that qualify for the Treasury Offset Program (for more on this you can check out Keith’s article on offsets here  or an extensive subchapter in Saltzman and Book, IRS Practice & Procedure Chapter 14A.)  The offset to a separate debt after allowance of the refund causes the refund to lose its relationship to the year where the overpayment arose. 

What about when someone is unhappy with the offset? IRC 6402(g) generally insulates Treasury and IRS from legal actions to restrain offsets. 

Despite that protection, the court addressed whether it was appropriate for the offset to occur, especially given that Seto would have been entitled to receive his money if he had simply filed his return two months later.

The IRS processed his return and applied his refund to offset a portion of his outstanding student loan debt on or before February 20, 2020, when Mr. Seto was formally notified of the government’s action. Nothing in the CARES Act states or clearly suggests that the student loan temporarily relief provisions applied retroactively. Absent such statutory language, courts cannot construe laws and implementing regulations to have retroactive effect. Hicks v. Merit Sys. Prof. Bd. ,819 F.3d 1318, 1321 (Fed. Cir. 2016) (“Retroactivity is not favored in the law and congressional enactments and administrative rules will not be construed to have retroactive effect unless their anguage requires this result. Accordingly, we will construe a statute to avoid retroactivity unless there is clear evidence that Congress intended otherwise.”) (cleaned up). Consequently, the enactment of the CARES Act has no bearing on Mr. Seto’s illegal exaction claim.

Conclusion

I have not dug deeply into the file, but the CARES relief provisions the court refers to were directed at Economic Impact Payments and not all claimed overpayments on taxpayers’ 2019 returns.  Barbara Heggie discusses this, and the March 25, 2020 Department of Education’s decision to halt requests for offset, in her April 2020 post Refunds, Offsets & Coronavirus Tax Relief. There are two different offset relief provisions at play and Seto needs the Department of Education relief to protect him and because of the timing of his refund it did not.  So I do not think that CARES has much direct bearing on the legality of the offset, but the Education policy came into effect only two days before then-President Trump signed CARES into law. The opinion notes as well that Seto did receive a couple of thousand dollars of the claimed overpayment due to a processed innocent spouse claim; I suspect that the court means injured spouse, with some of the overpayment likely attributable to Seto’s spouse.

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Super useful post, Les. Thanks for explaining the path that an overpayment takes before it can end up in a taxpayer’s hands.

  2. Omeed Firouzi says

    The Education Department pause on student loan payments and offsets was also retroactive to 3/13/2020, the date the national emergency began. So if the return had been filed just a couple weeks later, Seto may have been in the clear: https://www.dpi.nc.gov/media/7857/download

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