In the case of Hadsell v. United States, 127 AFTR2d 2021-808 (N.D. Cal. 2021) the taxpayer sought to apply a relatively large refund to his subsequent year’s tax liability at a time when he had an arrearage in child support. Instead of allowing him to apply the refund as a payment toward the subsequent year’s liability, the IRS offset the refund against the past due child support. Mr. Hadsell did not contest the fact the IRS did this nor the timing of its notification to him of the offsetting of his refund. Acting pro se, he brought an action to set aside the offset and to obtain damages for wrongful collection. The IRS moved to dismiss for lack of subject matter jurisdiction.
read more...Mr. Hadsell timely filed his 2016 return, electing to carry forward a $9,547 refund to 2017. On July 9, 2018, over a year later and after he filed his 2017 return, the IRS notified him that it had taken the 2016 overpayment and applied it to outstanding child support obligations. He had some liabilities in the subsequent year returns he attributed to the failure to carry forward the 2016 overpayment as he requested and to notify him in a timely manner.
The IRS argues that IRC 6402 both allows the offset in (a) and prevents a judicial review of it in (g). Section 6402(b) also sets out the provision for crediting an overpayment toward the estimated tax payment for a subsequent year. Section 6402(c) specifically allows, indeed requires with no discretion available to the IRS, offset of an overpayment to satisfy certain non-federal tax debts including past due child support. While the IRS has discretion to waive offset against federal debts, as we have discussed here in describing the offset bypass refund provisions, subparagraph (c) removes the discretion if debts exist which the Treasury Offset Program (TOP) covers.
In addition to arguing the mandatory nature of the offset, the IRS argued that section 6402(g) precludes court review of offsets with its sweeping language of prohibition:
[n]o court of the United States shall have jurisdiction to hear any action, whether legal or equitable, brought to restrain or view [reductions to a taxpayer’s overpayment]
The court acknowledged the breadth of the statutory language regarding court review of offset and acknowledged that applying the offset to non-tax debt did not give rise to a claim for damages under IRC 7433, citing Ivy v. Commissioner, 197 F. Supp. 3d 139, 142 (D.D.C. 2016), aff’d 877 F.3d 1048 (D.C. Cir. 2017). The court notes that any disputes Mr. Hadsell has regarding the past due child support must be fought with the child support agency and not the IRS.
The court finds, however, that although Mr. Hadsell has little maneuvering room with respect to the offset, he also raised issues regarding his 2017 liability that resulted in large part from the timing of the IRS offset – or at least its notification of the offset. He claims that the IRS accepted his carry forward election, citing to Martin Marietta Corp. v. United States, 572 F.2d 839, 842 (Fed. Cir. 1978) which held that
If a taxpayer, such as plaintiff, elects to credit an overpayment to its succeeding taxable year’s estimated tax liability, that election is irrevocable and binding upon both the taxpayer and the Internal Revenue Service.
The court raises concerns that the IRS may have irrevocably accepted the credit election to carry forward the overpayment. Neither party cited authority on this point. At what point in time does the credit election become irrevocable? Since the parties did not adequately address this aspect of the case, the court does not dismiss the section 7433 claim.
It’s easy to understand why someone with outstanding child support would try to make the election that Mr. Hadsell made and attempt to save for himself the value of the overpayment rather than allow it to pay down his past due obligation. Feelings can run high regarding child support payments. I once had a clinic client who stopped filing returns because he did not want the refunds to go to his ex-spouse for past due child support/spousal support payments.
I have seen taxpayers attempt to use the credit elect carryforward of a refund to attempt to skirt the bankruptcy provisions for payment of past due debts and seek to pass the benefit of the credit to themselves rather than the creditors. See, e.g., In re Feiler, 218 F.3d 948 (9th Cir. 2000) (deeming debtor’s prepetition waiver of a NOL carryback avoidable by the trustee as a fraudulent transfer); United States v. Kapila, 402 B.R. 56 (S.D. Fla. 2008) (same).
While it’s clear why a taxpayer wants to preserve the refund for themselves by pushing it forward to apply to a future tax liability of the taxpayer and it’s easy to see why the IRS, or TOP, would want to apply the overpayment to a past due tax or other debt subject to TOP, the issue of the timing of the offset action as it relates to the government’s ability to effect the offset appears novel. Did the filing of the subsequent year return prior to the time of the offset serve to cut off the government’s right to offset. Could it have waited even longer? Did it have an obligation to notify the taxpayer before the next filing season so that the taxpayer would not rely on the election and enter a cycle of problems similar to the problems that a levy could cause to a bank account with a host of bounced checks resulting?
It will be interesting to see how the court decides to limit the government’s ability to offset and whether there is or should be a time limit on the right that would otherwise exist. We have recently updated Saltzman and Book, Chapter 14A (behind WestLaw paywall) to create a much expanded discussion of offset. Michael Waalkes and I have just posted an article on SSRN walking through many of the issues raised by offset, including some of the issues presented by the CARES Act with its statutory waiver of almost all offset provisions as discussed here, here and here.
After declining to dismiss the wrongful collection claim brought under IRC 7433, the court did dismiss the Federal Tort Claims Act (FTCA) count in Mr. Hadsell’s complaint. The court pointed out that the waiver of sovereign immunity in 28 U.S.C. 2680 under this provision contains an applicable exception for “[a]ny claim arising in respect of the assessment or collection of any tax.” While the offset funds went to pay past due child support and not taxes the claim arose out of the IRS’s mechanism for assessing and collecting taxes and falls within the statutory exception provided in FTCA.
The law of unintended consequences, again. From a tax policy perspective, the only difference between underpaying or overpaying taxes in a year should be whether you have made in interest-free loan to the government that you get back on April 15 or you owe interest on the underpaid amount. Assuming that the taxpayer does not have a pressing need for the money along the way or investment opportunities whose return exceeds the underpayment interest rate, the taxpayer’s optimal path is to pay exactly the right amount. However, it is not always possible to calculate that in advance, and especially in a low-interest-rate environment many taxpayers prefer to overpay or leave a refund as a credit for the next year rather than have to pay interest at a higher-than-normal rate to the government. But that changes if the taxpayer is subject to TOP; the taxpayer has an incentive to err on the side of underpaying, which hurts the government and the taxpayer, and in any event leaves nothing for the TOP obligation. Same as if you live in a state or city teetering on the verge of bankruptcy, you may decide that you are are better off underpaying taxes than hoping for a refund.