IRS Offset Program

The offset provisions are found in IRC 6402. The basic rule is that the IRS may offset any refund due to a taxpayer against any outstanding federal tax debt. I use the word “may” because the IRS does have some discretion in deciding whether to offset and that discretion manifests itself in the offset bypass refund (OBR) program discussed previously that allows certain individuals with a hardship to obtain all or a portion of their refund despite having outstanding federal tax debt. The OBR procedure will not, however, allow a taxpayer to bypass the offset of their refund against one of the other debts included in agreements with the IRS such as child support, student loans or state tax obligations.

The TIGTA report naturally focuses on problems with the IRS offset program rather than other state and federal debts and identifies a few problems. It is interesting to look at the problems because in doing so we also learn more about how the program works. Most of the problems involve situations in which the offset crosses some boundary, e.g., offsetting a Form 1040 refund against a business debt. Because of the amount of money involved and the ease of collecting through offset rather than other enforced collection methods, solving these problems should be a priority for the IRS. The report focuses on the years 2011 to 2013. For those years the amount of the offset from individual refunds to individual debts averaged about $7 billion – a decent amount of money. The report did not talk about this type of offset very much because it is routine and the offset process works well here.

I would like the IRS to send a notice when it makes an offset that says something like, “You filed a return claiming a refund of $X which the IRS has allowed; however, you are not receiving your 2015 income tax refund of $X because we took $X to pay off your outstanding income tax liability for 2014 in the amount of $Y. Even though we applied $X to your 2014 liability, you still owe $Z for 2014.”  This type of offset is an in house offset that does not need to go through Treasury’s Financial Management Services. The IRS controls the information. It should provide the taxpayer as much information as possible so the taxpayer can plan for the future and can explain the problem in detail should they go for assistance concerning the debt. I would especially like it if the letter to provide more detail when the refund is offset to a non-IRS liability such as a student loan. I would like the letter to say “you are not receiving your 2015 income tax refund of $X because we have offset that refund to partially satisfy your obligation on your student loan. After the offset of your 2015 refund, your student loan has an outstanding balance of $Y.” I know I live in a dream world and this was not the focus of the TIGTA report but it would be nice to focus a bit on the information provided to the person whose refund is offset. By providing detailed information about what has happened, the individual will be better prepared to deal with the consequences of the offset.  I can only say that at the clinic we have a number of clients who come in each year seeking to find out what happened to their refund and it takes some digging to find out.  The IRS does provide some data but I would like it to provide more.

The report focuses on the problems the IRS is having making offsets of individual refunds to pay off business tax debts. The IRS cannot take an individual refund and apply it to pay off the debt of a corporation in which the individual owns stock but can offset the individual refund against a business debt of a sole proprietorship. For example, if I am due a refund of $X for 2015 and my sole proprietorship failed to pay employment taxes for 2014 of $Y, the IRS can take my refund and apply it against the employment taxes of the sole proprietorship. The dollar amounts of the individual income tax refunds of offsets of this type are much smaller than the offsets of individual refunds to individual liabilities. The amounts ranged from $16 million in 2011 to just under half that in 2013. TIGTA identified that the IRS misses many refund opportunities for offset here because “the IRS’s current process does not effectively identify sole proprietors with business tax debt.” The businesses use an EIN for the employment tax returns rather than the SSN of the sole proprietor. The IRS must match the EIN against its database in order to find the corresponding SSN. TIGTA identified 53,672 individual taxpayers who received approximately $74.5 million in tax refunds in 2013 that could have been offset. The IRS is using a process developed in the 1980s and TIGTA recommended use of a new process that would capture the data necessary to effect these offsets. The IRS agreed but said that to do so would require resources it did not currently have. Consequently, it does not sound as though this change will happen anytime soon.

I do not know the priorities of the IRS. This is low hanging fruit. It requires programming changes which requires computer resources. The use of the resources would eliminate the need for some resources in ACS or field collection to get back the money the hard way. This seems like a good catch by TIGTA and something that should go relatively high on the IRS list of changes it should make. Putting resources in capture money it already has instead of working hard to get a taxpayer to pay over money would always seem like a high priority item.

In addition to the problem of capturing refunds to satisfy the sole proprietor debts of individuals for employment taxes, TIGTA identified problems in capturing refunds when the liability for the debt is coded non-master file instead of master file. We should do a post on how the IRS classifies its accounts and explaining more about the distinction between master file and non-master file. I welcome input from a guest blogger on this issue. In broad terms, most accounts start in master file but sometimes unusual things happen on an account which requires that the IRS move the debt to non-master file accounts. Non-master file accounts can be hard to monitor for the IRS and create confusion when a taxpayer or a representative looks at a master file transcript for a period with known liabilities and sees a zero balance due because the account has transferred to non-master file status. The problems that plague individuals looking at these accounts also impede the IRS when it seeks to make an offset and TIGTA found numerous examples, some with large liabilities, in which the IRS failed to make an available offset. In some of these accounts the taxpayer owed a fair amount of money. The IRS agreed with TIGTA and has taken steps to correct its system to capture these refunds although with respect to some accounts additional programming is needed and may take some time to complete.

TIGTA found that in some instances the IRS offset refunds of individuals and used the money to satisfy the liabilities of limited liability (LLC ) companies. TIGTA identified $780,474 in incorrect offsets. LLCs are distinct from sole proprietorships and the offset in this situation was wrong. Interestingly, the IRS agreed to fix this problem and send refunds to the effected taxpayers. Contrast this with its action concerning low income taxpayers against whom it assessed hundreds of thousands of penalties incorrectly, according the Tax Court, where the IRS refuses to fix its mistake. The IRS seems willing to fix mistakes it (including TIGTA) finds but less willing to fix mistakes found by courts even though it concedes it will not litigate the issue further.

This TIGTA report bears at least a skim if you have concerns about the offset of your client’s funds because it provides some detail on the process. This is an efficient process that could become even more efficient in the future.