Refunds, Offsets & Coronavirus Tax Relief

We welcome back guest blogger Barbara Heggie. Barb is the Coordinator and Staff Attorney for the Low-Income Taxpayer Project of the New Hampshire Pro Bono Referral System.  A shout out goes to Silya Shaw for alerting readers of the Pro Bono and Tax Clinics listserv to the Department of Education action discussed below.  Les is also adding a new section on offset to Chapter 14A of the treatise “IRS Practice and Procedure” where you can soon find additional resources regarding offset issues.  This is the first of three posts discussing offset issues in this special time. Keith

For most low-income, working families, tax season is a time of hope – hope for paying off bills, getting caught up on rent, fixing the car, and maybe even signing up for that certificate program promising a better wage. This is because the Internal Revenue Code provides thousands of dollars in refundable credits for such families if they have “qualifying children,” including the earned income credit and additional child tax credit. For a family with three children under age seventeen and a household income around $20,000, the federal tax refund can amount to over $9,000.          

But what if there’s a federal tax liability from a prior year clouding the family’s financial picture? Perhaps someone was an independent contractor and didn’t pay sufficient self-employment taxes. Maybe someone completed a Form W-4 incorrectly and wound up grossly under-withholding. What will happen to the family’s current-year tax refund?            

And what about the new stimulus money – the “economic impact payments” – meant to help people get through the coronavirus crisis? Will this family see any of that money? What if jobs are lost and savings depleted because of this emergency? Does that make a difference?

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The short answers are: (1) the “normal” refund will probably be offset to pay down the prior-year tax debt, unless the family succeeds in securing a discretionary “pass” from the IRS, known as an offset bypass refund; and (2) the economic impact payment will probably still come, so long as there’s no child support arrearage on the books for the family’s taxpayers.

Section 6402(a) provides that the Secretary of the Treasury Department “may credit the amount of [a person’s] overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment.” (This is accomplished through the Treasury Offset Program.) Thus, the IRS may offset a person’s refund to pay down an old federal tax debt. The choice of the word “may,” rather than “shall,” means that Congress left an “out” for taxpayers; the Secretary doesn’t have to offset the refund.

The Internal Revenue Manual spells out how the Secretary should exercise this discretion, whether directly through the Internal Revenue Service (IRS) or by way of the Taxpayer Advocate Service (TAS). The mechanism for exercising the discretion is an offset bypass refund (OBR) which, in turn, depends on a showing of financial hardship. According to Internal Revenue Manual (IRM) 13.1.24.6.2.2.1, “Hardship for this purpose is economic hardship within the meaning of IRC § 6343 and the regulations thereunder (i.e., unable to pay basic living expenses).” IRM 21.4.6.5.11.1 stresses, “Handle each OBR on a case by-case basis. There is no exclusive list of expenses which would qualify a taxpayer for an OBR.”

Professor Keith Fogg blogged about OBRs for Procedurally Taxing in December 2015 and spelled out the mechanics of this tool. Traditionally, the amount of the refund offset that is bypassed via the OBR is limited to the precise amount that the taxpayer can document is needed in order to avert a specific financial catastrophe. Take the example of someone with a $3,000 federal tax liability for 2018 and an expected 2019 refund of $2,500. If the taxpayer requests an OBR and presents an eviction notice based on past-due rent of $1,000, the IRS might approve an OBR in that amount, assuming the taxpayer has also shown a lack of available assets to cover the back rent. Thus, the taxpayer would receive $1,000, and the IRS would use the remaining overpayment of $1,500 to credit the 2018 account. If the taxpayer also provided documentation of past-due medical bills, a utility shutoff notice, and an estimate for necessary vehicle repair – and if those totaled more than $1,500 – the IRS could issue a manual refund of the whole $2,500 overpayment.

But what if you can’t provide such documentation because a pandemic comes and your state issues a stay-at-home order and closes non-essential businesses, and you’re laid off and you lose Internet service? Are the traditional forms of proof necessary to secure an OBR? No, according to new guidance from TAS. A recent TaxNotes article published this guidance, TAS-13-0320-0008; it urges case advocates to consider the likelihood that a taxpayer’s ability to provide documentation of financial hardship may be impaired because of the unique circumstances and challenges of the coronavirus emergency. The guidance also reminds advocates of an important tool at TAS disposal whenever documentation can’t be secured, pandemic or no:

IRM 13.1.24. 6.2, Advocating for Taxpayers Seeking Offset Bypass Refund, clarifies when TAS can advocate for an OBR and, after an offset has occurred, when TAS can advocate for the reversal of the offset.

Many taxpayers seeking an Offset Bypass Refund will not have access or the ability to secure hardship documentation such as eviction notices, late bills, etc. Determine whether the taxpayer can validate the hardship circumstances through oral testimony or a third-party contact. If so, discuss the case with your LTA to determine if a written statement signed by the LTA confirming that the hardship was validated is appropriate. See IRM 3.17.79.3.3(2), Issuing Hardship Refunds, and IRM 3.17.79.6.4.2, Certifying Automated Clearing House (ACH)/Direct Deposit Hardship Refunds.

(Emphasis added.) The cited IRM provisions provide that a letter from the LTA verifying the existence of a hardship can take the place of third-party documentation.

But what if the federal tax debt isn’t the taxpayer’s only debt governed by section 6402 and the Treasury Offset Program? While Congress made the offset for federal tax debt discretionary, the Code section requires offsets for child support arrearages, non-tax federal debts, unpaid state income tax, and unemployment compensation debts. IRM 13.1.24.6.2.2.2 thus concludes: “This means that the IRS has no discretion to bypass one of those debts.” Moreover, “the IRS has adopted a policy of not issuing an OBR when the taxpayer has both a federal tax debt and any other type of debt for which offset is authorized by IRC § 6402.”            

Interestingly, section 6402(e)(2) provides that an offset for a state income tax debt is permitted against a person “only if the address shown on the Federal return for such taxable year of the overpayment is an address within the State seeking the offset.” Thus, a current New Hampshire resident who incurred both a federal and a Vermont state income tax liability for 2018 might qualify for an OBR in 2020 on a 2019 overpayment.

Despite the statutory mandate for the IRS to offset the nontax debts listed above, other federal agencies have the discretion to halt any refund offset originating from debts they hold. For example, the Department of Education announced on March 25, 2020, that it “has stopped all requests to the U.S. Treasury to withhold money from defaulted borrowers’ federal income tax refunds, Social Security payments, and other federal payments.” Given the economic magnitude of the pandemic, the Education Secretary went even further and “directed the Department to refund approximately $1.8 billion in offsets to more than 830,000 borrowers.” Perhaps the IRS and TAS will issue new guidance clarifying that an OBR may be granted if the taxpayer has both federal tax and student loan debt.

And now, finally, what about the economic impact payments – the stimulus money – promised by the CARES Act? Are they subject to offset to pay down federal or nonfederal debt? With the exception of child support arrearages, the answer is no.

Section 2201(a) of the CARES Act inserts a new section 6428 into the IRC, mandating the payment of these “recovery rebates,” subject to income limits and phaseouts:

  • $1,200 ($2,400 in the case of eligible individuals filing a joint return), plus
  • an amount equal to the product of $500 multiplied by the number of qualifying children (within the meaning of section 24(c)) of the taxpayer.

(See here, here, here, here, and here for extensive discussions in Procedurally Taxing of these provisions, their possible implementation, and the concerns they generate.)

Section 2201(d) of the CARES Act, entitled “Exception from Reduction or Offset,” spells out a broad prohibition against offsetting the economic impact payments to pay down federal and nonfederal debt:

Any credit or refund allowed or made to any individual by reason of section 6428 of the Internal Revenue Code of 1986 (as added by this section) or by reason of subsection (c) of this section shall not be –

            (1) subject to reduction or offset pursuant to section 3716 or 3720A of title 31, United States Code,

            (2) subject to reduction or offset pursuant to subsection (d), (e), or (f) of section 6402 of the Internal Revenue Code of 1986, or

            (3) reduced or offset by other assessed Federal taxes that would otherwise be subject to levy or collection.

The one exception is provided by omission; section 2201(d)(2) of the CARES Act lists IRC section 6402(d), (e), and (f), but not 6402(c). The first three subsections concern offsets of nontax federal debt, state income tax debt, and unemployment compensation debt, respectively; subsection (c) governs offsets of overpayments for child support arrearages.

Thus, economic impact payments/recovery rebates/stimulus checks cannot be offset to pay any debt except child support. “Normal” federal tax refunds remain fair game in the absence of an OBR, but OBRs may be slightly easier to come by in these coronavirus times.

Taxpayer Protection Program Sidesteps Right to Representation

We welcome guest blogger Barbara Heggie. Barb is the Coordinator and Staff Attorney for the Low-Income Taxpayer Project of the New Hampshire Pro Bono Referral System. In the most recent Annual Report to Congress, the National Taxpayer Advocate identified the high false positive rate associated with the IRS’s fraud detection systems as the fifth most serious problem affecting taxpayers. The IRS took steps to improve its refund fraud program for the 2019 filing season; the results were not fully in at the time of the National Taxpayer Advocate’s 2020 Objectives Report. In today’s post, Barb walks us through a recent false positive case from her clinic. She identifies IRS procedures that pose a high barrier to successfully passing through the verification process, particularly for taxpayers who need assistance from a representative. Barb suggests the IRS ought to make changes to comport with a taxpayer’s right to representation. Christin

I had my first encounter with the IRS’s Integrity & Verification Operations (IVO) function last month. It did not go well.

I had prepared a 2017 return a few weeks earlier for a disabled, fifty-something client in recovery from substance abuse, and he’d been anticipating receipt of a small overpayment. His main source of income that year had been Social Security, but he’d also had a few hundred dollars in wages. His payroll withholding, plus a bit of the Earned Income Credit, had added up to an early fall heating bill here in New Hampshire.

Instead of a refund notice, we each received a copy of a Letter 4883C from the IVO Taxpayer Protection Program; his return had been flagged, and he needed to verify his identity. Given this client’s severe anxiety concerning the IRS, I studied the letter and prepared to make the call alone. I anticipated no issues; I had all the documentation the letter required, including the flagged return, the prior year’s return, and all supporting forms and schedules for each.

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Once on the line with IVO, however, things quickly got strange. Following the preliminary, “normal” authentication, the customer service representative (CSR) asked me to answer these questions three: “What is your client’s place of birth? What is his mother’s maiden name? And what is his father’s middle name?” I had none of this information and have never asked such things of my clients, save for the place of birth for an ITIN application. I don’t collect birth certificates as a matter of course.

Interestingly, Letter 4883C did warn of “questions to verify your identity” – but then listed the documents to have on hand. Hence, I believed those documents would be the basis for the verification questions. The letter “encourage[s]” the client “to be available . . . on the call” with an authorized representative, but it fails to explain why that might, in fact, be essential.

Had I studied more than the 4883C letter, I would have realized that the call would involve “high risk authentication procedures,” necessitating “Additional Taxpayer Authentication.” IRM 21.1.3.2.3(2); 21.1.3.2.4(2); 25.25.6.4. Once in the land of Additional Taxpayer Authentication, the caller is subject to the TPP HRA IAT disclosure tool; that is, the Taxpayer Protection Program High Risk Authentication Integrated Automation Technologies Disclosure tool. IRM 25.25.6.4(2). This tool, in turn, generates a series of authentication questions for the taxpayer, the answers to which cannot easily be guessed by anyone else, including the taxpayer’s authorized representative. Tantalizingly, the IRM provides a long list of possible questions to ask in the ITIN identity theft context – possibly the same as those asked of SSN holders – but they’re all masked against public consumption. IRM 25.25.6.4(8).

Thus, if I had thought to read the IRM before placing the verification call, I wouldn’t have had a clue what questions might be asked. But I would have realized the futility of making the call without my client on the line.

And, so, I flunked the call. When I explained my client’s situation and offered to call right back with the answers, the CSR informed me that I had already used up my “one chance” to resolve the issue “the easy way.” The two hard ways were: (1) attending an in-person meeting with the client at a Taxpayer Assistance Center (TAC), or (2) verifying his identity by mail. Both methods required the authentication documentation originally requested, as well as two forms of identification. The CSR stated that he was making the mail-in option available to my client only because of his severe anxiety.

My client did, eventually, verify his identity at a TAC with the help of a volunteer attorney who was kindly working with him to reduce his anxiety about the IRS. Fortunately, both the client and the volunteer had only a few minutes’ drive to reach the TAC. But conversations with practitioners on the ABA Low-Income Taxpayer Clinic (LITC) listserv reminded me that this is often not the case. To receive a legitimately-claimed refund – already months late – a rural client may need to jump through ever-more burdensome hoops, such as an unpaid day off from work and an expensive tank of gas.

Clients lacking English fluency doubtless find further barriers standing in their way in such a system. One LITC colleague recalled an incident with IVO in which she and her low-English client participated in the call together via speaker phone, yet the CSR forbade this attorney from speaking for her client. Other LITC staff have recounted similar experiences. All such scenarios seem contrary to the authentication provisions of IRM 25.25.6.3.1(3)(1), which explicitly states that “the POA is authorized to act on behalf of the taxpayer.”

My client’s identity verification scenario was arguably less egregious than these. Moreover, in the context of the enormously costly, vastly complex problem of identity theft, overbroad rule-writing is understandable, if not optimal. Getting it right is as difficult as it is critical. And yet, as retired National Taxpayer Advocate Nina Olson wrote in her June 20, 2019, NTA blog post, “the soundness and effectiveness of any tax administration is measured by the trust its taxpayers have that they will be treated fairly and justly.” Overbroad IRM provisions can lead to an erosion of this trust in the system – a system which relies primarily on voluntary compliance.

More particularly, the procedures that led to my authentication difficulty violate the client’s right to retain representation. The right to retain representation implies, of course, the right to have a representative speak and act for the taxpayer. Any limitation on this right should come with justification, such as the need for a taxpayer to sign certain documents under penalties of perjury. Even then, the taxpayer holds the right to authorize a representative in certain exigent circumstances. See 26 CFR 1.6012-1(a)(5).

In the case of an IVO identity verification, IRM 25.25.6.3.1(3)(1) has the practical effect of limiting the representative’s authority, but without justification. This provision directs the CSR to “follow all instructions in the IRM as if the POA is the taxpayer.” (Emphasis added.) However, because the POA is not, in fact, the taxpayer, the POA cannot answer questions specifically designed to be answerable solely by the taxpayer. Thus, this IRM provision deprives the taxpayer of the chance to have a representative resolve the identity verification issue. Given the misleading nature of Letter 4883C, a taxpayer and representative may lose their “one chance” to make a speedy verification over the telephone and instead be forced to do so in person at an IRS office.

Security concerns provide no justification for this provision. A high level of security can be maintained by asking the representative to answer such questions as only the representative can answer. After all, the only two people addressed in a Letter 4883C are the taxpayer and the representative. And, presumably, if the IRS knows your client’s place of birth, mother’s maiden name, and father’s middle name, the IRS has the same information on you. As Sir Galahad discovered – alas, too late – the only correct answers to personal questions are your own personal answers.

The right to retain representation is part of the Taxpayer Bill of Rights (TBOR), found in IRC §7803(a)(3) and IRS Publication 1. As last year’s Facebook case emphasized, however, Section 7803(a)(3) specifies that various “other provisions” of the Code afford these rights. Thus, the Facebook court concluded, “no right was a new right created by the TBOR itself.” Rather, TBOR is more concerned with training and management of IRS employees, according to the United States District Court, N.D. California, San Francisco Division. Keith Fogg takes the discussion a few steps further in his forthcoming Temple Law Review article:

Perhaps more important than litigation is the role TBOR can play in shaping policy decisions at the IRS. It could play a major role in the regulations issued and in the sub-regulatory guidance that governs everyday life at the IRS. . . TBOR also has a role to play in internal discussions at the IRS which shape so much of the administrative process. If TBOR can alter the culture at the IRS to incorporate taxpayer rights as a major component of each policy decision, it will become an important part of tax administration whether or not it becomes an important part of litigation.

Several discussions on this topic can be found in Procedurally Taxing here, here, and here.

It may be that a bit of policy-shaping and culture-altering may come of the authentication tribulation my client and I experienced. I submitted a request on the representation issue in the Systemic Advocacy Management System (SAMS), #41352, and got a sympathetic reply from the analyst assigned to it. After a couple of weeks, she reported back that the issue had been elevated to the Revenue Protection Team, with the goal of finding ways “to make the system move more smoothly.” Moreover, she said, the issue would be added to the CSRs’ training package. With luck, all changes will be made with an eye to TBOR.