The average taxpayer gets a tax refund of about $2,500 every year because they have too much tax withheld from their paychecks. If you’re in this group, you probably expect the full amount of your overpayments refunded to you when the IRS processes your tax return. Unfortunately, this is not always the case. The Treasury Department can and does deduct certain types of unpaid debts from your tax refund. Such a deduction is called a tax refund offset.

The unpaid debts that can be deducted from your refund include:

  • unpaid child support.
  • state income tax.
  • student loans.
  • debts owed to federal agencies for reasons other than taxes.

Moreover, starting in 2014, individuals who are assessed a penalty for failing to comply with the “Obamacare” health insurance mandate can have the penalty deducted from their tax refunds. These penalties can be substantial. They will be phased over the next several years as follows:

  • for 2014, the penalty is the greater of $95 or 1 percent of income.
  • for 2015, the greater of $325 or 2 percent of income.
  • for 2016 and later, the greater of $695 or 2.5 percent of income.

A tax refund offset is the only means the IRS will have available to collect these Obamacare penalties.

Tax return offsets are handled by the Treasury Department’s Financial Management Service. FMS will take as much of your refund as is needed to pay off the debt and send it to the agency you owe. Any portion of your refund remaining after offset will be paid to you.

You will receive a notice from FMS if an offset occurs. The notice will include the original tax refund amount and your offset amount. It will also include the agency receiving the offset payment and that agency’s contact information.
 If you believe you do not owe the debt or you want to dispute the amount taken from your refund, you should contact the agency that received the offset amount, not the IRS or FMS.

What if you filed a joint tax return, but the unpaid debt was owed solely by your spouse, not you? Obviously it wouldn’t be fair to deduct your spouse’s debt from your portion of the tax refund. To avoid this, you may request your portion of the refund by filing IRS Form 8379, Injured Spouse Allocation. The FMS will compute your share of the tax refund and pay it to you. If you lived in a community property state during the tax year, it will divide the joint refund based upon your state’s community property law.

The fact that you owe a debt to a government agency doesn’t necessarily mean your refund will be offset. The agency you owe must submit the debt to FMS for an offset. You can contact the agency with which you have a debt, to determine if it has been submitted for a tax refund offset. You may call FMS at 800-304-3107 for the agency’s address and phone number.

The fact that your tax refund can be used to pay such debts is yet another reason why it is unwise to overpay your taxes by a substantial amount during any given year.

Stephen Fishman is a tax expert, attorney and author who has published 18 books, including “Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants,” “Deduct It,” “Working as an Independent Contractor,” and “Working with Independent Contractors.” He welcomes your questions for this weekly column.

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