How to stop student loans from taking your tax refund

There are ways to prevent a student loan tax offset but you'll need to be vigilant. (iStock)

Each year during tax season millions of Americans eagerly await refunds from the IRS. Over 70 percent of filers receive one and the average filer got back $2,869 in 2019, according to the IRS. For some Americans burdened with student loans, however, a refund may never come thanks to a student loan default tax offset.

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"A tax offset is when they take the money you were due as a refund from the IRS and, instead of you getting it, it gets sent to another group you owe money to," explained Joyce Turner, a CPA and partner at BNJ Accounting in Reading, Pennsylvania. "If you owe on student loans and have been ignoring them and haven’t made any arrangements, they can take your refund and offset the debt."

This is allowed under the Treasury Offset Program, but only when you've defaulted on loans made by the government rather than on private student loans. And an offset won't happen just because you fall behind on a payment or two. You have to be in default, which means your loan must be at least 270 days past due.

The good news is, even if you're that far behind, you may be able to stop the offset and reclaim your refund.

How can you stop a student loan default tax offset?

While the Treasury Offset Program allows the government to take your refund, they can't do so without notice. "They'll warn you before they take the money," Turner explained. Usually, a notification comes months before your refund is seized. When you receive it, you have 20 days to request a copy of your loan file from your servicer and you have the later of 15 days after loan information was mailed or 65 days from the initial offset notice to contest it.

If you want to stop the offset, you'll need to submit a Request for Review as instructed in the initial notification. You have to specify whether you want a review based solely on the information on your form, a telephone hearing, or an in-person hearing. If you want a hearing, you'll be required to explain why you believe it's necessary. And, if it's an in-person hearing, you'll have to cover your own travel expenses.

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Your Request for Review must specify a reason you're objecting to the offset and you'll need to provide documentation to back it up. One common reason is you've already entered into an agreement with the lender. "You can often set up a payment plan with the department you owe to avoid the offset," Turner explained. If you want to negotiate a plan with your servicer but aren't sure who it is, you can find out using the National Student Loan Data System.

You can also object if you don't actually owe the debt because it was fraudulently obtained under your name or if you're eligible to have it discharged for reasons such as school closure, total and permanent disability, or your school improperly certifying your eligibility. If you submit the proper documentation, you'll often be able to avoid the offset and get your full refund.

Just be sure your loan servicer has your current address, as notifications are sent to your last known location and you can't contest an offset simply because you didn't receive it.

Can you get back a refund that's been taken?

If you're not successful in stopping the student loan default offset, you could lose the entire amount of your refund if you owe at least that much on your loans. And you have just a few options to recover your money once that happens.

If you've actually paid the loan or the offset was taken in error, you should contact the Department of Education. If it turns out you didn't really owe, you'll get your money back. If you were actually in default, you could also recover your funds by applying for a hardship refund. This will be successful only in limited circumstances, though, such as when you're in the process of declaring bankruptcy that includes the loan.

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Finally, if your refund was seized because of your spouse's defaulted student loans, you also have options. "If you file jointly with a spouse and didn't know they owed, you could sometimes get innocent spouse relief," Turner said. You'll need to submit Form 8379, Injured Spouse Allocation, to try to get your share of the refund.

What should you do if you can't get your tax offset refunded?

Not everyone qualifies for relief from a student loan default tax offset. If you don't, you could face the loss of your refund check this year and in subsequent years until your debt is repaid. The good news is, there are some options to get out of default so you won't face this fate.

One is to pursue loan rehabilitation, which is available once per borrower and involves coming to a written agreement with your lender to make reasonable payments. You'll need to make at least nine required payments consecutively over a 10-month period and your payment amount will be based on your income. After you've successfully done that, the record of the default will be removed from your credit report.

You could also consolidate your loans using a Direct Consolidation Loan, but only after voluntarily making three full payments on your defaulted debt. After consolidating, you can choose an income-driven payment plan to reduce your payments and you'll be able to take advantage of federal borrower benefits such as deferment and forbearance. However, the record of the default will remain on your credit history.

Finally, you have the option to pay the loan off in full. Finding the money to do this can often be impossible. But if you can qualify for student loan refinancing from a private lender, you can use a refinance loan to pay off your defaulted debt. Chances are good you'll need a cosigner to qualify if your own credit has been hurt by your default, though -- and you'll lose access to federal borrower protections by converting your federal loans to a private one.

Don't lose your tax refund due to student loan default

If you're struggling to pay back your student loans, you aren't alone. For many, financial stress begins even before graduation. And while some companies offer student loan repayment assistance, many grads don't get this support and are left to figure out how to pay thousands on their own. If you're having trouble making payments, looking for a solution is of paramount importance as the potential loss of your tax refund is just one of many serious consequences you face if you default on your student debt.