Unemployment tax refunds may be seized for unpaid debt, taxes and student loans

  • The IRS is sending unemployment tax refunds starting this week. The American Rescue Plan waived federal tax on up to $10,200 of unemployment benefits, per person, collected in 2020.
  • But the federal government may use those funds to offset one's past-due debts and back taxes.
  • Private debt collectors may also try to seize the cash once it hits bank accounts.

The IRS will start issuing tax refunds on unemployment benefits this week. But some people may see a smaller refund — or none at all.

The lesser amounts will apply to those who have past-due debts, like federal and state taxes, child support, student loans and unemployment benefits that were paid in error, according to the IRS. The federal government can use tax refunds to offset overdue bills.

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In the private sector, funds may be garnished by third-party creditors (like banks, for past overdraft charges) once they hit a taxpayer's bank account, according to Nina Olson, executive director of the Center for Taxpayer Rights.

(Garnishment is a court order that allows for funds to be removed from someone's account.)

"This is no different than any other kind of government refund," said Janet Holtzblatt, a senior fellow at the Urban-Brookings Tax Policy Center.

Unemployment tax break

The American Rescue Plan waived federal tax on up to $10,200 of unemployment benefits, per person, collected in 2020.

Many taxpayers had filed their tax returns before this break became available. President Joe Biden signed the relief bill on March 11.

The IRS is automatically issuing refunds to those who overpaid their federal tax liability as a result. The agency identified more than 10 million taxpayers who may be eligible.

It's issuing refunds in two phases, which will continue through the end of summer, the IRS said Friday.

The first phase starts this week for single taxpayers with the "simplest" returns. They include returns filed by taxpayers who didn't claim children or refundable tax credits, the IRS said.

"This first group will be relatively small, but we will ramp up as we go," according to an agency spokesperson.

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However, the federal Treasury Offset Program allows up to 100% of a tax refund to be seized to pay debts owed to federal or state agencies, according to Erica York, an economist at the Tax Foundation. (This applies to government agencies, not private debt collectors.)

It's unclear how a pause in federal student-loan payments through September may affect the government's ability to seize a tax refund. The Department of Education didn't respond to a request for comment by press time.

Private creditors can also access tax refunds once deposited into a bank account, depending on state laws, York said. That may apply to private debts, such as medical bills or credit card debts, subject to a court order.

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The IRS is issuing the refunds via direct deposit for those who provided bank account information on their 2020 tax return. (The funds will be mailed as a paper check to the address of record if that information isn't available.)

Banks must obey court-ordered garnishment and state garnishment laws unless Congress exempts a specific payment from garnishment, according to a banking industry source.

Congress had exempted stimulus checks received since March 2020 from being seized by government agencies, according to Olson. (Child support was an exception for the first round of payments, she said.) However, that same protection isn't available for unemployment tax refunds.

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