Absent bankruptcy, the federal Treasury Offset Program (“T.O.P”) allows the IRS to offset a non-tax debt owed by a taxpayer to a federal agency against a federal income tax refund owed to the taxpayer. See 26 U.S.C. §6402. The right of offset (aka “setoff”) allows entities that owe each other money to apply their mutual debts against each other, thereby avoiding the absurdity of making party A pay party B when party B owes party A.
The IRS’ Treasury Offset Program authorizes the Secretary of the Treasury to intercept a taxpayer’s tax overpayment and apply it to preexisting debts. Section 6402(a) of the US Tax Code provides that the Treasury “may” credit a taxpayer’s income tax overpayment against any tax liability. Whereas, §6402(d) provides that Treasury “shall” credit a taxpayer’s income tax overpayment against a non-tax debt owed to another federal agency other than the IRS.
However, a taxpayer objected to the IRS intercepting a tax refund in the bankruptcy case of In re Addison, 533 B.R. 520 (Bankr. W.D.VA 2015). There, the taxpayer argued that the US Bankruptcy Code’s automatic stay provisions of 11 U.S.C. §362(a)(7) prohibited the IRS from offsetting the tax refund against the non-tax liability owed by the taxpayer to the US Department of Agriculture, which related to a mortgage foreclosure deficiency. The IRS countered and argued that §362(a)(7) did not apply because it was superseded by 11 U.S.C. §362(b)(26)’s negation of the automatic stay for setoffs by the IRS.
The Addison court rejected the IRS’ argument and held that §362(b)(26) did not apply to the facts of this case because §362(b)(26) only applied when the IRS was setting off tax debts owed to the IRS. In the Addison case, the IRS was setting off non-tax debts owed to the US Department of Agriculture. Specifically, the court stated §362(b)(26) constrains the reach of the automatic stay by excepting from violating the automatic stay the setoff under applicable nonbankruptcy law of an income tax refund…against an income tax liability. (emphasis added).
Practice Pointer: The IRS has broad tax intercept powers to collect debt on behalf of the federal government. However, these powers are not unlimited. In the bankruptcy concept, the IRS has the power to intercept tax refunds to offset tax liability relating to a taxable year that ended before the bankruptcy filing date, but the IRS does not have the power to intercept tax refunds to offset non-tax liability owed to other departments of the US Government.
For follow-up questions, contact attorney Robert V. Schaller by clicking here.