Your Tax Refund and Your IRS Payment Plan: Why the Refund Gets Kept and the Payment Is Still Due

Every spring the same call comes in. I'm on a payment plan. I've never missed a payment. Why did the IRS take my refund? And the follow-up: since they took $3,100, can I skip the next few months?

The answers are: because the law allows it and your agreement says so, and no. Here is the reasoning, and the narrow exception.

Why the IRS keeps the refund

IRC 6402(a) authorizes the IRS to credit an overpayment against any tax liability the taxpayer owes before refunding the balance. A payment plan does not turn that off. Treas. Reg. 301.6159-1(f)(3) lists actions the IRS may take while levy is prohibited because of an installment agreement, and the first one is crediting an overpayment against the liability under section 6402.

The IRS tells you this when the plan starts. IRM 5.14.1.2 instructs employees to inform taxpayers that federal tax refunds will be offset to pay overdue balances. The campus procedures in IRM 5.19.1.6.4.16 say employees must advise that any future refunds are applied to the balance due, regardless of the type of agreement. The IRS payment plans page says the same thing: future refunds are applied to your balance until it is paid.

The offset reaches further than some people expect. IRM 5.14.1.4.2 says refunds are subject to offset during agreements including refunds on individual income tax returns of people whose sole proprietorships or partnerships owe taxes and have agreements. If your business owes, your personal refund can be applied.

Why the monthly payment is still due

This is the part that catches people. IRM 5.19.1.6.4.16 states that offsets do not replace the monthly payment due. The IRS payment plans page says to keep making scheduled payments even if a refund is applied.

Think of it this way. The refund shortens the plan. It does not pause it. A $3,100 offset on a plan paying $400 a month removes roughly eight months from the end of the plan, less the interest that would have accrued. It does not give you eight months off at the front.

If you skip a payment because of an offset, that is a missed installment, and a missed installment is the first listed reason for default in IRM 5.14.11.3. A CP 523 follows. See what a CP 523 default notice means.

The order of offsets

If you owe more than one kind of debt, the order matters. IRM 21.4.6.4 says a tax overpayment must offset to an outstanding federal tax debt before it offsets against other debts or is applied to a credit elect. Federal tax debts come first. Other debts, such as past-due child support or certain federal agency debts, are handled through the Treasury Offset Program run by the Bureau of the Fiscal Service, not the IRS.

A credit elect is your choice to apply a refund to next year's estimated tax. If you owe a prior balance, the offset takes priority over that choice. Self-employed taxpayers who plan to cover the first estimated payment with a credit elect should know that if a balance is outstanding, the credit may never get there. Pay the estimate separately.

The hardship exception: offset bypass refunds

There is a narrow way to keep a refund. The IRS calls it an offset bypass refund. IRM 21.4.6.5.7.1 says that under certain hardship circumstances, the IRS may issue a manual refund without first satisfying the outstanding balance. Hardship here means economic hardship within the meaning of IRC 6343 and its regulations: being unable to pay basic living expenses. There is no fixed list of qualifying expenses; each request is handled case by case.

Timing is everything. The IRM says that once the tax on the return is assessed, the overpayment is created and the offset occurs, and there is no longer any overpayment to refund. Absent a clerical error, an offset bypass refund generally must be issued before the assessment date of the original return. If the request comes more than 30 days after that date and no clerical error occurred, the IRM tells employees to inform the taxpayer the offset cannot be undone.

That means the request has to be made early, generally around the time you file, and backed by documents showing the hardship and the specific dollar amount needed to relieve it. IRM 21.4.6.6.5 notes a taxpayer may submit Form 911, Request for Taxpayer Advocate Service Assistance, or request a hardship refund directly. The IRS cannot bypass an offset to child support or another federal agency debt under the Treasury Offset Program; only the agency owed can do that.

Planning around the offset

A refund is money you lent the government interest-free. While you are on a payment plan, that money goes straight to your balance. That is not a bad result, since it reduces interest and penalties. But it is not cash in your hand in April, and if your household budget counts on a refund, the plan and the budget will collide.

• Budget as if there will be no refund while the plan is running.
• If you are typically over-withheld by a large amount, consider whether a smaller refund and larger paycheck would make the monthly payment easier to keep. Do not swing so far that you owe next year; a new balance is its own default risk. See avoiding a new tax balance during your plan.
• If your refund was offset in error, for example to a period that was already paid or to the wrong taxpayer, contact the IRS promptly. Offsets can be reversed in limited situations described in IRM 21.4.6.
• If you are married and only your spouse owes, and your joint refund is offset to your spouse's debt, the injured spouse allocation on Form 8379 is the procedure to request your share.

Old refunds you never claimed

Offsets can work in your favor. If you skipped filing a year in which you were owed a refund, that refund can still reduce your balance, as long as you file before the refund statute of limitations runs out. IRM 5.14.1.4.2 tells employees that when a taxpayer may be due a refund that can still be credited within the refund statute, they should tell the taxpayer to file that refund return before the statute expires to reduce the balance on the agreement.

It is one of the few times a late return makes your payment plan shorter. If you have an unfiled year where your withholding was likely more than your tax, find out quickly whether it is still within the window.

When an offset pays the plan off

If a refund is large enough to cover the whole remaining balance, the plan is finished. Any amount left over after the balance is paid is refunded to you, subject to any other debts that can be offset. Watch for confirmation that the account shows a zero balance, and if you were on direct debit, confirm that the monthly draft has stopped. If a draft comes out after the balance is paid, the excess is an overpayment you can ask to have refunded.

Your annual statement shows the offset

Every year the IRS mails each taxpayer with an installment agreement an annual statement, CP 89, listing the beginning balance, the payments made during the year, the penalties, interest and other charges, and the ending balance. Section 3506 of the IRS Restructuring and Reform Act of 1998, as amended, requires that statement, and Treas. Reg. 301.6159-1(h) repeats it. A refund offset will show up there as a payment. Check it against your own records each year.

The offset is not a penalty for being on a plan. It is the IRS applying your money to your debt. The only mistake is treating it as a payment holiday. Keep paying, and the plan ends sooner.