Will the IRS Take Your Tax Refund If You Have a Defaulted Student Loan?

In the complex world of federal student loans and debt collections, the Internal Revenue Service (IRS) has two particularly powerful tools: the ability to withhold tax refunds and the power to garnish wages without a court order. These measures, among others, can lead to significant financial distress if a student loan falls into default.

Government Powers Over Defaulted Student Loans

When a student loan is in default, the government can take extraordinary actions to recover the debt. Here are some of the key powers the government holds:

1. Withholding Tax Refunds

The first and most direct way the IRS can seize funds from a defaulted student loan borrower is by withholding tax refunds. Any Treasury payments, including tax refunds, may be used to apply to the outstanding balance of a defaulted federal student loan. This means that a portion of your tax refund could be used to pay off your defaulted student loan. This measure applies not only to your regular income tax refund but also to other types of federal payments.

2. Wage Garnishment Without a Court Order

In addition to withholding tax refunds, the IRS can garnish up to 15% of your gross earnings without a court order. This means that a portion of each paycheck can be directly sent to the Debt Collection Center to pay off the defaulted student loan. This process is faster and can be significantly more invasive for the borrower than a court-ordered garnishment.

3. Making a Lawsuit Against Voluntary Default

The government can also sue for the debt if they believe there is willful intent to avoid payment. While this is rarely done, the threat is there. The government's actions are designed to prevent this scenario by offering various assistance programs for borrowers in financial distress.

Communicating with Your Loan Service Company

It is crucial to communicate with your loan service company to avoid these actions. By staying in contact and addressing any issues that may contribute to default, you can significantly reduce the likelihood of the government taking further actions against you. Ignoring the issue can lead to more severe consequences.

Sarcasm Alert

Let’s be honest, the government doesn’t offer a machine that simply drains the knowledge from your brain that you acquired in college. However, the collection process for student loans can certainly leave you feeling drained and financially strained.

Consequences of Defaulting on a Student Loan

Defaulting on a student loan is not just a matter of non-payment; it can have severe financial consequences. Here are some of the most significant negative impacts:

1. Destroyed Credit

When a student loan is in default, your credit score is severely impacted. A credit score of around 450 is common, and it can take years to recover. This low credit score can make it difficult to obtain loans for major purchases, such as a car or house.

2. Unpaid Loan as Income

The IRS considers the unpaid portion of your student loan to be income. As a result, you will receive a 1099 form for the unpaid balance, and you will owe taxes on it. This leads to an additional burden of paying taxes on money you have already failed to pay back.

3. Seizure of Assets

Both the IRS and the Department of Education can seize several types of assets to recover the defaulted loan, including:

It’s worth noting that the US government is not bound by state exemption laws, meaning they can seize assets that are protected from creditors in other contexts.

Absolutely, Any Federal Debt Can Be Paid by Your Tax Refund

Many types of debt, including federal student loans, can be paid off using a tax refund. This applies not just to student loans but also to child support in arrears and even personal debt like credit cards or mortgages. However, the tax refund must be used to clear federal debts first.

Intercept: The Legal Term for Tax Refund Seizure

When a tax refund is seized to pay off a delinquent federal student loan, it is called an intercept. This is a common occurrence, and the government has several other methods for collecting on defaulted loans if a tax refund is not available.

Bankruptcy and State Exemptions

Not everything can be seized by the government. In the case of bankruptcy, student loans generally cannot be discharged, but they can be repaid over a longer period. Additionally, state exemption laws prevent some assets from being seized, but the US government is not bound by these laws when it comes to federally owed debts.

Resolution and Early Payment

While not resolving a federal student loan early is expensive, it is possible to find ways to pay off the debt sooner. The government offers various repayment programs and assistance options, including income-driven repayment plans and loan forgiveness programs. Seeking these options can significantly reduce the financial burden and prevent further collection actions.

It’s important to recognize that defaulting on a student loan is not just a personal financial issue but a complex legal and bureaucratic challenge. By understanding the powers the government holds and the potential consequences, you can take proactive steps to avoid these serious financial consequences.