How to reclaim your refund after a student loan tax offset
A tax refund offset can occur if you’re in default on federal student loans.
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Stephanie Colestock has more than 11 years of experience in personal finances. Her work has been featured by MSN, CBS News, Credit Karma, and USA TODAY Blueprint.
Updated October 16, 2024, 2:35 AM EDT
Failure to make federal student loan payments on time can spark what’s called a tax refund offset, which allows the government to step in and collect any income tax return you may be due. But if Uncle Sam takes your tax refund to pay your defaulted loans, you may be able to get the money back if you can prove financial hardship.
Here’s what you need to know about a student loan tax offset hardship refund.
- What is a student loan tax offset?
- What is a student loan tax offset hardship refund?
- What are the eligibility requirements for a tax offset hardship refund?
- How to request a student loan tax offset hardship refund
- How to avoid a student loan tax offset
What is a student loan tax offset?
When federal student loan borrowers fall behind on their loan repayment, the Department of Education allows the government to recoup the debt in other ways. This most often occurs as part of the Treasury Offset Program, or TOP.
The TOP allows the government to offset, or withhold, certain benefits and government-issued funds from individuals, businesses, and other entities who may owe money to the federal government. In many cases, this includes delinquent student loan borrowers. Eligible payments that can be seized through the TOP include income tax returns, Social Security benefits, federal wages, and more.
If your federal student loans go into default, you could receive a delinquent debt notice from the lender directly. Lenders are required to provide this tax offset notice to the loan holder at least 60 days prior to submitting the debt to the TOP. Upon receipt of this notice, you’ll have the option to pay the debt, dispute the debt, or negotiate a payment agreement for the balance.
If the debt remains delinquent with no resolution for 120 days, the agency will forward it to the offset program. The debt will then be entered into the Bureau of Fiscal Service’s database, where it will trigger an offset if a government payment agency attempts to send you money.
This means that if you’re expecting an income tax refund this year and have fallen behind on your federal student loan payments, the government could withhold your refund instead to cover your federal loan delinquencies.
How the pandemic deferment affects student loan tax offsets
The federal government paused federal student loan payments in March 2020 in response to the COVID-19 pandemic. Since then, eligible borrowers have seen 0% interest and no payments on their federal student loan debt. The U.S. Department of Education also paused collection activities on any defaulted loans at that time, so delinquent borrowers didn’t have to worry about offsets.
But payments will soon be resuming, along with collection efforts on any defaulted federal loans. For borrowers who were previously in default — or who can’t afford to make their payments moving forward — a tax offset can be a real concern.
What is a student loan tax offset hardship refund?
Even if you’re delinquent on your federal student loan debt, you may still be able to keep your income tax refund or other government payments. To do so, you’ll first need to apply for an offset hardship refund.
If approved by the lending agency, a hardship refund may enable you to still receive a portion of your federal income tax refund, if not the entire amount. You’ll still owe on your defaulted loans, but your government payments won’t be withheld to satisfy the delinquent debt.
What are the eligibility requirements for a tax offset hardship refund?
In order to qualify for a tax offset hardship refund, you’ll need to meet certain criteria or be able to demonstrate financial hardship. Some eligibility requirements include:
- You have an open bankruptcy filing.
- Your loan was forged, and you were the victim of identity theft.
- You’re on permanent disability.
- You’re already making payments as agreed, per your repayment agreement.
- There was an error with your loan(s) and you’re not actually in default.
- Your loan is eligible for discharge because your school has closed down.
If your spouse is actually responsible for the tax offset, you may be able to request your share of a tax refund by filing IRS Form 8379 as an injured spouse. This doesn’t mean either of you are physically injured. It just means that a tax offset of your joint return would be damaging to you even though the debt wasn’t yours.
How to request a student loan tax offset hardship refund
If you default on your federal student loans, or were in default before the government began pausing payments, you may wish to request a student loan offset hardship refund before your income tax refund (or other payments) are withheld.
Follow these steps to request a student loan tax offset hardship refund:
- Contact the TOP at 800-304-3107 to find out exactly which agency holds the delinquent debt(s).
- Reach out to that agency directly to see if there are any programs or payment arrangements to get your loan out of default or avoid additional missed payments.
- To file for an offset hardship exception, you’ll likely need to fill out a form from your loan servicer.
- Your servicer will want to know the reason for your hardship and why you believe that you’re eligible for an exemption. Expect to provide evidence of your hardship, including utility disconnection statements, eviction notices, proof of homelessness, or proof of exhausted unemployment benefits.
How to avoid a student loan tax offset
The easiest way to avoid a tax offset is to pay your federal student loans on time and as agreed. But this isn’t always possible, and hardships may arise that prevent you from being able to make your monthly loan payments.
If you’re struggling to pay your federal debt and want to avoid a student loan default, here are a few options to explore.
Request deferment or forbearance
Federal student loans offer forbearance and deferment options for borrowers who are temporarily unable to make their regular monthly payments.
With forbearance, your loan payments will be suspended or reduced for a specific period of time, though the balance will continue to accrue interest. With deferment, federal loan payments will be postponed temporarily if a hardship exists. But eligible loans won’t accrue additional interest charges during a deferment period.
Keep in mind that if you‘re looking to have a portion of your debt forgiven after a certain number of payments as part of a student loan forgiveness program, the months spent in deferment or forbearance typically don’t count toward your required time frame.
To apply for either deferment or forbearance, contact your federal student loan servicer.
Income-driven repayment plans
An income-driven repayment (IDR) plan allows you to adjust the monthly payment on your eligible federal student loan(s) so that it’s affordable. IDRs ensure that your monthly student loan payments don’t account for a significant portion of your income.
The Department of Education offers four different IDR plans to choose from, depending on the types of federal student loans you have: Income-Based Repayment (IBR), Income-Contingent Repayment (ICR), Pay As You Earn (PAYE), and Revised Pay As You Earn (REPAYE).
The required monthly payment amount on these plans typically ranges from 10% to 25% of your discretionary income, though some borrowers may have no payment at all. And take note that the required payment may adjust up or down if your income changes in the future.
To apply for an IDR plan, contact your loan servicer.
Federal consolidation loan
Loan consolidation may help you reduce your monthly student loan payment and simplify the process.
If you have federal student loan debt, you may be able to apply for a Direct Consolidation Loan. This will combine all your eligible federal student loans into one loan, with a single interest rate that will be a weighted average of the rates on your consolidated loans. You’ll have one monthly payment and only one account to keep track of.
For more information about Direct Consolidation Loans, or to apply online, visit the Federal Student Aid website.
Refinancing into a private student loan
If your loans aren’t eligible for consolidation or you also have private student loan debt, you may consider refinancing your federal loans, private loans, or a combination of both into a new private student loan. These are offered by private lenders, each with their own eligibility requirements, loan terms, and interest rates.
Refinancing federal loans into private loans means the loss of certain federal loan benefits, such as IDR plans and Public Service Loan Forgiveness (PSLF). So keep that in mind before you move forward. But private loans may offer lower interest rates in some cases, which could save you money on your loan repayment in the end.
If you choose to refinance your student loan debt into a private student loan, it’s important to shop around and compare lenders to make sure you’re getting the best possible rates for your situation.
Adjust your tax withholding
If you’re concerned about losing your tax refund to an offset, you may want to consider whether you should be getting a taxpayer refund in the first place.
Getting a tax refund is the result of a tax overpayment throughout the year. You essentially gave Uncle Sam an interest-free loan all year, and he’s returning the money to you come tax time.
Most of us could think of better ways to use those funds, especially if you have student loans in default. It may be wise to adjust your tax withholdings so that you’re paying as close to your exact tax bill as possible. This allows you to keep more of your money in your pocket during the year, and there won’t be a refund to be offset in the first place.