Individual Income Tax Insights: Oregon Tax Court Says ‘No’ to State Refund Offset for Spouse’s Federal Student Loan Debts

The growing student debt crisis has been the subject of much discussion over the last several years. As of Dec. 31, 2016, the total outstanding amount of federal student loan debt in the United States was almost $1.3 trillion, according to data compiled by the U.S. Department of Education.[1] In addition to this massive burden on graduates, another problem is the default rate. As of September 2016 (the end of the fiscal year), over 10 percent of the total outstanding student loan debt was either in default or 90 days or more past due, according to USA Today. Student loans that are either delinquent or in default can have some unexpected consequences come tax time. Taxpayers should be aware that some states are working with the federal government to offset state income tax refunds in order to satisfy student loan debt.

One of the ways the U.S. Department of Education recovers delinquent student loan debt is through the Treasury Offset Program through the U.S. Department of Treasury’s Bureau of the Fiscal Service, which allows federal payments (like income tax refunds) to be offset by debts owed to other federal agencies. Through the State Reciprocal Program (SRP), the federal government and state governments offset their own payments (including tax refunds) by the debts owed to either. This means that individuals expecting a refund of state income tax overpayments may be not-so-pleasantly surprised with a Notice of Refund Offset instead of a check.

For joint filers, the SRP can be especially harsh: a state department of revenue may offset one spouse’s federal student loan debt with the refund due to both spouses. That was the exact issue in six cases that the Oregon Tax Court decided on February 24.

In Smith v. Dep't of Revenue, No. TC-MD 160196N, 2017 BL 57612 (Or. T.C. Feb. 24, 2017), the plaintiff-taxpayer appealed the Oregon Department of Revenue’s decision to offset her Oregon income tax refund to pay a federal student loan debt. The plaintiff was the sole earner of the household income and had filed a federal injured spouse allocation. The student loan was solely the plaintiff’s spouse’s obligation. The department argued that “pursuant to its reciprocal agreement with the U.S. Department of the Treasury [and related federal regulations[2],] . . . it was required to offset [the p]laintiff’s 2015 Oregon income tax refund to pay her spouse’s debt to the U.S. Department of Education.”  The Oregon Tax Court denied the department’s motion for summary judgment and held that the taxpayer-plaintiff was entitled to a full refund. The court’s rationale was that because the plaintiff’s refund was not “owed jointly” to both spouses, but rather “owed solely” to the plaintiff, it could not be offset to pay a debt which “belonged solely to [the] plaintiff’s spouse.”

The Oregon Tax Court decided five other cases with either the same or similar issues on February 24. In Towe v. Dep't of Revenue, No. TC-MD 160241N, 2017 BL 57592 (Or. T.C. Feb. 24, 2017) and Johnson v. Dep't of Revenue, No. TC-MD 160266C, 2017 BL 57601 (Or. T.C. Feb. 24, 2017), the issues were exactly the same as in Smith and ended in the same result. The court reached the same result in Carpenter v. Dep't of Revenue, No. TC-MD 160288G, 2017 BL 57579 (Or. T.C. Feb. 24, 2017), even though both taxpayers had earned income during the tax year at issue and there was an additional federal tax debt involved.

Interestingly, the two other similar cases that were decided on the same day reached essentially the same result, but for a totally different reason: the Department of Revenue “failed to appear.” See Gooding v. Dep't of Revenue, No. TC-MD 160248C, 2017 BL 57574 (Or. T.C. Feb. 24, 2017) and Robertson v. Dep't of Revenue, No. TC-MD 160279C, 2017 BL 57964 (Or. T.C. Feb. 24, 2017).  Because the department provided no evidence that there was a reciprocal agreement with the U.S. Department of Treasury, the court found in favor of the taxpayers.

The fact that all six of these cases were decided the same day shows quite clearly the position of the Oregon Tax Court on these types of offsets. As more federal student loans become either delinquent or in default, we will likely see many more state taxing authorities and state judicial systems grappling with this issue.

Do you think taxpayers filing joint returns with their spouses should have their state income tax refunds offset to pay their spouse’s defaulted or delinquent federal student loan obligations? Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn.

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[1] The data from the National Student Loan Data System is compiled at the end of each quarter. This number represents the total as compiled through Q1 of FY2017.

[2] 31 C.F.R. § 285.6(k)(1)(i) requires that “[i]f a payment is owed jointly to more than one payee, the entire payment shall be offset for a debt of either payee, unless otherwise prohibited by law or regulation.”