IRS Could Give Tax Credits, Only To Confiscate Them

The government could seize child tax credit of defaulted student loan borrowers

Worried mother looks at laptop screen on coffee table with toddler on her lap
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Early next year, millions of financially struggling parents behind on their student loans could receive large tax credits only to see the IRS immediately seize them.

Key Takeaways

  • Monthly payments of the newly expanded child tax credit are protected from being seized to pay overdue government debts, but the tax-time credit of as much as $1,800 per child is not.
  • Consumer advocates say this distinction could hurt the very families the child tax credit expansion was meant to help most, and are calling for a fix.
  • One potential solution reportedly under consideration would be for the government to expunge defaulted borrowers’ records of missed payments. 
  • Conservatives have long argued against forgiveness or other remedies they say discourage fiscal responsibility and aren’t fair

Unless the current rules are changed, here’s why. The monthly payments that many parents have been getting because of this year’s expanded child tax credit are exempt from the IRS’s usual policy of taking tax refunds when things like back taxes, child support, and defaulted federal student loan payments are due. But no such exemption was made for the half of the 2021 credit—worth up to $1,800 per child—that’s being delivered at tax time, or for those who chose to receive the entire credit then, instead of in monthly installments.

Plus, the federal government’s freeze on student loan obligations is set to expire at the end of January—in the middle of tax season—and that freeze has been protecting those with defaulted loans from collections.

The potential financial blow against the most vulnerable families—the very same ones that the new child tax credit was intended to help most—could be stopped, said Abby Shafroth, an attorney for the National Consumer Law Center, an advocacy group for low-income consumers. Lawmakers could change the law or President Joe Biden could clean the slate for defaulted borrowers by expunging their records of missed payments, she said. The White House is considering the latter option behind the scenes, according to a report by Politico on Monday that cited documents it obtained and unnamed sources familiar with the plans.

“The people in default on federal student loans are the people who are demonstrably in financial distress,” Shafroth said. “We’re slamming not just them but their children.”

While it’s not clear who opposes making the 2021 tax-time credit exempt from seizure, conservatives have long argued that loan forgiveness and other leniency toward borrowers would discourage financial responsibility, encourage colleges to hike costs even higher, and effectively force people who didn’t attend college or chose a less expensive school to subsidize people who overspent on their educations. 

Specifically, intercepting the tax refunds of low-income borrowers in default, along with wage garnishment, can mean borrowers with smaller balances are able to fully pay them off within a couple of years, according to a 2018 paper by the American Enterprise Institute, a conservative think tank.

An Irony in the Current Structure

Since the pandemic started, though, many government policies, especially under the Biden administration, have been about government assistance. The American Rescue Plan pandemic relief bill made several changes to the 2021 child tax credit aimed at turning it into a tool to reduce child poverty. It increased the maximum credit amount to $3,600 from $2,000 per child (depending on the age of the child and income of the family,) extended eligibility to families who previously made too little money to claim a tax offset, and authorized half of it to be delivered as monthly payments starting in July.

Because people who default on student loans are more likely to come from a low-income background—just the families the government is most eager to help with the tax credit—there is an irony in the current structure of the law enabling seizure of the money, Shafroth said. 

Eighty-seven percent of students who default on their loans (meaning they haven’t made a payment in 270 days) were recipients of need-based Pell Grants, while 40% came from the bottom 25% of all households by income, according to one analysis by the Center for American Progress, a progressive think tank.

Millions of households with children could have their remaining tax credit seized at tax time. Almost 9 million federal student loan borrowers are in default, according to data from the Department of Education. And about 27% of all defaulted borrowers had at least one child, according to a separate study published in 2017 by the Center for American Progress. 

Meanwhile, just the advanced monthly payments are projected to lift an estimated 1.76 million out of poverty, according to a study by the Urban Institute think tank earlier this year.

Seizure of the tax credit would be an especially harsh blow for those who opted, for one reason or another, to take the entire refund at the end of the year instead of receiving the monthly payments for half of it. 

“For folks who haven’t been receiving advance payments, that’s a lot of money,” Shafroth said. “And it’s especially a lot of money to families that are living in poverty. It’s money that would otherwise be lifting millions of children out of poverty, but would instead go to the Department of Education unless action is taken very soon.”

Have a question, comment, or story to share? You can reach Diccon at dhyatt@thebalance.com.