Offsetting State Tax Returns for Unpaid Local Taxes

It’s that time of year when taxpayers are dreaming about what to do with their tax refunds.  But, for some taxpayers, those dreams will disappear due to an offset.  An offset is the reduction or withholding of a payment due to a prior debt.  For years, the IRS has had an offset program to take money from federal refunds to pay off a taxpayer’s debt.  Usually the offset is for unpaid federal taxes, state taxes, federal student loans or child support.  Many states have had similar offset programs for years.  More and more cities are also getting in on the action.  And, the states are taking steps to make it easier on them.

Detroit Partnering with Michigan For State Tax Refund Offsets

In December 2018, Michigan passed a bill to help cities collect unpaid local income taxes.  Unpaid city taxes administered by the state can be offset by the state.  So, instead of receiving their full state refund, a taxpayer may receive a reduced amount, or nothing at all.

The Michigan offset program requires a city to enter into an agreement with the state.  Detroit was the first city in Michigan to enter into an agreement.  The Michigan Department of Treasury provides administration, enforcement, and collection functions for Detroit’s city income tax.  Under the agreement, an income tax debt administered by the state is now automatically taken from a taxpayer’s state tax refund.  So, that would include unpaid Detroit city income taxes.

This change is expected to increase administrative costs.  However, those increases are expected to be dwarfed by the expected city income tax revenue increases.

Offset Programs in Other States

Many states have state tax refund offset programs.  However, the states vary widely on what types of debts can be offset.  Qualifying debts are generally those owed to the federal government or the state government.  Ohio has a pretty typical offset program.  The program allows the offset of income tax refunds for:

  • delinquent taxes to Ohio or the IRS;
  • miscellaneous debt to the Ohio Attorney General’s Office;
  • premium payments to the Ohio Bureau of Workers’ Compensation; and
  • back child/spousal support or public assistance payments to Ohio and Family Services.

In California, their program is a little bit more robust.  The Franchise Tax Board administers the offset program.  It is called the Interagency Intercept Collection Program.  It began in 1975 and has expanded since then to not only include personal income tax refunds, but also lottery winnings and unclaimed property tax payments.  In 2017, California’s program collected $344 million for over 500 agencies.

California allows tax refund offsets for debts from:

  • the State of California;
  • cities, counties, or special district districts in California; and
  • state colleges, community colleges, or other post-secondary educational institutions.

And, debts owed to the cities and counties are not just limited to taxes.  Localities can collect on all different types of unpaid bills.  Qualifying debts include:

  • property taxes;
  • delinquent fines;
  • bails;
  • parking tickets; and
  • court-ordered payments.

Where Offset Programs for Unpaid Local Taxes Are Headed

There are still states that have offset programs, but don’t include unpaid local taxes as an option to offset. One example that falls under this category is Colorado. If the current trend continues, though, soon there won’t be any states that don’t offset unpaid local taxes.

As technology has improved, the ability for different taxing agencies to work together has improved, too.  States now use secure file transfer systems for localities to submit confidential taxpayer information over the Internet.  The systems have become more and more automated.  State tax departments no longer have to conduct searches to find a match in their system.  Instead, as soon as the locality uploads their list of delinquent taxpayers into the state’s system, the computer automatically finds the matches and produces the offset.

So, clearly Michigan isn’t breaking new ground with their recently enacted law allowing the state to offset for local unpaid taxes.  But, it is going along with the trend of states helping municipalities to go after unpaid local taxes more aggressively.

Localities that partner with their state are reaping the rewards.  But, first it’s on the state to have laws on the books allowing for the off-set of unpaid local taxes.  And, then it’s on the state to set-up an offset program that automates as much of the process as possible.  As this happens, more and more localities will enter into offset agreements with their state. The sooner each state gets a system that can simplify and automate offsets for unpaid local taxes, the greater the windfall will be for each municipality.

And, there will be a greater number of taxpayers seeing their dreams of a big tax refund go right down the drain.

By Noelle Erber, J.D.

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All stories by: CCHTaxGroup