Can a Loan Judgment Take Your Taxes?

Ignoring payments on an unsecured loan may leave you subject to a lawsuit as the creditor attempts to recover what you owe. While the civil judgment a creditor receives from the court following a successful lawsuit gives it the ability to garnish some forms of income, most lenders do not possess the right to seize your tax refunds.

Facts

If you owe a secured loan, most states don't require that your lender file a lawsuit against you and seek a judgment before seizing the collateral you used to obtain the loan. Unsecured loans, however, don't provider lenders with any collateral. Thus, unpaid lenders must recover consumer debts through lawsuits. Without the court judgment from a lawsuit, most creditors cannot take legal action against you -- such as garnishing your bank accounts and wages. Even with a judgment, however, most lenders cannot garnish your tax refund.

Significance

The only loan judgment that can result in direct garnishment of your tax refund is a judgment from the U.S. Department of Education due to a defaulted federal student loan. Because you owe money directly to the federal government, the Department of Education will direct the Internal Revenue Service to withhold any refund you were scheduled to receive so that it may apply the money to your outstanding loan balance. Private loan holders, however, do not possess this privilege.

Prevention/Solution

Before the IRS withholds your tax refund, it will notify you in writing of the impending seizure. When this occurs, you can contact the guaranty office listed on the tax offset notice to contest the withholding. Grounds for contesting a tax offset include, but are not limited to: you suffer from a financial hardship, you already paid off your student loan, your student loan is no longer in default or the defaulted student loan was incurred as a result of identity theft.

Time Frame

You have a total of 65 days in which to contest the tax withholding after receiving formal notification. You also have the right to request a copy of your loan file that includes the loan's status and payment history. Should you request a copy of your loan file, you then have 15 days after receiving the file to contest the impending tax offset.

Warning

Although many forms of federal benefits, such as Social Security and military annuities, are exempt from bank account garnishment, once you deposit your tax refund money into your bank account it loses its exemption status. Thus, a private creditor with a judgment can apply for a writ of garnishment against your bank account and seize your tax refund directly from your bank.