We have previously discussed the mechanics of the advance credit, both in the original CARES legislation from last spring and also in the Tax Relief Act legislation from late last year. For a really good primer on the mechanics of all of this, I recommend the recently retired sage of tax procedure, Carlton Smith So, How Will the “Recovery Rebate” Refunds Work This Time? Part 1 and Part 2. In this post I will flag how things have changed a bit since Carl’s initial post, and also offer some brief observations on why the current status for individuals who are entitled to receive 6428/6428A credits when they file their 2020 tax returns puts people in a less favorable place than if they were fortunate enough to receive the advance payments.
As background, individuals who receive an advance payment or payments that exceed the amount of their eligible credit (as later calculated on the 2020 return) will not have to repay any of the payment. If the amount of the 6428 and 6428A credit as determined on the 2020 return exceeds the amount of the advance payment, taxpayers are entitled to claim the difference as a refundable tax credit on their 2020 returns.
There is an uneasy relationship between tax procedure and refundable credits. Typically (and I am simplifying here quite a bit) a refundable credit is treated as a payment for a particular tax year, and a taxpayer will have an overpayment if the sum of their payments and credits exceeds their tax liability for that year. Just because a taxpayer has an overpayment does not necessarily mean a taxpayer gets a refund, however. Section 6402(a) allows (but does not require) the IRS to offset any overpayment of one tax against any other federal tax debt; Section 6402(c), (d), (e) and (f) require IRS (through Treasury) to offset or apply the balance of any overpayment to certain defined other debts, including past due child support, and state income taxes and covered employment compensation debt.
In an off-Code part of the law, the original CARES legislation trumped the offset rules. CARES did not distinguish between advance payments and amounts that would be claimed later on 2020 tax returns. Essentially CARES said that IRS could not exercise its discretion under Section 6402(a) to offset the economic impact payments and amounts later claimed on 2020 returns against past due federal taxes, and also overrode the mandatory offset rules in Sections 6402(d)-(f), but preserved the mandatory offset for past due child support.
Fast forward to December and the Tax Relief Act.
Sec. 273(b) of the Tax Relief Act retroactively changes the off Internal Revenue Code provision found in CARES Act Sec. 2201(d). What are the changes? As I mentioned above the original CARES Act provided that BOTH the advanced credit that the IRS distributed in the spring (the original EIP) and any amount of the 6428 credit that was later claimed on the 2020 return was exempt from the IRS applying to past due federal income taxes or to all mandatory offsets (e.g., state tax debt, debt to other federal agencies), except for child support.
First the good news. The TRA provided some additional protection for the second round of EIP’s by providing protection from all offsets, including for past due child support. It also protected the second round of advance payments form bank garnishment or levy by private creditors and debt collectors.
That is the good, at least from the taxpayer perspective. What about the bad? The TRA now provides that the recovery rebate credit a taxpayer claims on a 2020 tax return (under both 6428 and 6428A) loses the protection from discretionary and mandatory offsets under Section 6402. It will also be applied to any unpaid current 2020 tax liability, a necessary step to determine if a taxpayer has an overpayment in the first instance. There is also no protection from garnishment or levy if a taxpayer is lucky enough to get a 6428/6428A fueled refund. So in sum, what IRS refers to as the “Recovery Rebate Credit” (the amount that is claimed on the 2020 return, rather than the Economic Impact Payments paid out in advance), is subject to ALL offsets, just like any other credit claimed on a tax return that generates an overpayment.
Congress’ decision to place these benefits in the tax code and also to attempt to ensure that the IRS deliver them to the majority of people before filing a 2020 tax return (or in some instances even in the absence of a return), raises a lot of procedural issues. In this brief post, I did not attempt to exhaustively discuss those issues, but to highlight some differences between the 6428 and 6428A mechanics and typical refundable credits, like the EITC and the Additional Child Tax Credit. The post suggests that there are significant substantive differences between the advance payment mechanism and the typical way that individuals receive benefits by claiming a refundable tax credit on a tax return. This brief discussion may also be of relevance as Congress considers the possibility of using the tax system in additional ways to deliver regular benefits in advance of (or even in the absence of) filing a tax return. How and whether benefits are offset ( and whether the IRS will facilitate or publicize the ability to request a bypass of offsets when taxpayers are experiencing hardship, a topic of recent comments submitted by the ABA Tax Section), as well as what happens when there may be changing circumstances when it is time to reconcile, are issues that will have a material impact on the effectiveness of any program that is tethered to the tax code.
For another day, and another post, are issues relating to how taxpayers prove eligibility for claimed refundable credits, especially given that eligibility proof for a benefit embedded in the tax code typically means a correspondence audit. As Congress possibly looks to the tax system to play a bigger role, how the IRS administers these provisions looms even larger in the welfare of some of the population’s most vulnerable.