The Little-Known Offset Bypass Refund

Certain taxpayers can receive refunds even if they have unpaid IRS debt

If a taxpayer has unpaid federal tax debts, the IRS typically offsets future refunds to pay down those debts. The statutory authority for the IRS to do this offset is §6402(a):

(a) General rule. In the case of any overpayment, the Secretary, within the applicable period of limitations, may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall, subject to subsections (c), (d), (e), and (f), refund any balance to such person.

However, it is essential to note that the statute says “may” and not “shall.” In Estate of La Sala, 71 T.C. 752 (1979), the Tax Court held that the estate tax marital deduction was not optional, relying on the word “shall” in conjunction with the legislative intent:

It is important to note that other refund offsets, such as past-due child support under §6402(c), use “shall” and are mandatory; the IRS has no discretion in these situations.

While the IRS has discretion on offsetting refunds toward unpaid federal taxes, its policy is to offset automatically by default. One exception is the offset bypass refund, or OBR; however, it is very limited as to who can use it and when to request it.

Offset Bypass Refund Overview

The IRS’s OBR policy is found in Internal Revenue Manual (IRM) 21.4.6.5.7.1 (10-01-2024), Offset Bypass Refund (OBR). IRM 21.4.6.5.7.1(1) states:

Under certain hardship circumstances, the IRS may issue manual refunds of excess credits without first satisfying the IRS Outstanding Balance Liability (OBL). This type of refund is called an Offset Bypass Refund (OBR). Hardship for purposes of an OBR is economic hardship within the meaning of IRC 6343, and the corresponding Treasury regulations (i.e., unable to pay basic living expenses). Handle each OBR on a case by-case basis. There is no exclusive list of expenses which would qualify a taxpayer for an OBR.

An OBR must generally be issued before the tax assessment date (i.e., the 23C date) for the original return (TC 150) on which the overpayment was reported. Therefore, time is of the essence: the IRS must be contacted immediately after the tax return is electronically accepted, and the OBR must be requested. Once the refund is applied to an outstanding federal tax debt, the OBR is unavailable.

Hardship under §6343 concerns when the IRS should release a levy. Treas. Reg. §301.6343-1(4)(i) states the following with respect to the hardship determination:

The levy is creating an economic hardship due to the financial condition of an individual taxpayer. This condition applies if satisfaction of the levy in whole or in part will cause an individual taxpayer to be unable to pay his or her reasonable basic living expenses. The determination of a reasonable amount for basic living expenses will be made by the director and will vary according to the unique circumstances of the individual taxpayer. Unique circumstances, however, do not include the maintenance of an affluent or luxurious standard of living.

Be prepared with specific financial information and documentation to demonstrate whether some or all of the refund amount qualifies for an OBR. Here is an example from IRM 21.4.6.5.7.1(14):

The taxpayer has an overpayment on their return showing $1,000. They have requested a hardship refund of $600 to avoid eviction. A review of their account shows a prior year tax liability of $500. If you decide to honor the hardship request for $600, you must treat $100 of the refund as an OBR. The remaining $400 overpayment offsets to the Federal tax debt.

It is essential to have the IRM provision available for reference when requesting an OBR to ensure the IRS representative handles the situation appropriately. It may be necessary to educate them on the existence of the OBR option.

A taxpayer can also use the IRS Taxpayer Advocate Service (TAS) to assist with an OBR. TAS posted an informative blog entry on the OBR process and how it can assist taxpayers.

Hardship Determination and IRS Collections

Taxpayers in financial hardship due to their income and/or expenses also typically qualify for currently not collectible (CNC) status for their unpaid IRS debts. This means the IRS will not expect payments, but the collection statute of limitations continues to run. See IRM 5.16.1.2.9 (03-03-2025) regarding the hardship determination for CNC status.

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