Can You Sue the IRS for Holding Your Refund?

Waiting for a tax refund that the Internal Revenue Service (IRS) has delayed can be frustrating, especially when those funds are needed. While taking legal action against the IRS may seem like a solution, it is a path governed by strict federal rules. It is possible to sue the IRS for a held refund, but this option is only available after a taxpayer has fully exhausted all required administrative remedies. The process is complex and requires careful navigation of legal requirements before a lawsuit can be considered.

Common Reasons the IRS Holds Tax Refunds

A delay in receiving a tax refund can happen for several reasons. One of the most frequent causes is a manual review to verify the accuracy of the information on the tax return. Discrepancies between the taxpayer’s data and information reported to the IRS by employers or financial institutions can trigger this hold while the agency resolves the inconsistencies.

Another reason for a hold is the Treasury Offset Program (TOP). This federal program is authorized to intercept a tax refund to pay off other outstanding debts, such as past-due federal tax liabilities, overdue child support, other federal agency non-tax debts, or certain state income tax obligations. If your refund is subject to an offset, you will receive a notice from the Bureau of the Fiscal Service detailing the offset.

The IRS may also flag a return due to suspected identity theft. If the agency’s filters detect unusual activity, such as a tax return filed with a Social Security number that has already been used, it will freeze the refund. Resolving this requires the taxpayer to verify their identity, which can add considerable time to the refund timeline.

A more intensive reason for a hold is a formal audit or examination. If your return is selected for an audit, the IRS will not issue the refund until the examination is complete and any proposed changes to your tax liability are resolved. A refund may also be held if you have filed a claim for relief as an injured or innocent spouse, which requires a detailed review by the IRS.

Required Administrative Steps Before Suing

Federal law is clear that a taxpayer cannot file a lawsuit for a refund until they have given the IRS a formal opportunity to address the issue. This principle is known as the exhaustion of administrative remedies. Your original tax return does not legally qualify as a formal claim for this purpose; you must file a specific claim for refund with the IRS.

This formal claim is made by filing Form 1040-X, Amended U.S. Individual Income Tax Return, or in some cases, Form 843, Claim for Refund and Request for Abatement. On the correct form, you must state the exact dollar amount of the refund you are seeking and identify the tax period. You must also provide a detailed written explanation of the legal and factual reasons you believe you are entitled to the money.

After filing the formal refund claim, you enter a mandatory waiting period. A lawsuit cannot be initiated until one of two conditions has been met: at least six months have passed since you filed the formal claim with no action by the IRS, or you have received an official notice of disallowance from the IRS denying your claim. This waiting period ensures the agency has adequate time to consider the claim.

The Taxpayer Advocate Service (TAS) can be a resource in this process. TAS is an independent organization within the IRS dedicated to helping taxpayers resolve problems with the agency. While contacting TAS is not a legally required step, a case advocate can often investigate the cause of a refund delay and help facilitate a resolution without litigation.

The Refund Lawsuit Filing Process

Once all administrative remedies have been exhausted and the waiting period has passed, you can proceed with filing a lawsuit. You have two options for a tax refund suit: your local U.S. District Court, which offers the possibility of a jury trial, or the U.S. Court of Federal Claims, where a judge will hear the case.

A lawsuit is subject to a strict statute of limitations. Your complaint must be filed within two years from the date the IRS mails the official notice of disallowance for your claim. Missing this two-year window will permanently bar you from bringing your case to court, regardless of the merits of your claim.

Initiating the lawsuit involves drafting and filing a complaint with the chosen court. This legal document outlines the factual background of your dispute with the IRS and presents the legal arguments for why the court should compel the agency to issue the refund. Given the procedural complexities, this step almost always requires an attorney who specializes in tax litigation.

Recoverable Amounts in a Refund Lawsuit

If your lawsuit against the IRS is successful, the court will order the IRS to pay the specific amount of the tax refund you were determined to be owed. In addition to the refund principal, the judgment will include statutory interest. This interest is calculated from the original date of the overpayment.

It is possible to recover some costs associated with the lawsuit. To be awarded attorney’s fees and other litigation costs, you must demonstrate to the court that the IRS’s position in the legal dispute was not “substantially justified.” This is a high legal standard to meet, as it requires proving the government’s arguments lacked a reasonable basis in law and fact.

Taxpayers should be aware of what cannot be recovered in a refund suit. The law does not permit awards for damages related to emotional distress or financial hardship due to the delayed refund. Punitive damages are not available in these cases, so the recoverable amount is limited to the overpayment, applicable interest, and in rare cases, litigation costs.