Why Was My IRS Refund Reduced and What Can I Do About It?

Seeing a lower-than-expected tax refund can be frustrating, especially if you were counting on that money. The IRS has the authority to adjust refunds for various reasons, and understanding why yours was reduced is the first step toward resolving any issues.

Before taking action, review any IRS notices explaining the adjustment. There are steps to correct errors or address outstanding debts, as well as options if you need to make payments.

Reasons for a Reduced Refund

When the IRS lowers your refund, it’s usually due to outstanding financial obligations, discrepancies in reported income, or adjustments to claimed credits and deductions.

Outstanding Federal Debts

If you owe money to government agencies, the IRS can use your refund to cover those debts through the Treasury Offset Program (TOP). This allows federal and state agencies to claim part or all of your refund for unpaid federal student loans, delinquent child support, or past-due state income taxes.

For example, if you owe $2,000 in defaulted student loans and your refund was originally $1,500, the entire refund may be taken to reduce your balance. The Bureau of the Fiscal Service (BFS), which manages these offsets, will send a notice explaining the deduction and where the payment was sent. If you believe the offset was made in error, you’ll need to contact the agency that received the funds, not the IRS, as the IRS only processes the offset but does not handle disputes.

Errors in Reported Income

If the income on your tax return does not match what the IRS received from employers, banks, or other institutions, your refund may be adjusted. The IRS cross-checks reported earnings using W-2s, 1099s, and other income statements.

For example, if your employer reported $50,000 in wages but you only reported $45,000, the IRS may recalculate your taxable income and adjust your refund. This could lead to a lower refund or even additional tax owed. In some cases, a 20% accuracy-related penalty may apply if the discrepancy is deemed negligent or a substantial understatement.

To avoid this, ensure that the income figures on your tax return match your official documents. If an employer or financial institution made a mistake, request a corrected form before disputing the adjustment.

Disputed Credits or Deductions

The IRS may reduce your refund if it determines that certain tax credits or deductions were incorrectly claimed. Common areas of adjustment include the Earned Income Tax Credit (EITC), the Child Tax Credit (CTC), and deductions for self-employment expenses.

For instance, if you claimed the EITC but your income exceeds the eligibility threshold—$63,398 for a married couple with three children in 2023—the credit may be disallowed, lowering your refund. Similarly, if you deducted business expenses without proper documentation, the IRS may disallow those deductions, increasing your taxable income.

In cases of fraud, the IRS may ban you from claiming certain credits for up to 10 years. To minimize the risk of reduction, ensure you meet all eligibility requirements and keep thorough records.

Prior Overpayments

If the IRS previously issued a refund that was too high due to an error, they may reduce your current refund to correct the overpayment. This often happens when the IRS later reviews past returns and finds miscalculations, unreported income, or disallowed credits.

For example, if you received an extra $500 in a prior year due to a miscalculated credit, the IRS may deduct that amount from your current refund. If you amended a previous return and owed additional tax, the IRS may also adjust your refund. In some cases, interest may be applied to the overpayment, increasing the amount deducted.

If you are unsure why your refund was adjusted for a prior-year issue, reviewing past tax transcripts through the IRS’s online account system can provide clarity.

Reading IRS Notices

When the IRS adjusts your refund, they send a formal notice explaining the reason. These letters, often labeled CP12, CP49, or CP2000, detail modifications made to your return, including recalculations of tax liability or offsets applied.

The notice specifies the original refund amount, the adjusted total, and a breakdown of the differences. Some include comparisons between what you reported and what the IRS determined, making it easier to identify discrepancies. If the adjustment was due to an IRS correction, such as a math error, the notice may indicate that no further action is needed unless you disagree. If additional documentation is required, the notice will provide a deadline for responding. Ignoring deadlines can result in further reductions or additional tax assessments.

IRS notices may also include information about interest or penalties applied to your account. If your refund was reduced due to a prior-year overpayment correction, the notice might indicate whether interest was charged. Some notices also contain appeal rights, allowing you to contest the adjustment if you believe it was made in error.

Correcting the Issue

Disputing an IRS refund adjustment starts with verifying the accuracy of the changes. Reviewing your tax transcript through the IRS’s online account system provides a detailed breakdown of the IRS’s calculations.

If discrepancies exist, compare these figures with your original tax return and supporting documents—such as W-2s, 1099s, or receipts for claimed expenses—to pinpoint errors. If the IRS miscalculated your tax liability or incorrectly disallowed a tax benefit, gather relevant documentation before disputing the adjustment.

To formally challenge an adjustment, respond to the notice with a written explanation and copies of relevant documents. If the notice includes a response deadline, submit the dispute before that date to avoid complications. The IRS typically allows taxpayers to reply by mail or fax, and in some cases, a response can be submitted through the IRS’s online portal.

If the adjustment is complex or involves legal tax interpretations, consulting a tax professional or an enrolled agent can be beneficial. Taxpayers also have the right to request an appeal through the IRS Independent Office of Appeals if their initial dispute is denied. Filing an appeal requires submitting a written protest outlining the specific points of disagreement and providing supporting documentation. If the IRS’s decision is upheld, taxpayers may still have the option to amend their tax return if new evidence supports their original filing position.

Potential Payment Options

If your refund was reduced and you now owe a balance, determining how to manage the payment efficiently can help avoid penalties and interest. The IRS offers multiple repayment methods, including direct payments through the Electronic Federal Tax Payment System (EFTPS), credit or debit card transactions, and traditional paper checks or money orders mailed to designated IRS addresses.

For those unable to pay in full, installment agreements allow taxpayers to spread their liability over time. Short-term payment plans, available for balances under $100,000, require full repayment within 180 days without setup fees. Longer-term agreements, applicable to liabilities below $50,000, involve monthly payments and a setup fee of $31 for online applications or $107 for mail-in requests. Interest, currently set at the federal short-term rate plus 3%, continues to accrue until the balance is fully paid.

Automatic withdrawals can prevent late fees, and modifying an existing plan to adjust payments is possible if financial circumstances change.

Checking Effect on Future Refunds

A reduced refund this year can affect future tax filings, particularly if the adjustment was due to recurring issues like underreported income or disallowed credits. If the IRS adjusted your refund due to an income discrepancy, it may trigger closer scrutiny in future years, increasing the likelihood of additional reviews or audits.

If your refund was reduced due to prior-year overpayments or outstanding debts, any future refunds may also be subject to offsets until the balance is fully repaid. The Treasury Offset Program continues to apply refunds toward unpaid federal and state obligations, meaning that if you still owe money, next year’s refund could also be affected.

If the IRS disallowed a tax credit due to eligibility concerns, you may be required to provide additional documentation in future years to claim the credit again. In some cases, if the IRS determines that a credit was claimed improperly, a taxpayer may be barred from claiming it for multiple years, significantly impacting refund amounts going forward.