In a recent case in the Western District of Michigan, a Bankruptcy judge ruled that the US Government had the right to set off a debt under 11 USC 553 even when the Setoff was listed as an asset and exempted under 11 USC 522.
The Judge ruled that 11 USC 553 Setoff provision trumps the voidable preference provision of 11 USC 547.
In this case, the USDA had foreclosed on a government sponsored mortgage and assessed a deficiency against the debtor. The court held that the federal government is a unified creditor (IRS took the money, but USDA was the creditor) so there was mutuality of obligation.
But, if you file Bankruptcy BEFORE your tax return is submitted, the debt would be discharged and there would be no right to Setoff.
So, if you get a letter from the USDA saying they are going to Setoff your income tax refunds – go see a Bankruptcy lawyer.
So, this is advice to the those that have this fact situation arise – any USDA loan guarantees will be offset against an income tax refund, so file your clients before they file their federal 1040.