First, we must note that the IRS rules prohibit the recipient of a tax refund from depositing the refund into an account that the recipient does not own: “You can direct your refund to any of your checking or savings accounts, but you cannot direct your refund to someone else's account, except for your spouse's account, if this is a joint refund.” IRS Publication, Frequently Asked Questions about Splitting Federal Income Tax Refunds. Also, the rules governing federal ACH payments require that you alert the IRS of an ACH payment has been directed to an account that is not owned by the recipient of a tax refund. 31 CFR 210.8(d)also see Guide to Federal Government ACH Payments (Greenbook), Section 4 — Returns, page 4-3.

As to exercising a right of setoff, it would not apply in the situation you described – the person who owes you a debt (the grandson) does not have an ownership interest in the deposit account at your institutions.

Generally speaking, if a tax refund recipient were to have a deposit account at your institution, we believe that your bank would have a valid right of setoff against a tax refund that is deposited in an account at your institution.  Under Illinois law, the right of setoff can arise under the common law or under a contract with the customer (generally the account agreement or the loan agreement). Under the common law right of setoff, the deposit account to be set off must be owned by the same party or parties that owe the debt to the bank. But under a contractual right of setoff, the account agreement can provide for a broader right of setoff, and there is no requirement that the identity of the account owner exactly match the identity of the debtor. Selby v. DuQuoin State Bank, 223 Ill.App.3d 105, 107 (5th Dist. 1991); Fisher v. State Bank of Annawan, 163 Ill.2d 177, 181 (1994). If the contractual right of setoff applies, you should also determine that either the debt has already matured or that the deposit or loan agreement gives you express authority to setoff deposits for an unmatured debt. See Bonhiver v. State Bank of Clearing, 29 Ill.App.3d 794, 804 (1st Dist. 1975). We recommend that you examine your deposit account and loan agreements to determine whether the contractual right of setoff applies in any given situation.