My 2006, 2005 And Part Of My 2004 Tax Refund Was Offset For A Student Loan Debt. The Collections Agency Did Not Apply All Of The Offset To The Loan. Is This Allowed?

According to GC Services, the collection agency, they are not required to pay off the student loan with the offset from my tax refunds. They are stating that I still owe 80.01 in principal and if I do not take out a $1000 loan in 3 months my loan will be back up to more than $400. What options do I have? They stated they are charging me 25% interest per day plus collection fees. This does not sound legal..is it?