The direct payments that a number of states authorized for residents last year, while inflation raged, are presenting new questions this tax season: Will that money be taxed by the feds?
The answers matter to the Internal Revenue Service, state tax authorities and tax preparers after approximately 20 states green lit the payments last year.
Most importantly, the answers matter to Americans who are hoping to hold onto every penny while inflation rates stay uncomfortably warm even after if it has finally come off last year’s boil.
The list of states with 2022 rebates included Arkansas, California, Colorado, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, New York, Oregon, South Carolina and Virginia, by Auxier’s count. Three states issued 2021 direct payments, California, Idaho and Maryland, Auxier said.
The IRS “is aware of questions involving special tax refunds or payments made by states in 2022; we are working with state tax officials as quickly as possible to provide additional information and clarity for taxpayers,” the federal tax collector said in a statement on Friday.
“The list of states with 2022 rebates included Arkansas, California, Colorado, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, New York, Oregon, South Carolina and Virginia.”
The IRS said it expected to give extra “clarity for as many states and taxpayers as possible” this week.
In the interim, taxpayers who don’t know about tax rules connected to their state payments should wait for extra guidance or check with a tax professional about what to do next.
Wait to hear about the guidance instead of calling the agency, the IRS advised. For anyone who’s already filed a 2022 income-tax return, don’t file an amended return, the agency added. It’s a new twist for an agency that has been staffing up and hoping for a smoother tax season than recent years.
“The IRS is going to have to decide how these are treated for federal tax purposes. I suspect there are going to be a list of answers,” said Edward Karl, vice president of tax policy and advocacy at the American Institute of CPAs.
What’s more, the state-specific criteria and legislative labels for the payments may cause the IRS to assess tax in some cases, but not in others, he said.
Here’s why this is important: Assessing federal tax will either shaving your refund or deepen a tax liability “when every penny helps, or hurts” depending on the person’s tax situation, Karl said. “It’s all meaningful to many, many millions of taxpayers.”
Taxpayers are waiting
The Federation of Tax Administrators, an organization representing state tax administrators, said it is “hopeful that the IRS will complete its review as quickly as possible, so that taxpayers have the information they need to accurately report, if required, these payments on their federal personal income tax returns.”
Last year, 18 states authorized one-time direct payments to residents while others enhanced pre-existing payment programs, said Richard Auxier, senior policy associate at the Tax Policy Center, who’s been studying the trend.
State checks for some residents of these approximate 20 states are different from stimulus checks in one key way: The IRS was clear from the start that federal stimulus checks did not count as federally taxable income.
Overall, 35 states — flush with revenue and budget surpluses — enacted legislation framed as financial relief in a time of high costs, Auxier said. That included tax-rate reductions and the one-time payments.
For example, California in 2022 has its “middle-class tax refund,” which benefited over 31.6 million Californians and their dependents, and the Golden State has already paid over $9 billion via direct deposits and debit cards. Depending on income and dependents, a married couple could receive up to $1,050.
The payment “is not taxable for California state income-tax purposes. You do not need to claim the payment as income on your California income tax return,” explained the state’s Franchise Tax Board. However, the agency said it was sending IRS paperwork, the so-called 1099-MISC form, to households that received at least $600.
The wording of the California law might leave it open to some interpretation by federal tax authorities, said Annette Nellen, an accounting and finance professor who directs San Jose State University’s graduate tax program. She pointed to one section saying the payments “shall not be a refund of an overpayment of income taxes.”
Still, officials at the California tax agency did their best to interpret the law before sending out the tax forms to many residents and the IRS, Nellen said.
California’s “lawmakers put the IRS in a bad situation — and taxpayers,” she said.
What if I already filed my taxes?
It’s early in the tax filing season. The IRS started taking in 2022 returns two weeks ago, on Jan. 23. While early 2023 filing numbers aren’t available yet, comparable statistics from last year hint that returns are starting to pour in.
By the week ending Feb. 4, 2022, the IRS already received 16.6 million individual income-tax returns, data shows.
This year, the IRS is saying many refunds will be smaller because pandemic-era boosts to provisions like the earned income-tax credit and the child- and dependent-care credit have gone away.
Ahead of filing a tax return, getting extra IRS guidance on complicated tax questions is always a plus.
But that may be little comfort to a taxpayer who’s either filed already, or hoping to file as soon as possible.
A household that’s quick to file may need that income-tax refund money sooner rather than later to cover expenses, Karl said. “They may need to hold off on filing, which becomes an issue for those individuals.”