The IRS announced in a news release (IR-2023-23) on Feb. 10, 2023, that it would allow taxpayers to exclude from 2022 federal taxable income certain special payments from 17 states. The IRS also addressed the federal income tax treatment of refunds and rebates in four other states.
Many states offered residents rebates and other relief payments in response to the pandemic. The IRS acknowledged that determining whether a general welfare or a disaster relief payment that is included in income can be “a complex fact intensive inquiry.” The IRS said that after balancing “the need to provide certainty and clarity” and “in the interest of sound tax administration,” it will not challenge taxpayers who exclude from income the payments from specific state programs in 17 states. Thus, the IRS stated that if a taxpayer does not include the amount of one of these payments in its 2022 income for federal income tax purposes, the IRS will not challenge the treatment of the 2022 payment as excludable from income on an original or amended return. Payments treated as tax rebates in four other states can be excluded from income depending on whether the taxpayer benefits from a state tax deduction.
Grant Thornton Insight
The IRS wrote the release in a way that appears intended to avoid the appearance that it is reaching a conclusion as a matter of law. Instead, the IRS is providing only that it will not challenge the exclusion from income of a specific list of state payments. The relief does not appear to apply to any payments not explicitly identified by the release, nor does it appear to affect employer disaster relief payments. The ability of employees to exclude payments from employers from income as qualified disaster relief is a determination that must be made under Section 139(b). The determination of whether any other state payments not identified in the announcement are included in income would also have to be made based on the general rules for qualified disaster payments and the general welfare doctrine. The IRS noted that other payments made by states “are generally includable in income for federal income tax purposes,” and it specifically identified Alaska’s Permanent Fund Dividends and any payments from other states provided as compensation to workers.
Covered state payments
The IRS stated it will not challenge taxpayers who exclude from income payments from the following programs in 17 states:
- Alaska: Energy Relief Payment (supplementing the Permanent Fund Dividend, which is not excludable)
- California: Middle Class Tax Refund
- Colorado: Colorado Cash Back
- Connecticut: Child Tax Rebate
- Delaware: Relief Rebate Program
- Florida: Pandemic Temporary Assistance to Needy Families
- Hawaii: Act 115 Refund
- Idaho: 2022 Tax Rebate
- Illinois: Individual Income Tax Rebate and Property Tax Rebate
- Indiana: Automatic Taxpayer Refunds #1 and #2
- Maine: Pandemic Relief Funds
- New Jersey: ITIN Holders Direct Assistance Program
- New Mexico: Multiple rebate and relief programs
- New York: Supplemental Child Credit and Supplemental Earned Income Tax Credit
- Oregon: One-time Assistance Payments
- Pennsylvania: One-Time Bonus Rebates
- Rhode Island: 2022 Child Tax Rebates
State tax refunds
The IRS also provided that payments under programs from four states, Georgia, Massachusetts, South Carolina and Virginia, would be considered refunds of state taxes paid and can only be excluded from income if the taxpayer did not receive a tax benefit such as a federal deduction based on the amount refunded:
Grant Thornton Insight
This does not appear to provide any special relief for payments from these states. The IRS considers them state tax refunds as to which ordinary tax benefit rules apply. For example, Rev. Rul. 2019-11, which provides that all or a portion of a state tax refund must be included in income based on application of the tax benefit rule, generally requires a taxpayer to include in gross income any recovered amounts that the taxpayer deducted in a prior tax year to the extent those amounts reduced the taxpayer’s tax lability in the prior year. Taxpayers will not need to include payments from these four states in income if they claimed the standard deduction or their itemized deduction for state tax was capped at $10,000 and the amount of nondeductible state tax exceeded the refund payment amount.
Next steps
Taxpayers filing their individual returns should assess any state tax payments for their potential eligibility for the IRS relief or their exclusion from income under the general rules. Some states may have issued Form 1099s for payments exceeding $600 that the IRS has now provided do not need to be included in income. Taxpayers should ensure these amounts are reflected correctly on their returns. Taxpayers who have already filed returns can also exclude the affected payments from income on an amended return.
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