IRS Clarifies Federal Taxes and State Payments

The IRS has recently announced that “in the interest of sound tax administration and other factors,” taxpayers in many states will not need to report various payments on their 2022 tax returns. In short, the IRS has determined it will not challenge the taxability of payments related to general welfare and disaster relief.

So what does this mean? People in the following states do not need to report these state payments on their 2022 tax return: California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Maine, New Jersey, New Mexico, New York, Oregon, Pennsylvania and Rhode Island. (Alaska is in this group as well, but there are additional, special rules in this case.)

A difficult situation

Here’s the background: In 2022, certain states granted special tax refunds or payments related to the pandemic and its associated consequences. A variety of state programs distributed these payments in 2022 and the rules surrounding their treatment for federal income tax purposes are complex, says the IRS. While, in general, payments made by states are includable in income for federal tax purposes, there are exceptions that would apply to many of the payments made by states in 2022.

Refund of state taxes paid

If the payment is a refund of state taxes paid and either the recipient claimed the standard deduction or itemized their deductions but did not receive a tax benefit (for example, because the $10,000 tax deduction limit applied) the payment is not included in income for federal tax purposes.

Payments from the following states in 2022 fall in this category and will be excluded from income for federal tax purposes unless the recipient received a tax benefit in the year the taxes were deducted.

• Georgia
• Massachusetts
• South Carolina
• Virginia

General welfare and disaster relief payments

If a payment is made for the promotion of the general welfare or as a disaster relief payment, for example related to the COVID-19 pandemic, it may be excludable from income for federal tax purposes under the General Welfare Doctrine or as a Qualified Disaster Relief Payment, according to the IRS. Determining whether payments qualify for these exceptions is a complex fact-intensive inquiry that depends on a number of considerations.

The IRS has reviewed the types of payments made by various states in 2022 that may fall in these categories. Given the complicated, fact-specific nature of determining the treatment of these payments for federal tax purposes, balanced against the need to provide certainty and clarity for individuals who are now attempting to file their federal income tax returns, the IRS has determined that, in the best interest of sound tax administration, the IRS will not challenge the treatment of the 2022 payment as excludable for income on an original or amended return.

In addition, since the pandemic emergency declaration is ending in May 2023, this is only an issue for the 2022 tax year.

However, emphasizes the IRS, other payments that may have been made by states are generally includable in income for federal income tax purposes. This is just a summary of complicated rules and there are exceptions. Please reach out to your LMC tax professional should you want further clarification.

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