The uncertain economy, historically high inflation, and rising interest rates have many cash-strapped Americans scrambling to gather the documentation necessary to file their tax returns, particularly those that are expecting a refund. Indeed, the Internal Revenue Service (IRS) has already begun accepting returns for the 2022 tax year as of Jan. 23, 2023.
Unfortunately, for millions of taxpayers, a number of unanswered questions have caused the IRS to take the unusual step of asking some taxpayers to delay filing their returns. The issue involves the federal tax treatment of a number of state-issued rebates and one-time tax refunds issued last year.
Image source: Getty Images.
State-issued refunds and rebates
During 2022, a number of states -- including California, Colorado, Illinois, Virginia, and South Carolina -- issued tax rebates to eligible taxpayers, to help ease the burden for residents suffering from high prices in the grocery aisle and at the gas pump. Unfortunately, federal authorities have yet to rule on whether these payments are taxable and are racing to find the answers.
The IRS issued a statement late last week saying it was working to address the issue. "The IRS is aware of questions involving special tax refunds or payments made by states in 2022," the agency said in a statement. "We are working with state tax officials as quickly as possible to provide additional information and clarity for taxpayers."
For example, California issued "middle-class tax refund" payments to more than 16 million residents, ranging from $200 to $1,050 and totaling more than $9 billion. The state's tax regulators have ruled the payments are not taxable for state income tax calculations but may be taxed by federal authorities. As a result, California's Franchise Tax Board -- the state's taxing authority -- issued millions of 1099-MISC forms detailing the payments. Because the issue is complex, the IRS has yet to issue a ruling.
Virginia residents face a similar dilemma. The state issued a one-time tax rebate of between $250 and $500 to eligible taxpayers who had a tax liability in the previous year and met certain income requirements. The state decided to treat the payment like a regular tax refund, which further complicated the matter. The rebate will be taxable for taxpayers that itemize their deductions but not for those who use the standard deduction.
"There are a variety of state programs that distributed these payments in 2022 and the rules surrounding them are complex," the IRS said in a statement.
Now what?
If you're one of the millions of taxpayers that received a special state-issued payment last year, a decision should be reached soon. The IRS said, "We expect to provide additional clarity for as many states and taxpayers as possible next week."
Federal tax authorities went a step further. "For taxpayers uncertain about the taxability of their state payments, the IRS recommends they wait until additional guidance is available or consult with a reputable tax professional."
Authorities also suggested that for those with questions, "the best course of action is to wait for additional clarification on state payments." Furthermore, for those that have already filed, the IRS said (emphasis mine), "We also do not recommend amending a previously filed 2022 return."
Tax experts at H&R Block and Intuit's TurboTax have concluded that California's middle-class tax refund payments aren't taxable for federal purposes, meeting the guidelines that "certain payments to promote general welfare are excludable from federal income," according to The Wall Street Journal. As a result, the companies have continued to submit federal tax returns.
The IRS will have the final word as to whether or not these payments will be subject to federal taxes. For taxpayers that have received these state-issued payments, its best to wait for a final determination before sending off your tax return -- even if you're expecting a refund. It will likely save you headaches down the road.
