Earlier this month, the Internal Revenue Service (IRS) urged millions of U.S. taxpayers who had received state tax rebates or refunds last year to hold off on filing their 2022 tax returns. The federal tax treatment of these payments -- which were similar to the stimulus checks issued by the federal government during the pandemic -- was still undetermined.
Now, just weeks later, the IRS has concluded the majority of its research on the subject, issued guidance on the taxability of these state payments, and given those taxpayers the go-ahead to file their federal tax returns.
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A brief recap of the issue
Last year, the combination of soaring prices in the grocery aisle and record-high gas prices made it difficult for many individuals and families to make ends meet. To assist them, many state governments issued tax rebates, stimulus payments, or tax refunds to eligible taxpayers in an effort to ease the challenges that arose due to that historically high U.S. inflation.
However, the variety and complexity of these state payments meant there was no "one size fits all" answer as to whether these payments were taxable for federal income tax purposes. "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."
Now, taxpayers have the answers they need.
The verdict is in
On Friday, the IRS issued guidelines that turned out to be good news for the majority of taxpayers. "The IRS has determined that in the interest of sound tax administration and other factors, taxpayers in many states will not need to report these payments on their 2022 tax returns," the agency said in a statement.
The IRS went on to say, "If a payment is made for the promotion of the general welfare or as a disaster relief payment, for example related to the outgoing pandemic, it may be excludable from income for federal tax purposes under the General Welfare Doctrine or as a Qualified Disaster Relief Payment."
As a result of the determination, people in the following states do not need to report these state payments on their 2022 tax returns: Alaska, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Maine, New Jersey, New Mexico, New York, Oregon, Pennsylvania, and Rhode Island.
For several states, however, the answer isn't as cut and dried.
The exceptions
For taxpayers in Georgia, Massachusetts, South Carolina, and Virginia, the taxability of these special payments hinges on certain criteria. "State payments will not be included for federal tax purposes 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."
That means the payments won't be taxable for the majority of people in these states, since roughly 90% of taxpayers claim the standard deduction.
One additional caveat: Any portions of payments from states provided as "compensation to workers" are to be counted as income for federal income tax purposes, as are Alaska's Permanent Fund Dividend payments.
Taxpayers who have questions about whether a payment they received is subject to federal taxes should contact the IRS or consult a local tax professional.
