Stimulus Update: Will You Have to Pay Taxes on Your State Stimulus Check?

Few things are less fun than unexpected taxes.

In unwelcome news, millions of Americans must suddenly wonder if they will have to pay taxes on stimulus money sent by their state. Whether payments were a tax refund, tax rebate, or inflation check, no one can agree on whether they will be taxed.

That's where the Internal Revenue Service (IRS) comes in. Sometime this week, the IRS is expected to provide a clear answer as to whether a state-issued stimulus is considered taxable income for the 2022 tax year.

On Friday, the IRS released a statement saying that it's working with state tax officials to provide clarity for taxpayers. What appears to be taking time is the number of checks that landed in bank accounts and how many states are involved. In total, 19 states introduced stimulus programs, each with its own set of rules.

IRS considerations

Millions of Americans have been issued a rebate, refund, or relief check by their state. These are the taxpayers potentially impacted by the IRS decision. If you're one of those people, you likely have questions.

Unfortunately, it could be days before we have a definitive answer. Here are two of the most pressing questions the IRS must grapple with:

• Will all state stimulus funds be treated the same, no matter how the checks were labeled? For example, is it possible that residents of one state will not be required to claim the payment because theirs was called a "tax rebate," while recipients in another state have to claim the funds because theirs was called "inflation relief?"
• Does it matter how much money recipients earn per year? Some states sent checks to all residents, including those with plenty in their savings accounts and brokerage accounts. Will high-income individuals be required to pay taxes while others are not?

What to do now

If you've already filed your 2022 tax return, wait for the IRS decision before making your next move. As mentioned, the decision that comes down will depend upon several factors. Per the IRS: "We also do not recommend amending a previously filed 2022 return."

Steps to take if you're hit with taxes

If word comes down that state-issued stimulus checks are considered taxable income, don't worry. No one wants to pay more in taxes than expected. Here are three often-overlooked tips for reducing your tax obligation:

1. Revisit your filing status. If you're unmarried but have a qualifying dependent, investigate whether filing as head of household may reduce your tax obligation. Children are not your only potential dependent. You may also be able to file as head of household if you paid more than half the cost of keeping a home for an elderly parent and that was the main home for you and your parent for more than 50% of the tax year.
2. Remember charitable contributions. It's not just significant contributions that count. Scan your 2022 bank statements to identify all contributions. Did you donate cupcakes to a fundraiser at your child's school? You can deduct the expense of making those cupcakes. Whether you're donating $200 a month to a food bank or $12 a month to an animal rescue organization, donations quickly add up.
3. Make year-end contributions. 2022 may have ended on Dec. 31, but you have until April 18, 2023, to contribute money to a traditional individual retirement account (IRA) or, if you're self-employed, a Solo 401(k). Those funds are "pre-tax," meaning the money you contribute will not be subject to income tax until you withdraw it from your retirement account.

The good news is that once the IRS has made its final decision, you'll still have plenty of time to get your 2022 tax return filed, amended, or adjusted.