Stimulus Update: Will You Owe Taxes on Your State Stimulus Check?

Should you be setting aside some of your stimulus money for the IRS?

A growing number of Americans have received stimulus money deposited into their bank accounts in 2023. In fact, close to half of all locations across the country have authorized direct payments, even as the federal government has failed to take action to offer a much-needed fourth check.

For those who have received funds, there's one big question that is worth answering. How will this money from the state be treated for tax purposes and will the IRS take a cut of the cash?

Will your state stimulus payment be taxable?

The previous three stimulus checks Americans received over the past several years were all provided by the federal government and they were structured as advances on tax credits. As a result, they were not classified as income and thus they were not subject to federal income tax.

When it comes to state stimulus checks, though, things may work a little differently. In fact, it is an open question as to how the federal government will treat the money the states are providing this year -- and it may come down to how exactly the payments are categorized.

If the money the states send out is considered to be a refund of state taxes that residents paid, then those who claimed the standard deduction wouldn't have to report the money on their federal income tax returns -- but those who itemized would. However, if the money the state sends out is considered to be a rebate rather than a refund, it's not clear exactly how the IRS will treat the payments.

In general, the IRS explains that all income is taxable unless it clearly falls within an exemption to the federal law. There are a few possible exemptions that could apply to state stimulus money. For example, the money the state is paying out could be classified as a non-taxable gift. Or it could fall within the "general welfare exclusion" that exempts certain means-tested benefits from federal taxation.

However, not all state stimulus checks are means-tested and fall within the general welfare exclusion. And, until the IRS issues official guidance, there is a chance that at least some people who receive state stimulus funds could find themselves owing taxes on the money.

Saving some of your stimulus check could be a good idea

Because of the lack of clarity surrounding the rules for taxation of state stimulus checks, it might be a good idea to save at least a little bit of the funds you receive. That way, if it does turn out that you're going to owe taxes on the money, you won't be caught off guard and left struggling to pay a bigger IRS bill than you might expect.