The IRS is not going to tax payments from most of the states that cut checks to residents last year in order to help them defray rising living costs.
This week, the IRS has been trying to determine if the money from 21 states to their residents would count as money that was subject to federal income tax.
For 16 states, the answer is a straight “no,” the IRS announced Friday evening. For the remaining five states, there’s some nuance, and likely some consternation for the taxpayers who need to see what the rules mean for them.
Last week, the IRS publicly advised people with tax questions about their state payment to wait on filing while it determined the money’s tax status. By that time, the tax authority already received nearly 19 million income tax returns and issued almost 8 million refunds.
On Friday the IRS listed where people don’t have to report the inflation-related payments on their 2022 return: California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Maine, New Jersey, New Mexico, New York, Oregon, Pennsylvania and Rhode Island.
California alone had issued more than 16 million payments on its “middle-class tax refund” for more than $9 billion, reaching over 31 million state taxpayers and their dependents.
Here’s where it gets more complicated.
In Alaska, an extra energy relief payment does get excluded from federal income taxes, but the yearly payment from the state’s Permanent Fund Dividend is included, the agency said.
For people in Georgia, Massachusetts, South Carolina and Virginia, the special 2022 payments will be excluded from federal income taxes — so long as the money is a refund for paid state taxes “and either the recipient claimed the standard deduction or itemized their deductions but did not receive a tax benefit.”
It’s not immediately clear how many taxpayers in these states will be affected by the tax twist.
The distinctions on when federal tax kicks in may lie in the wording of the various state laws and how they fit with IRS doctrines on the special circumstances to exclude an otherwise potentially taxable payment.
“The IRS appreciates the patience of taxpayers, tax professionals, software companies and state tax administrators as the IRS and Treasury worked to resolve this unique and complex situation,” it said Friday.
But patience was quickly wearing thin. The tax question should have been figured out before the start of tax season, said one critic inside the agency. (Tax filing season started on Jan. 23.)
“This was a known issue, with ramifications for tens of millions of taxpayers, tax return preparers (who still prepare most federal income tax returns) and tax software developers,” Erin Collins, the IRS National Taxpayer Advocate, said in a Thursday blog post.
“The failure to have identified and resolved this issue before the filing season suggests that someone, or everyone, was asleep at the switch,” she added.
The National Taxpayer Advocate’s office did not immediately respond to a request for comment Friday.
Friday’s announcement comes while the IRS is trying to run a smoother tax season compared to recent years.
The agency has $80 billion in funding over a decade after the Democrat-controlled Congress passed the Inflation Reduction Act last summer.
The IRS approach to the situation is something that could come up as lawmakers consider the Biden administration pick for IRS commissioner.
Biden’s nominee, Danny Werfel, is scheduled to appear before the Senate Finance Committee on Feb. 15.