IRS identifies tax payments sent by 4 states last year as taxable. The majority of citizens in states that offered tax breaks or stimulus payments last year are exempt from reporting them on their federal forms. Nonetheless, some citizens of four states do, largely as a result of the way these payments were created in those states.
According to a recent Internal Revenue Service decision, taxpayers in Georgia, Massachusetts, South Carolina, and Virginia who received state tax refunds and used the state and local tax (SALT) itemized deduction without exceeding its cap must pay federal taxes on those payments.
However, the agency concluded that citizens of 17 other states are exempt from paying any federal taxes on their state payments received in 2022 in the “interest of sound tax administration and other criteria.”
Jared Walczak, vice president of state programs at the Tax Foundation, explained to Yahoo Finance that the reason why the payments made by these four states are federally taxable is due to how the states defined the payments.
In contrast to tax rebates or stimulus payments, he claimed that the reason the IRS singled out these four states was because they framed their payouts as tax refunds. Because of this, the IRS views them as a reduction in net state tax burden.
Let’s say that John had $5,000 deducted from his pay as state taxes. He used the SALT deduction, often known as the state and local tax deduction, to deduct $5,000 from his federal tax return when he decided to itemize.
Although though John deducted the whole $5,000 on his federal taxes, he only owed the state government $4,000 when he later submitted his state tax return. As a result, John received a $1,000 tax refund. The $1,000 refund would subsequently be reported as taxable income on John’s federal return for the following year once his state had sent him a 1099-G form.
For taxpayers that claimed the SALT deduction and benefited from it, the IRS treats these contributions from the state similarly. The standard deduction or the SALT deduction that exceeds the $10,000 threshold for certain states’ residents is unaffected.
According to the tax benefit rule, the amount of a refund that you received after deducting something in the past and doing so in the present is taxable, according to Norfolk, Virginia-based certified public accountant Vivian Paige.
To be eligible for this money, she continued, “you had to have a tax liability.” “But you didn’t get the money if you filed a return with no liabilities,” said the tax official.
According to the Department of Taxation, Virginia deemed the state payments to be taxable for federal purposes in advance of the IRS’s final instruction.
Paige added that Virginia had already informed everyone that the reimbursement will be included on the 1099 they received from the state if they received one.
These four states
Only those in the four states that the IRS singled out received a state rebate. Each of them is summarized below.
Georgia: Georgia’s residents received excess tax refunds in 2022 as a result of a historical state budget surplus. Depending on filing status, the payments had a maximum of $250 or $500 and a minimum of the lower of those two sums or the total tax due on their 2020 return. This implies that instead of receiving the entire $250 refund in 2020, a single filer with a $100 tax bill receives a $100 refund.
Massachusetts: Tax revenue surpassed the state’s statutory annual revenue ceiling in 2022. As a result, the taxpayers got back 14.0312% of what they owed in taxes for 2021. Additionally, this means that state taxpayers were only eligible for the refund if they reported a 2021 income tax return state tax liability.
South Carolina: The state’s governor approved an up to $800 tax refund for citizens of the state in 2022. Only those taxpayers who reported a tax liability on their 2021 income tax return were eligible for the rebate.
Virginia: According to the state governor, eligible households received one-time tax rebates of up to $250 (single filers) and $500 (joint filers) as a payment to “assist families cut the cost of living” amid a period of high inflation. The rebate was only given to taxpayers who had a tax burden on their 2021 income tax return.
Technically speaking, taxing these refunds is the right choice, but Walczak questioned why the IRS insisted on making this distinction given their willingness to flout laws in 17 other states.
The agency’s failure to provide guidance to affected taxpayers who previously filed their tax returns without disclosing the state stimulus amount is another problem.
Those impacted taxpayers who have already filed a return but did not list their tax refunds as taxable income will likely be forced to file an updated return, according to Walczak.