Inflation Relief: IRS Clarifies Where Taxpayers Must Report State Bonus Checks

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The IRS has provided guidance on how taxpayers in some states should handle special tax refunds or payments sent to households in 2022 as a way to deal with soaring inflation, ongoing COVID-19 hardships and other financial challenges.

In a Feb. 10 news release, the IRS said that, “in the interest of sound tax administration and other factors,” taxpayers in many states won’t need to report these payments on their 2022 federal tax returns. Special payments were made by 21 states in 2022, the agency said.

Following a review of the rebates and payments, the IRS determined that it will not challenge the taxability of payments related to general welfare and disaster relief. This determination means that people in the following states don’t need to report the state payments on their 2022 federal tax returns: California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Maine, New Jersey, New Mexico, New York, Oregon, Pennsylvania and Rhode Island.

In Alaska, the same rules apply to supplemental Energy Relief payments received in addition to the annual Permanent Fund Dividend.

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For taxpayers in Georgia, Massachusetts, South Carolina and Virginia, state payments will not need to be included in income for federal tax purposes if they meet certain requirements. This applies if the payment was a refund of state taxes paid and either the recipient claimed the standard deduction or itemized their deductions, but didn’t receive a tax benefit. In other cases, state tax payments might be taxable. Some of the payments issued in Illinois and New York might also be taxable, Fortune reported.

Many Taxpayers Could Be Confused Over IRS Language

The IRS noted that rules surrounding the treatment of special state payments for federal income tax purposes are “complex” — and the guidance the agency provided is proof enough of that. Much of the wording is hard to decipher unless you’re a tax expert.

For example, the IRS release stated that it has “reviewed the types of payments made by various states in 2022 that may fall in these categories and given the complicated fact-specific nature of determining the treatment of these payments for federal tax purposes balanced against the need to provide certainty and clarity for individuals who are now attempting to file their federal income tax returns, the IRS has determined that in the best interest of sound tax administration and given the fact that the pandemic emergency declaration is ending in May, 2023 making this an issue only for the 2022 tax year, if a taxpayer does not include the amount of one of these payments in its 2022 income for federal income tax purposes, the IRS will not challenge the treatment of the 2022 payment as excludable for income on an original or amended return.”

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If that paragraph seems confusing to you, you’re not alone. As Forbes recently noted, the IRS has a “spotty record” providing guidance when new legislation changes tax laws. For example, when the Biden administration passed the Inflation Reduction Act last year, the IRS didn’t immediately provide information on tax changes included in the bill. Instead, it only provided broad guidelines that confused many taxpayers. The same thing happened after the American Rescue Act was passed in 2021.

In a recent blog post, the Taxpayer Advocate Service wrote that the IRS “must issue guidance and provide education in a proactive and timely manner. Timely guidance is vital to taxpayers, tax professionals, and industry, and it is just good tax administration. It is key to eliminating confusion and frustration for taxpayers and tax professionals, earning the trust of the American people, and providing quality service. Sometimes, timing is everything.”

If you have questions about how special state tax payments might affect your 2022 federal tax returns, you might want to contact a tax professional. For more information on the IRS’s guidance, visit the IRS site.

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