IRS Says Payments Sent Out in 4 States Last Year Are Taxable

Understanding your 401(k) projections is key to retirement planning. Maksim Shchur/Shutterstock

Most taxpayers in states that gave some kind of stimulus or tax rebate payment last year will not have to report them on their federal returns this year. However, some residents in four states will have to.

According to guidance issued by the Internal Revenue Service (IRS) earlier this month, taxpayers in 17 of 21 states that handed out such payments last year don’t have to report them on their federal taxes.

However, taxpayers in Virginia, Georgia, South Carolina, and Massachusetts who got tax refunds and claimed the state and local tax itemized deduction under certain circumstances will have to pay federal taxes in light of those payments. Residents in those states who itemized their deductions and did not reach the $10,000 cap on deductions for state and local taxes could fall into that category, according to Bloomberg News.

“If the payment is a refund of state taxes paid and either the recipient claimed the standard deduction or itemized their deductions but did not receive a tax benefit (for example, because the $10,000 tax deduction limit applied) the payment is not included in income for federal tax purposes,” the IRS said. In those states, it will “fall in this category and will be excluded from income for federal tax purposes unless the recipient received a tax benefit in the year the taxes were deducted,” according to the guidance.

Officials in Georgia, Massachusetts, and Virginia issued statements to taxpayers this month, warning them they could have federal tax payments after the IRS issued its guidance, reported Bloomberg. The South Carolina Department of Revenue has not commented on the revision.

In an FAQ posted on its website, the Georgia Department of Revenue issued an advisory that they could face taxes on their share of the $1.1 billion special refund program that was part of a state law that passed in the legislature last year.

“Taxpayers who took the standard deduction on their federal tax forms will not have their refunds subject to federal taxation,” the FAQ states. “Taxpayers who took the itemized deduction but did not receive a tax benefit will not have their refunds subject to federal taxation.”

But the Georgia agency stipulated that “taxpayers who took the state and local tax deduction (SALT) on their federal return and received more than the refund they would have otherwise with the standard deduction will have their refunds subject to federal taxation.”

“If you itemized your 2021 deductions, include the special refund, in your gross income to the extent you received a federal tax benefit from the 2021 deduction. The federal tax benefit received, if any, depends on your specific tax situation,” it says.

According to Bloomberg, officials in Massachusetts and Virginia stated taxpayers who got a refund in 2022 for taxes paid in tax year 2021 will receive or have received form 1099-G, which can be reported on their federal taxes this year.

The Internal Revenue Service headquarters building in Washington, D.C., is seen in a file photo. Chip Somodevilla/Getty Images

As for Massachusetts, $500 and $250 checks sent out by the state to about 1 million low-income “essential” workers last year aren’t included in the IRS memo, but according to MassLive, they may be subject to federal income tax. If a Massachusetts resident got a tax refund from the state and “claimed the standard deduction or itemized their deductions but did not receive a tax benefit in 2022, the person does not need to make a federal tax payment on their tax refund,” the website says.

Why?

It boils down to how states defined the payments, said Tax Foundation vice president Jared Walczak in a recent Yahoo Finance interview.

“The IRS has singled out these four states because they structured their rebates as tax refunds,” Walczak said. “And therefore the IRS is regarding them as a reduction of net state tax liability.”

Meanwhile, Walczak told Bloomberg that the agency is essentially penalizing taxpayers in those states.

“This ‘problem’ applies to all 21 states, not just the four that structured their payments as ‘refunds’ rather than rebates,” he said. “The IRS is taking a formalistic interpretation that four states’ payments offset tax liability, while all the others did not, even though they are functionally equivalent.”

And Walczak noted that the IRS did not include guidance to individuals in these states who may have already filed their returns before the IRS issued its guidance. The tax agency on Feb. 3 called on taxpayers to hold off on filing their taxes until the guidance was issued on Feb. 10.

“Any affected taxpayers who have already filed and did not include their tax refunds as taxable income will be required to file an amended return,” he said.