Guidance on State Tax Payments to Help Your Tax Clients  

woman advising clients

In a recent announcement, the IRS issued guidance on the federal tax status of special payments made by 21 states in 2022. If you or your clients live in these states, understanding the details of the IRS decision on state tax rebates will help you navigate the complex tax landscape and provide clarity to your clients.  

Why did states make special state tax payments in 2022? 

In 2022, several states made additional payments to taxpayers other than typical state tax refunds. Most of these special payments fall under two categories: disaster/ pandemic relief and rebates of state taxes.  

Disaster & pandemic relief  

The following 17 states made payments to taxpayers related to disaster or pandemic relief: Alaska*, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Maine, New Jersey, New Mexico, New York, Oregon, Pennsylvania, and Rhode Island. 

These payments are generally not considered income for federal tax purposes under the General Welfare Doctrine and/ or because they are a Qualified Disaster Relief Payment.   

The IRS has stated that it “will not challenge the taxability” of these payments, and taxpayers may exclude them from their income for federal tax purposes. 

Special considerations for Alaska 

According to this IRS announcement, Alaska issued a special supplemental energy relief payment in 2022 that is considered non-taxable. However, the IRS clarified that the “annual payment of Alaska’s Permanent Fund Dividend” is still regarded as taxable income, just as it is every year. 

State tax rebates 

Four states (Georgia, Massachusetts, South Carolina, and Virginia) paid special tax rebates in 2022 for state taxes paid in 2021. Most taxpayers who received these rebates will not have to include them in their income for federal tax purposes as long as they meet the following two criteria:  

  • The payment must be a refund of state taxes paid  
  • The taxpayer claimed the standard deduction or itemized deductions but did not already receive a tax benefit (most likely because they met the $10,000 tax deduction limit)  

As a tax preparer, consider whether your clients meet these criteria before excluding the rebate from income, especially if they itemize deductions. For example, if a client only paid a total of $9,000 in state taxes, they can deduct this entire amount from their income as it is under the $10,000 cap for deducting state and local taxes. If they also received a special state rebate of $1,000, they cannot exclude this rebate from income because they already received the benefit when they deducted the initial $9,000.  

In effect, the rebate means they only truly paid $8,000 in state taxes. Excluding the rebate from their income would create a double benefit, allowing them to deduct or exclude the same money twice.  

However, if a client who itemized deductions paid $11,000 in state taxes and received a $1,000 rebate, they would be able to exclude the rebate from income since the amount of the rebate is over the $10,000 cap. 

The key takeaways 

This IRS announcement provides much-needed clarity for individuals who received special state tax payments in 2022. Most recipients will not need to include these payments in their income for federal tax purposes. By understanding the exceptions and exclusions outlined, you can serve your clients better and help them navigate their tax obligations effectively.  

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