The IRS is asking millions of taxpayers more than 20 states including California, Colorado and Florida who received tax rebates last year to hold off on filing their taxes.

The reason: The agency said it is seeking to clarify whether those tax rebates and special refunds are considered taxable income. “We expect to provide additional clarity for as many states and taxpayers as possible next week,” the IRS said on February 3.

On Friday, the IRS provided guidance to those taxpayers: For the most part, those rebates aren’t taxable.

“During a review, the IRS determined it will not challenge the taxability of payments related to general welfare and disaster relief,” the tax agency said in its February 10 update.

About 16 million California residents received “middle-class tax refund” checks of $350 per eligible taxpayer last year, part of a relief package designed by the state to help residents cope with soaring inflation at a time when the state had a budget surplus.

More than 20 states authorized tax rebates last year as their coffers were buoyed by strong economic growth and federal pandemic aid. The IRS on Friday said taxpayers in the following states won’t need to report the rebates as income:

• Alaska (but only for the supplemental Energy Relief Payment received; the annual Permanent Fund Dividend is usually taxable on the federal level.)
• California
• Colorado
• Connecticut
• Delaware
• Florida
• Hawaii
• Idaho
• Illinois
• Indiana
• Maine
• New Jersey
• New Mexico
• New York
• Oregon
• Pennsylvania
• Rhode Island

The IRS added that many people in the following states won’t have to report their rebate checks as income if they meet some requirements. For instance, this is the case if the rebate is a refund of state taxes paid and the taxpayer claimed the standard deduction or itemized deductions but did not receive a tax benefit, the IRS said. These states include:

• Georgia
• Massachusetts
• South Carolina
• Virginia

Delay in filing

Those one-time windfalls threw a wrench into tax season for millions of Americans, many of whom count on getting timely tax refunds to pay down debt, make a purchase or get on top of bills. Last year, the average tax refund (for the 2021 tax year) was almost $3,200, a 14% jump from the prior year, according to IRS data — an amount that’s bigger than the typical worker’s paycheck.

“This uncertainty is unfair to taxpayers,” wrote Jared Walczak, vice president of state projects at the Tax Foundation, a right-leaning think tank, in a blog post. “Tax experts have long known that the taxability of state rebate payments would be an issue, but the IRS remained silent until February 3rd, at which point it basically said we’ll get back to you soon.”

 

File and amend, or file and get penalized?

Taxpayers in these states who had already filed returns and who report the rebates as taxable may need to file amended returns to exclude the money if the IRS decides they aren’t taxable, according to the National Taxpayer Advocate, the watchdog arm of the IRS.

Conversely, taxpayers who already filed their returns and excluded the payments could have been subject to potential penalties, tax and interest if the IRS had decided the rebates were taxable.

“[T]he IRS missed the boat” by failing to provide timely guidance on this issue, wrote National Taxpayer Advocate Erin Collins in a Thursday blog post.

She added, “Giving taxpayers a choice between waiting to file their returns and receive their refunds or filing returns now that the IRS may later determine to be inaccurate is not acceptable.”

Adding to the confusion for taxpayers is that the federal government’s tax rebates — sent in the form of three stimulus checks during the pandemic — were not considered taxable income by the IRS.

Some taxpayers took to social media to express their frustration at the IRS guidance that they should delay filing their tax returns. The agency started accepting returns for this year’s tax season on Jan. 23.

“So I tried to sit down this morning for a fun game of Do Your Taxes, but turns out the IRS hasn’t decided if California’s Middle Class Tax Relief payments are taxable or not…,” one taxpayer wrote on Twitter.

Income or not?

The IRS issued the statement after Rep. Kevin Kiley, a Republican from California, wrote to the tax agency to say that his office had been contacted by “numerous” constituents asking for help on the issue.

“Many of the 16 million residents of California who received the refund are unable to file a 2022 tax return because they do not have clear guidance as to whether to include this payment” as taxable income, he wrote in the February 2 letter.

Adding to the confusion is that some states seem to be indicating that the rebates count as taxable income, according to Collins, the National Taxpayer Advocate. For instance, California’s Franchise Tax Board said it is sending tax forms to all recipients of the rebate, noting that the “payment may be considered federal income.”

Yet at the same time, many tax preparers “have concluded that some state payments are not taxable and have programmed their software so that these payments are not reported,” Collins added.

 

 

Source: CBS News