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Were last year’s state payments taxable? Taxpayers wait while the IRS decides.

Heard on:
The Internal Revenue Service building.

The Internal Revenue Service building in Washington. Even though tax season is upon us, the agency hasn't yet ruled whether special payments from states will be exempt. Stefani Reynolds/AFP via Getty Images

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We are a couple of weeks into tax season, and the IRS is telling people in nearly two dozen states to hold off on filing their returns.

Those states sent out some kind of tax rebate or inflation relief payment last year, and the IRS hasn’t figured out yet whether those payments are taxable.

Tax policy is Richard Auxier’s thing. He works at the Urban-Brookings Tax Policy Center in Washington, and people come to him when they’re confused about something tax-related, which is pretty often. 

“I feel like my job is typically to be like, ‘It’s not that complicated,'” Auxier said.

But this time? “This time, it really is,” he said. Complicated, that is. 

But why?

Shouldn’t it be easy for the IRS to say either “Yes, that payment you got from the state last year is taxable” or “No, it’s not”?

Well, for one thing, Auxier said, every state took a different approach in terms of how much money it sent to whom and why.

The reason and the why and the how is now going to start to affect the possibility of this being taxable,” he said.

Remember those Economic Impact Payments — or relief/stimulus checks — the federal government sent out earlier in the pandemic? Those were not taxable.

“Because we were still in the COVID emergency,” explained Francine Lipman, a law professor at the University of Nevada, Las Vegas.

She said disaster relief payments are generally not taxed. “2022, good news/bad news. It’s no longer COVID relief distributions. In some cases it is, in some cases it’s not.”

If a state gave out money last year to help people struggling with inflation or just because, that may well be taxable. 

Or it might not be. It also depends on who got the payments. Everyone? Just low-income people? 

Jared Walczak at the Tax Foundation said deciding those issues won’t answer another big question, which is why is the IRS just doing this now? 

“The IRS has known or should have known for a year that there were going to be questions about the taxability of state tax rebates,” Walczak said.

But it waited until tax season was underway to make any statement.

“And that statement was just hold on, wait and see,” he said.

The IRS says it will have an answer for taxpayers soon.

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