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During the pandemic, 21 states made direct payments to residents to help them keep up with rising costs. The IRS recently addressed whether people would have to report those payments on their federal income-tax returns.
For people in 17 states, there’s a simple answer: They do not need to worry about reporting the relief money on their 2022 returns, the agency said earlier this month.
But there’s a wrinkle for residents of four states: Georgia, Massachusetts, South Carolina and Virginia. The IRS said there might be instances where taxpayers in these states will need to count the money as part of their income on their federal return.
What’s the difference? Tax professionals say that while most people in these four states will not have to report the money on their returns, the sliver of taxpayers who itemized their deductions and previously took a state and local tax deduction — instead of taking the standard deduction — do need to pay attention.
“It is safe to say it will not impact that many people,” said LuSundra Everett, president of the Virginia Society of Enrolled Agents.
For reference, 90% of the 154.3 million individual tax returns filed for the 2021 tax year used the standard deduction, according to IRS records through mid-November.
At a time when inflation is slowly coming off four-decade highs, anything that helps people hang on to their money is good news. And anything that keeps tax returns as simple as possible is always welcome.
When otherwise taxable government payments are meant to promote general welfare or provide disaster relief, the IRS notes that it has leeway to exclude the payments from income for federal tax purposes.
The inflation-relief payments in 17 states fell in this category, the IRS said.
Those states are: Alaska, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Maine, New Jersey, New Mexico, New York, Oregon, Pennsylvania and Rhode Island.
(There’s still some nuance. In Alaska, for instance, residents don’t have to report their extra payment to defray energy costs, but they do have to report the annual payment they get from the state’s Permanent Fund Dividend.)
“ The IRS classified the inflation-relief payments from four states as refunds of paid state taxes. ”
For the four other states, the IRS classified the inflation-relief payments as refunds of paid state taxes. For example, Massachusetts payments were sourced from $2.94 billion in excess 2021 tax revenue paid out last year. Its payments equaled 14% of a taxpayer’s state income-tax liability on their 2021 return.
In Virginia, where refunds were up to $250 for eligible individuals and $500 for married couples filing jointly, and in South Carolina, where refunds were up to $800, the money was pegged to 2021 state income-tax liabilities. In Georgia, where refunds were up to $250 for eligible individuals and $500 for married couples filing jointly, the money was linked to 2020 income taxes.
These four state payments “will be excluded from income for federal tax purposes unless the recipient received a tax benefit in the year the taxes were deducted,” the IRS said.
Through its “tax benefit rule,” the tax agency said, it generally requires that a taxpayer lump into their gross income the recovered amounts they deducted “in a prior taxable year to the extent those amounts reduced the taxpayer’s tax liability in the prior year.”
In other words, “something that saved you federal taxes by way of a deduction will come back to you as income if you get it repaid to you from another source,” said Mark Misselbeck, tax principal at Katz Nannis & Solomon.
Taxpayers who wrote off their state and local tax costs on their 2020 and 2021 taxes may deduct up to $10,000 in state and local taxes.
If a person was able to deduct all of their state and local tax costs — and later get another payment connected to that tax year — the tax agency would it include it as income for federal taxes during this filing season.
Even if a person itemized their taxes, they might not receive a tax benefit if the $10,000 cap kicked in and they still had state and local taxes they couldn’t deduct.
“If the payment is a refund of state taxes paid” and the recipient “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 agency said.
People should consult with tax professionals if they have questions about how the IRS guidance relates to their own tax situation if they’ve deducted state and local taxes in previous years.
But for most people, the upshot means they can heave a big sigh of relief. “For people who got this rebate and took the standard deduction, there’s nothing to do because there was no additional tax benefit,” Everett said.
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