IRS Clarifies Federal Tax Impact of Special State Payments

Taxpayers who received disaster relief and other special payments during 2022 now have guidance from the Internal Revenue Service (“IRS”) regarding the federal income taxation of these payments. On February 10, 2023, the IRS issued a press release clarifying the federal tax status of special payments made by 21 states during 2022.[1]

General Welfare and Disaster Relief Payments

The IRS will not challenge the taxability of payments for general welfare and disaster relief made by a group of 17 states.[2] For example, taxpayers in each of these 17 states who received a payment during 2022 related to the Covid-19 crisis can exclude such payment from federal taxable income when filing Form 1040 for 2022. Of course, since the covered payments in each state may not use consistent terms and nomenclature, the IRS is not closely scrutinizing the eligible payments. Instead, the IRS is giving a wide berth to the exclusion of all such payments. According to the IRS:

“If a taxpayer does not include the amount of one of these payments in its 2022 income for federal income tax purposes, the IRS will not challenge the treatment of the 2022 payment as excludable for income on an original or amended return.”

State Tax Refunds

Taxpayers in Georgia, Massachusetts, South Carolina, and Virginia are eligible to exclude special 2022 state tax refunds from federal taxable income if the taxpayer 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).[3] This treatment is consistent with the status of regular state tax refunds when a taxpayer did not receive a federal tax benefit from payment of state tax.

For more information, please contact Michael Cumming (mcumming@dykema.com or 248-203-0740), Scott Kocienski (skocienski@dykema.com or 248-203-0868), Asel Lindsey (alindsey@dykema.com or 210-554-5298), Richard Lieberman (rlieberman@dykema.com or 312-627-2250), Lisa Hendrix Weigel (lweigel@dykema.com or 312-627-2296), Nardeen Dalli (ndalli@dykema.com or 248-203-0793), or your local Dykema relationship attorney.

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[1] The February 10, 2023, IRS press release is located here.

[2] Alaska, California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Maine, New Jersey, New Mexico, New York, Oregon, Pennsylvania, and Rhode Island. For Alaska, the exclusion applies only for a supplemental Energy Relief Payment received, not the annual Permanent Fund Dividend.

[3] Illinois and New York issued multiple payments. One such payment is eligible for exclusion from federal taxable income as a refund of taxes and the other payment is eligible for relief from federal tax as a disaster relief payment.