Don't file your taxes yet, IRS says amid confusion over state benefits

The Internal Revenue Service (IRS) building is seen in Washington, U.S. September 28, 2020. REUTERS/Erin Scott

The Internal Revenue Service is telling taxpayers - including more than 16 million in California - to hold off filing their taxes until the agency can issue guidance on state-issued inflation payments.

Dozens of states distributed stimulus-like payments or tax rebates in 2022 to counter inflation, which reached a 40-year high in 2022. The IRS on Tuesday said it needed more time to determine which of those payments are federally taxable, and told taxpayers not to submit returns until it finalized those rules.

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"For taxpayers uncertain about the taxability of their state payments, the IRS recommends they wait until additional guidance is available or consult with a reputable tax professional," the agency said. "For taxpayers and tax preparers with questions, the best course of action is to wait for additional clarification on state payments rather than calling the IRS."

Faced with a glut of excess revenue stemming from wage gains in 2021 and 2022, nearly two-dozen states issued payments to combat inflation over the summer. California's middle class tax refund distributed payments worth between $200 and $1,050; close to 16 million taxpayers have received the payouts already, and 23 million are eligible.

New York awarded inflation relief payments worth $270 for average to low-income residents and enacted rent and property tax relief. Oregon sent one-time $600 checks to low-income households, and Georgia gave tax filers a $500 credit after they submitted their 2021 return.

The tax status of those payments will vary by state, and depends on the program's stated purpose, tax professionals say.

If the payments were for pandemic relief, for example, they should be exempt from federal tax because they fall under disaster relief. If they were for inflation or other economic relief, they're probably taxable.

"It's all up to what the [state] legislature decided," said Jared Ballew, director of government relations at Drake Software. "Was it for the benefit of that money, or is it like a tax refund, which would be taxable on a federal level?"

The holdup threatens to complicate a tax season that so far IRS officials and tax policy experts say has run relatively smoothly. But the agency has struggled to implement some tax code changes backed by President Biden and other prominent Democrats, although they were signed into law several months ago, or even earlier.

"They had the opportunity to see this coming," Ballew said.

The landmark Inflation Reduction Act that was enacted last year included tax rebates for consumers that purchase American-made electric vehicles.

But the IRS has left in place broad guidelines that include vehicles without the requisite amount of U.S.-made parts, allowing them to remain eligible for the tax break for a longer-than-expected period.

Another of Biden's key legislative victories, the American Rescue Plan Act of 2021, levied taxes on transactions worth $600 or more that were made through third-party payment apps, such as Venmo and PayPal.

The IRS delayed guidance on that question, too, saying it will not apply until the 2023 tax year.

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