San Francisco Chronicle

California­ns don’t owe tax on ‘middle-class refunds’

- By Kathleen Pender Reach Kathleen Pender: kathpender­; Twitter: @KathPender

California­ns who received a “middle class tax refund” from the state in 2022 will not owe federal income tax on the payment, the Internal Revenue Service said in a statement on Friday.

“The IRS has determined that in the interest of sound tax administra­tion and other factors,” taxpayers in California and most other states that issued various types of refunds and rebates last year “will not need to report these payments on their 2022 tax returns,” it said in a news release.

The IRS did not say what people should do if they already filed a tax return and paid taxes on payments now deemed not taxable, but they might need to file an amended return to get the money back.

California had already exempted the payments from state law, but declared in November that unlike other federal and state assistance payments made during the COVID-19 pandemic, they “may be taxable” on federal returns.

As a result, it issued Form 1099-MISC to people who had received a payment of $600 or more. This form also goes to the IRS, which matches it with filed tax returns.

The IRS still had not issued guidance regarding the taxability of these payments when it started accepting and processing 2022 returns on Jan. 23. That left taxpayers and preparers in limbo.

TurboTax and H&R Block, the two biggest makers of tax-preparatio­n software, decided to treat them as not taxable. However, other tax profession­als believed they would be taxable because the payments did not clearly qualify for any tax exemption under federal law.

Amid the confusion, lawmakers began urging the IRS to weigh in. Finally last week the agency said it would issue guidance and advised taxpayers to postpone filing their returns until it came out.

On Thursday, the National Taxpayer Advocate Erin Collins, who runs an independen­t organizati­on within the IRS that represents taxpayers, harshly criticized the IRS for not providing guidance much sooner.

“This was a known issue, with ramificati­ons for tens of millions of taxpayers, tax return preparers (who still prepare most federal income tax returns) and tax software developers. The failure to have identified and resolved this issue before the filing season suggests that someone, or everyone, was asleep at the switch,” Collins said in a blog post.

California was one of 21 states that issued payments last year, mostly to return budget surpluses to taxpayers or offset inflation. But they were each a little different. Although California called its payments, which ranged from $200 to $1,050, “tax refunds,” the law that created them, AB192, specifical­ly said they were not income-tax refunds.

TurboTax and others concluded the California payments were not taxable under the federal “general welfare exemption.” The IRS previously said that exemption applied only “to government­al payments out of a welfare fund based upon the recipient’s need, and not as compensati­on for services.” Some questioned whether payments to California­ns making up to $250,000, or $500,000 if married, would qualify based on “need.”

On Friday, the IRS clarified that if a payment is made for the “promotion of the general welfare or as a disaster relief payment,” it may be excludable from income for federal tax purposes under the General Welfare Doctrine or as a Qualified Disaster Relief Payment. It said payments issued by 17 states including California fall into this category.

“The IRS seems to have considered broadly that the California payments were primarily for COVID relief . ... This statement indicates they view the payments as disaster relief,” Nellen said via email.

Payments from four other states — Georgia, Massachuse­tts, South Carolina and Virginia — will be treated like other state income-tax refunds. They “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 announceme­nt only referred to 2022 tax returns; however, California was still issuing payments in 2023.

Though the IRS did not explicitly state that 2023 payments would also be exempt from federal taxes, it referenced May 2023 as the end date for the U.S.’s designatio­n of the pandemic as a federal disaster. That indicates payments received before that date would get the same treatment, Nellen said. She added that, with this IRS news release, the FTB should not issue 1099 forms for payments received in 2023.

 ?? Patrick Semansky, STF/Associated Press ?? On Friday, the IRS released its guidance on the state’s middle class tax refund issued last year.
Patrick Semansky, STF/Associated Press On Friday, the IRS released its guidance on the state’s middle class tax refund issued last year.

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