Are My State Pandemic Relief Payments Taxable?
Continuing a trend seen throughout the COVID-19 pandemic, during 2022 a number of states offered some type of financial relief to taxpayers. A number of news outlets focused in recent days on the fact that it was unclear whether those state payments represented federally taxable income. Worse, many people already had filed 2022 tax returns (potentially containing errors), not realizing that this issue existed. Fortunately, the IRS provided some clarity last weekend, and the purpose of this article is to explain what happened and share the outcome. For those of you who just want the answers, skip to the “solution” section below. For those who want a bit more information on what led to the confusion, start with the “background” section below.
The Internal Revenue Code is the highest source of U.S. tax authority. It tells us in Sec. 61 that “all income from whatever source derived” is taxable, unless a specific exception is provided to exclude it. Elsewhere within we learn that no expenditures are deductible unless specific language allows them. So, our starting point (with all items – not just relief payments) is generally that every single “betterment” is taxable, and every outlay is nondeductible.
With that general explanation of the playing field, some primary exceptions apply in the state relief payment context:
- One exception is provided in Sec. 139 of the Code, which excludes from taxable income anything determined to be a “qualified disaster relief payment.” This section came to life following the nation’s 9/11 attacks, and has been used for a variety of relief payments since then.
- Another exception in the Code is allowed for refunds of state taxes (taxes previously paid by an individual to a state tax authority that in turn are refunded to that individual because payments exceeded the actual amount of tax incurred). This tax-free treatment doesn’t apply to all refunds, though. If an individual utilized itemized deductions on a federal return, and included state taxes paid in those deductions (thereby lowering income in that year), the subsequent refund of some of those previously-deducted taxes generally is taxable. (This makes sense, as it causes the net deduction to equal the net amount actually paid, even if the pieces of that “netting” are scattered over two years.)
- The above exceptions are statutory, meaning they are housed in the Code – the highest authority. Another exception could be described as administrative application of the Code by the IRS, and is known as the “general welfare doctrine.” This has its roots in a subsection of Code Sec. 139, which excludes certain benefits that promote general welfare in a nondiscriminatory manner. While the section specifically applies to Native Americans, in practice the IRS has used this same approach for a variety of other benefits received by much broader groups.
On February 3, the IRS issued a statement acknowledging that plenty of questions existed about the taxation of state relief payments, and that it planned to provide more guidance the following week.
To many, it seems absurd that the IRS waited so long to provide clarity to the question of whether relief payments were taxable. But perhaps a bit of latitude is in order. The exceptions above are primarily statutory, and the rules were set in motion long ago for everyone’s own use determining tax treatment. It is not necessarily the IRS’ duty to analyze every single state-level payment to determine its taxability in advance. (That’s what the rules are for.) But on the other hand, the IRS is the gatekeeper for all tax returns filed, and has the authority to question treatment of items reported on a return. These payments were pervasive (21 states offered 2022 relief of some kind – going out to millions of recipients). Some would argue that the IRS must have seen this confusion coming, and waiting this long to provide the answer that they did seems a bit tardy.
In any case, their task at hand was determining whether various state payments met the definition of a “qualified disaster relief payment,” or would be afforded favorable treatment under the somewhat applicably vague (and highly subjective on the IRS’ part) general welfare doctrine. If not, then the general rules applicable to state tax refunds (exception #2 above) would apply.
Over the weekend, the IRS provided guidance for each of the 21 states’ relief payments. Interestingly, it did so not by stating that certain payments qualified and some didn’t, but instead by assuring that it “will not challenge (taxpayer’s) treatment” if their reporting is consistent with the following:
- For the following 14 states, the payments may be treated as tax-free (falling under exceptions #1 or #3 above):
- California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Indiana, Maine, New Jersey, New Mexico, Oregon, Pennsylvania and Rhode Island
- For the following 4 states, the payments are deemed to be a refund of previously-paid taxes (rather than a pure “relief” payment per se), and therefore the taxability depends on whether a tax benefit was received in the prior year (excluded in whole or in part for some, but not others, based on the criteria explained in exception #2 above):
- Georgia, Massachusetts, South Carolina, Virginia
- For the following 3 states, there were multiple payments (or the relief payments contained multiple components) and the components are treated differently, depending on whether they fall into (a) categories #1 or #3 above vs. (b) #2 above.
- Alaska, Illinois, and New York
From the information above, hopefully readers can determine how their relief payments will be treated, and understand the nuances that led to some confusion in recent weeks. Unfortunately, the IRS began accepting and processing returns on January 23, and guidance on this issue was delayed until late in the day on February 10. Many who filed tax returns in that period reporting tax-free relief payments are no doubt relieved (pun fully intended – all of this author’s puns are intended) that this is resolved. But others may find the need to re-file their returns to update the treatment of these payments.
For more information, please contact Stan Rose or your BNN tax advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.