On Feb. 3, 2023, the Internal Revenue Service (IRS) told taxpayers who received special tax payments or refunds in 2022 from the state in which they reside to wait on filing their federal taxes until additional guidance was provided.
In 2022, over 20 states provided a one-time state refund to deliver relief related to the pandemic and its associated consequences. The 2023 tax season started on Jan. 23; however, the IRS had not defined if the state refunds should be considered taxable income on federal tax returns.
The recommendation applies mainly to states like California, which offered a Middle-Class Tax Refund that aided over 31 million taxpayers and their dependents. Other states that sent rebates to taxpayers after they stated having budget surpluses were also advised to hold off on filing taxes.
Each state that offered its constituents a relief refund had different rules and regulations for that process which made it harder to determine what is taxable on the federal level.
There is ample reason to believe many of these payments are not taxable for federal income tax purposes. If the taxpayer received a tax benefit in an earlier year or received aid under general welfare, then that refund is not taxable. Other refunds given by the states are normally includable in income for federal income tax purposes. This includes any disbursements from states provided as compensation to workers.
According to the statement put out by the IRS on Feb. 10–regarding guidance on state tax payments to help taxpayers, in the interest of sound tax administration and other factors–taxpayers in many states won’t need to report these special tax payments on their 2022 federal tax returns.
Out of the states that provided relief, Michigan was not among them in 2022. “This is not an issue for Michigan taxpayers,” said Tina Rolling, an Associate Professor of Business Administration at Alma College.
The IRS determined that a refund from the state for the promotion of the general welfare or as a disaster relief payment may be excludable from income for federal tax purposes under the General Welfare Doctrine or as a Qualified Disaster Relief Payment. For example, a refund related to the outgoing pandemic would not be federally taxed.
Although the IRS’s statement to hold off on filing taxes does not affect Michigan taxpayers, tax season is underway. Here is some general information to aid in the process of filing taxes:
The IRS is responsible for determining what income is taxable or not taxable. Taxes provide proceeds for federal, local and state governments to fund vital services like law enforcement and public works that benefit all citizens who could not provide such services for themselves.
Those who need to file taxes but choose not to, are likely to receive consequences from the IRS. Those consequences include penalties, fines, interest or more severe measures. Those who fail to file taxes on time are likely to encounter a Failure to File Penalty. The penalty for failing to file is 5% of the unpaid tax liability for each month the return is late, and up to 25% of total unpaid taxes.
There is no penalty for failing to file taxes if a refund is due; however, there is a possibility of losing that refund. There is a limited time period to claim a refund.