There was considerable confusion during 2022 as to whether certain state payments being made to state residents in 2022 were taxable for federal income tax purposes. Twenty-one states made some sort of such payments in 2022.
Finally, after the start of the 2023 tax filing season, the IRS issued Information Release 2023-23 on Feb. 10, 2023. The IRS stated that due to the need for quick guidance to taxpayers already filing tax returns, for 2022 payments only, it would not challenge a taxpayer's treatment of the payments in most of these states as excludable for income tax purposes on a 2022 original or amended tax return. This helped resolve the issue for 2022.
However, several of those state programs have continued to make payments in 2023. It is not clear that the IRS will treat 2023 payments the same as 2022 payments.
IR-2023-23
Information Release 2023-23 described the special tax refunds or payments made by certain states as creating a unique and complex situation. The release states that, while in general payments made by states are includable in income for federal tax purposes, there are exceptions that would apply to many of the payments made in 2022.
For a refund of state taxes paid, the IRS applied the general rule that the refund is not included in income for federal tax purposes if the recipient claimed the standard deduction or otherwise did not receive a tax benefit from the refund; for example, because of the $10,000 limit on the federal tax deduction of state taxes. The IRS identified payments from Georgia, Massachusetts, South Carolina and Virginia as falling into this category for 2022, as do some of the payments made by Illinois and New York.
The other possible basis for exclusion of payments was described as payments based on general welfare or disaster relief. The IRS basically said that time would not permit an analysis of whether the state payments fell into the category of general welfare or disaster relief payments; however, it would not challenge the exclusion of such payments made by the following states: Alaska (only for the supplemental Energy Relief Payment received in addition to the annual permanent Fund Dividend), California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois (only for the payments that were not tax refunds), Indiana, Maine, New Jersey, New Mexico, New York (only for the payments that were not tax refunds), Oregon, Pennsylvania and Rhode Island. Whether in fact these payments qualify under the general welfare or disaster relief provisions remains an open question for 2023 payments.
General welfare
The preamble to the U.S. Constitution includes as a responsibility of government to provide for the general welfare. Code Sec. 139E added by the Tribal General Welfare Exclusion Act of 2014 provides an exclusion from income for payments from certain benefit programs provided by an Indian tribal government for the general welfare of its members. The IRS is applying the general welfare doctrine to payments made under social benefit programs for the promotion of general welfare. It applies to governmental payments out of a welfare fund based upon the recipient's need and not as compensation for services.
It is not clear that all of the state payments being made would qualify under this standard. In many cases, there was no individual determination of need for the payments. Sometimes the payments were only made to lower-income taxpayers, which might be thought to make at least a general association to the need of the recipient, but it did not involve a determination as to the specific need of any particular recipient.
Disaster relief
Following the disaster relief provided as an itemized deduction on the federal tax return, the IRS currently seems to require that an exclusion for disaster relief must be associated with a federally declared disaster. A federally declared disaster requires a presidential disaster declaration and usually applies only to specific counties of a state for a specific period of time.
The COVID disaster was unusual in that it was a federally declared disaster that applied to all of the states and initially had no end date. President Biden finally declared an end to the COVID disaster on May 11, 2023. Therefore, there was a federal disaster declaration in effect for all of 2022 that applied to all citizens.
The IRS in IR-2023-23 seemed to take some comfort in the existence of the federal disaster for all taxpayers for all of 2022 in reaching its position on the exclusion of state payments for 2022. The same logic might apply to payments through May 11, 2023; however, that is not certain. Many of the state payments did not specifically identify the COVID disaster as the reason for the payments. There have certainly been a number of federal disaster declarations already for 2023; however, these are of the typical type and limited to taxpayers in particular counties for particular periods of time. The state payments at issue here were also not typically tied to such disaster areas.
Treatment of state payments
Taxpayers and their advisors will want to look at the specific enactment language for the payments in their particular state to see if they can fall into either the general welfare exclusion or the disaster relief exclusion. If the payments were structured as a state income tax refund, then the general rule applies for 2023 that the exclusion applies only if there was no federal tax benefit from the state tax that is being refunded. It is possible that the IRS may issue some additional guidance on the treatment of such state payments on 2023 federal tax returns. In the absence of such guidance, taxpayers and their tax return preparers will have to deal with the complex issues of whether the payments can qualify as a general welfare or disaster relief payment without the cover of the COVID disaster declaration for most of 2023.
It is possible that a payment in 2023 could be considered to relate back to the COVID disaster period; however, that would be another issue that would have to be addressed to support exclusion treatment.
