Is it too much to ask the IRS to clarify what people will be taxed on?
Twenty-two states sent residents tax rebates of some kind last year. Do those rebates increase your federal income-tax liability? The IRS isn’t sure.
The federal tax-collection agency didn’t say anything about whether it was intending to collect taxes on state-tax rebates from 2022 until February 3, 2023, at which point it said, “There are a variety of state programs that distributed these payments in 2022 and the rules surrounding them are complex.”
Be that as it may, the IRS had all of last year to get in touch with state revenue departments and figure this issue out. Now, it’s saying that people who received rebates shouldn’t file early, since they might need to amend their returns depending on how the IRS decides to tax them.
Jared Walczak describes the definitional problem the agency faces in a blog post for the Tax Foundation:
The federal Internal Revenue Code begins with a definition of income that includes “all income from whatever source derived,” including from state governments, but there are exceptions. Three are potentially relevant in determining the taxability of state rebate checks:
- Qualified disaster relief payments are not taxable, even if made through the tax code. The COVID-19 pandemic qualifies; an emergency declaration was issued for the pandemic in March 2020 and is still in effect. If the IRS construes a state’s tax rebates as a pandemic response, those rebates would not be subject to federal income tax.
- The general welfare doctrine establishes that social benefit programs are excluded from definitions of gross income. From an economist’s point of view, food and housing assistance for low-income families are income. But from a tax collector’s point of view, they are not. This applies to social benefit programs run through the tax code as well, so a rebate narrowly tailored to assist specific populations may be excluded from federal taxation under this doctrine.
- If a taxpayer received no federal tax benefit because of the transfer, then the rebate may not be taxable.
Back in 2021, when a handful of states offered rebates, it was easier to frame them as pandemic aid. In 2022, however, few of these rebates were framed as assistance to mitigate pandemic-era disruptions, at least directly. More often they were tied to inflation relief, or simply offered as a way to return some of states’ large surpluses to taxpayers. What states said, moreover, is not the end of the story: the framing might factor into the IRS’s determinations, but ultimately federal officials will have to weigh the facts and circumstances in each state.
This definitional question is entirely in the IRS’s hands. It’s not a question of outdated technology. It’s not a question of insufficient staff for tax enforcement. It’s not a question of taxpayers dodging their tax liability. It’s a simple yes-or-no question of whether a form of income that millions of Americans received last year will count against them on the federal tax returns.
“It’s unfair to taxpayers that we’re more than a week into February and still don’t know what millions of them are supposed to put on their federal tax returns,” Walczak writes. “This could have — and should have — been avoided.”
Despite all the attention tax dodgers have received in the past few years, by failing at this basic task, the IRS is putting itself at odds with the vast majority of Americans who just want to pay what they owe and move on with their lives. We have an unbelievably complex tax code in this country, with thousands and thousands of pages of laws, rules, and regulations, yet we’re not sure whether a source of income we’ve known about for an entire year will be subject to the federal income tax because bureaucrats at the IRS are dragging their feet. That’s completely unacceptable, and it won’t be fixed by rewarding the agency with $80 billion in new funding.