Could Your State Stimulus Check Be a Red Flag for an IRS Tax Audit?
For individuals and families struggling to make ends meet amid persistent high inflation, stimulus checks issued by some states were a much-needed blessing after the Internal Revenue Service (IRS) issued the last round of federal Economic Impact Payments (EIPs) to qualified Americans.
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However, for those who live in states that sent their residents inflation relief or stimulus rebates, questions have arisen regarding whether or not recipients will need to pay federal taxes on state stimulus checks as income, as well as which states will be affected.
After recommending individuals in states who received “special tax refunds or payments” to delay filing their 2022 tax return, the IRS clarified who will need to pay federal taxes on stimulus payments made by 21 states.
According to the agency, people living in states who issued payments “related to general welfare and disaster relief” will not be required to report these payments on their 2022 tax returns. States affected by this “general welfare and disaster relief” payment classification are California, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Maine, New Jersey, New Mexico, New York, Oregon, Pennsylvania and Rhode Island.
However, if you live in Alaska, Georgia, Massachusetts, South Carolina and Virginia, you’ll need to be aware of certain conditions before doing your taxes to successfully avoid a potential audit.
Alaska provides a Permanent Fund Dividend (PFD) to its residents every year. In 2022, it issued $3,284 to each eligible adult and child. For federal tax purposes, Alaskans will only need to pay a percentage for relief funds received per the State of Alaska Department of Revenue. The taxable amount of the 2022 PFD is $2,622. The non-taxable portion ($662) stems from the supplemental Energy Relief Payment.
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For Georgia, Massachusetts, South Carolina and Virginia, paying federal tax on stimulus funds depends on whether you take the standard deduction on your tax return or itemize your deductions. According to Market Realist, you won’t need to claim your state stimulus payment as income if:
the payment is a refund on paid state taxes, and
the recipient claimed the standard deduction, or
the recipient itemized deductions but didn’t receive a tax benefit.
As the IRS news release spelled out, residents in these four states will need to pay taxes on state-issued stimulus checks if they itemized deductions and received a tax benefit from those deductions in 2022. Stimulus payments in these states are considered a “refund of states taxes paid,” per the IRS.
The reason for this is a possible deduction overclaim resulting in a potential alert to IRS auditors. Taxpayers may deduct up to $10,000 in state taxes on their federal return. The state stimulus check is considered a refund on state taxes paid and would reduce a filer’s net payment for state taxes by whatever amount they received.
If a taxpayer received a tax benefit in the year the taxes were deducted, the state payment will need to be included as income on their federal tax return. If a stimulus check recipient claims their full state tax deduction (including the state stimulus amount) it may get red flagged by the IRS as an overclaim by that stimulus amount. If that same individual claims the deduction without the state stimulus amount included, they’ll pay a bit more in taxes.
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The IRS also mentioned that states providing stimulus checks as compensation to workers are includable as income. This would include over one million front line workers in Minnesota who received a $487.45 payment during COVID-19 pandemic and who will need to report this check as federal income, per the Minnesota Department of Revenue.
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