Following up on guidance for payments made in 2022, the IRS on Wednesday issued Notice 2023-56, which describes the federal tax consequences of payments of state tax refunds and certain state tax payments made to individuals in 2023 and later years.
In a news release (IR-2023-23) issued in February, the IRS said that, in regards to programs (many of which were related to the COVID-19 pandemic) that made payments to certain state residents in 2022, it would not challenge the treatment of these payments as excludable from income on an original or amended return based on the general welfare doctrine. Under that doctrine, payments made under legislatively provided social benefit programs for the promotion of the general welfare are excludable from gross income, or as qualified disaster relief payments under Sec. 139.
Notice 2023-56 provides that for 2023 and later years:
- If an individual claims the standard deduction for a tax year in which the individual paid state income taxes that are refunded, the refund in a subsequent tax year is not includible in the individual’s gross income. An individual who itemized deductions and deducted amounts of state income taxes paid, however, is required to include the state tax refund in gross income to the extent that the individual received a federal income tax benefit from the prior deduction of the taxes. Refunds of state property tax are treated similarly.
- In addition, the IRS said spillover payments — those made in early 2023 under the 2022 programs covered by IR-2023-23 — are excludable from federal gross income for individual taxpayers who did not receive a payment under the program in 2022.
- State payments made under a state program for the promotion of the general welfare are not includible in an individual’s gross income. To qualify under the general welfare exclusion, the payments must be made from a governmental fund; be for the promotion of the general welfare (that is, based on individual or family need); and not represent compensation for services. Payments based on criteria other than individual or family need do not qualify.
The IRS requested comments on the application of the rules described in the notice. The deadline for comments is Oct. 16, although the IRS may consider comments submitted after that date if that does not delay further guidance being issued. The IRS is specifically requesting comments on state sales tax refunds, noting that it might not be practicable to determine the amount of state sales tax that an individual paid during a tax year.
After considering the comments, the IRS said it plans to issue more guidance on federal income taxes and state payments.