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IRS Acquiesces in Action on TurboTax Decision

Posted on Feb. 13, 2023

Guest blogger Bob Kamman analyzes the latest IRS announcement on the taxability of special state payments made in 2022. Previous PT coverage is here and here. PT readers may also be interested in Professor Annette Nellen’s excellent posts on the issue. Christine

As promised a week earlier, IRS announced late Friday afternoon, February 10, in Information Release 2023-23, its views on whether various “special payments made by 21 states in 2022″ are taxable.

The announcement is a landmark “Action on Decision.” Rather than expressing its views on a court ruling, IRS simply admitted that it will go along with what TurboTax and H&R Block have been doing for weeks.

Of course, that’s not what IRS said in the Notice. But it’s the only conclusion that can be drawn from the failure to cite any precedent or establish any new framework for analysis. Instead, we are told that “IRS will not challenge the taxability of payments related to general welfare and disaster relief.”

“Challenge” may be a word that describes working at IRS, but is it an appropriate term for interaction between the Service and taxpayers?

When I worked at National Office in the 1970s, one of the joys of reading the Washington Post was its daily example of bureaucratic “Gobbledygook.” This 139-word sentence from the Notice would definitely be a winner, if the feature still existed:

The IRS has reviewed the types of payments made by various states in 2022 that may fall in these categories and given the complicated fact-specific nature of determining the treatment of these payments for federal tax purposes balanced against the need to provide certainty and clarity for individuals who are now attempting to file their federal income tax returns, the IRS has determined that in the best interest of sound tax administration and given the fact that the pandemic emergency declaration is ending in May, 2023 making this an issue only for the 2022 tax year, if a taxpayer does not include the amount of one of these payments in its 2022 income for federal income tax purposes, the IRS will not challenge the treatment of the 2022 payment as excludable for income on an original or amended return.

Translation: TurboTax and other software companies, along with H&R Block and other major tax preparation companies have been ignoring these payments for the last three weeks. Exclusion was the only practical solution.

Still, IRS did not answer all of the questions that tax preparers are asking, perhaps because IRS did not ask any of us to review the announcement. Here are three examples:

Massachusetts:

The Bay State had two programs last year. For one of them, it refunded about 14% of the state income tax that individuals paid. IRS must have called the Massachusetts Department of Revenue, asked them what was happening, and were told about this program. So, they put it in the category of “state tax refunds” taxable only if claimed as an itemized deduction on last year’s 1040.

But there was also a “Covid-19 Essential Employee Premium Payments” program, which sent $500 payments to Massachusetts residents with household income less than 300% of federal poverty level and earned income of at least $12,750 in 2020 or $13,500 in 2021. Everyone was considered an Essential Employee, so this was in the nature of an Earned Income Credit. No 1099’s were issued because the amounts were under $600. The IRS announcement ignores these payments.

Illinois:

As an IRS footnote explains, “Illinois and New York issued multiple payments and in each case one of the payments was a refund of taxes, which should be treated as noted above, and one of the payments is in the category of disaster relief payment.”

Illinois made one refund of property taxes, only to people who paid property taxes. They also made payments to people who filed state income tax returns, regardless of whether they paid state income tax. The amounts in this second category were $50 per person, and $100 per dependent up to three. Which would you say should be reported as a tax refund, and which is disaster relief? There were AGI limits for both of these payments.

California:

Some of the payments from this 2022 legislation are not being made until early in 2023. California taxpayers, however, report receiving 1099-MISC forms from the Franchise Tax Board for 2022 even though their debit cards had not yet been issued last year.  The IRS announcement has some of them worried that it applies only to 2022 payments, and that this time next year, after having more time to think about it, IRS will issue new guidance.

Parting Thoughts:

The last word on this issue should come from Michael Desmond, former Chief Counsel, who participated in a Webinar sponsored by Tax Analysts on February 1, along with former Commissioner Charles Rettig and former National Taxpayer Advocate Nina Olson. Not referring specifically to this situation, which had not yet attracted media attention, but to IRS challenges in general on how to spend new funding, Desmond said:

And I look at that through an enforcement lens, perhaps, when things go wrong on the back end and you do end up in an audit situation, but I think the IRS can really do a lot on the front end to lay out those programs in a way, put guidance out on the front end and address all of the open questions or as many as possible for new programs like that, so you don’t have compliance issues on the back end. Having more resources, I look at it from the lens of Counsel, but having more resources to be able to issue letter rulings in areas where historically there has not been the staffing to do that, to answer those questions on the front end. That is, call it compliance, call it enforcement, call it service, whatever it is, from the taxpayers perspective, getting those questions answered through a letter ruling up front, through published guidance up front, so you never have the audit start, you don’t have the enforcement issue on the back end is I think a way that the deployment of resources, the new resources can really be utilized effectively, and that will increase voluntary compliance.

That “former” in front of his title is unfortunate.

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