The Middle Class tax refund (MCTR) by the state of California is tax-free as per the announcement made by IRS on Feb. 10, 2023, vide R-2023-23. Similar to middle class tax refund by California, IRS also announced exemption for other 21 states. With this, the ongoing debate and controversy are set to rest on the taxability of various state payments to its residents.
Is middle class tax refund taxable?
Basically, under the Internal Revenue Code, the Federal tax law, all income is taxable unless it is explicitly declared exempt. From that point, the receipt of middle class tax refund received from California state is principally taxable, even though it is made exempt from state tax. Therefore, tax professionals were arguing whether the amount would be tax exempt or taxable.
The argument in favor of the conclusion that MCTR payments were not taxable was section 61 of the IRC, which provides that a receipt may be excluded from income if the following three criteria are satisfied,
- Payment to a taxpayer is made from a government fund
- Payment is made for the promotion of general welfare
- it does not represent compensation for services
However, some tax professionals believed that unless IRS brings out some notification declaring the Middle Class Tax Refund by California as exempt from tax, it should be included in the taxable income for Federal tax purposes.
IRS declaration on Middle Class Tax Refund & other state payments
IRS has given reasoning for exempting payments by 22 states, that includes the state of California:
If a payment is made for the promotion of the general welfare or as a disaster relief payment, for example related to the outgoing pandemic, it may be excludable from income for federal tax purposes under the General Welfare Doctrine or as a Qualified Disaster Relief Payment. Determining whether payments qualify for these exceptions is a complex fact intensive inquiry that depends on a number of considerations.
……………….
Payments from the following states fall in this category and the IRS will not challenge the treatment of these payments as excludable for federal income tax purposes in 2022.
- Alaska [1]
- California
- Colorado
- Connecticut
- Delaware
- Florida
- Hawaii
- Idaho
- Illinois [2]
- Indiana
- Maine
- New Jersey
- New Mexico
- New York2
- Oregon
- Pennsylvania
- Rhode Island
List of payments by state in 2022 that are tax exempt as per IRS
| State | State payment program and link to state website |
|---|---|
| Alaska | Energy Relief Payment (supplementing the Permanent Fund Dividend) |
| California | Middle Class Tax Refund |
| Colorado | Colorado Cash Back |
| Connecticut | Child Tax Rebate |
| Delaware | Relief Rebate Program |
| Florida | Pandemic Temporary Assistance to Needy Families |
| Hawaii | Act 115 Refund |
| Idaho | 2022 Tax Rebate |
| Illinois | Individual Income Tax Rebate |
| Indiana | Automatic Taxpayer Refund #1Automatic Taxpayer Refund #2 |
| Maine | Pandemic Relief Payments |
| New Jersey | ITIN Holders Director Assistance Program |
| New Mexico | Multiple rebate and relief programs |
| New York | Supplemental Child Credit and Supplemental Earned Income Tax Credit |
| Oregon | One-Time Assistance Payments |
| Pennsylvania | One-Time Bonus Rebates |
| Rhode Island | 2022 Child Tax Rebates |
Above table is made from IRS chart.
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