IRS warns taxpayers to hold off filing returns in 20 states as it checks if it can tax special refunds

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FEBRUARY 10, 2023

Erin Collins, the National Taxpayer Advocate, cautioned that realistically it could take six months to nine months for a refund, if you file your 2021 federal income tax return by paper. – Supplied by the Taxpayer Advocate Service

Well, so much for early promises by the IRS that taxpayers could expect to “experience improvements” as they file their 2022 returns this year.

Taxpayers in more than 20 states were warned last week by the Internal Revenue Service to hold off filing their tax returns for now until the IRS irons out how the taxpayers in those specific states should report, if at all, money received from their states through special tax refunds or payments in 2022.

We’re looking at one mind-boggling blunder that puts tens of millions of taxpayers on the hook in states that include California, Massachusetts and Virginia.

Taxpayer advocate blog blames IRS

The National Taxpayer Advocate issued a highly critical blog Thursday that questioned why the IRS waited so long to address whether special tax refunds or payments will be treated as taxable income on a federal income tax return. The same blog also stated that the IRS failed to provide timely guidance involving a change in reporting of payments of more than $600 on platforms, like Venmo and PayPal.

The ongoing uncertainty about how to report one’s special tax refund immediately touches the lives of taxpayers in several states.

And I’d suggest that down the road it could add to the paper backlog at the IRS if people in several states aren’t clear on how to correctly report their taxes soon.

“This was a known issue,” wrote advocate Erin Collins, who is the “voice of the taxpayer” within the IRS.

“The failure to have identified and resolved this issue before the filing season suggests that someone, or everyone, was asleep at the switch,” Collins wrote.

When waiting to file a return is recommended

Taxpayers are stuck in a filing season ditch. If they’re depending on getting a decent size federal income tax refund early in the season, forget it. They need to delay filing a return as the IRS works out what experts say could be fairly complex guidance. The IRS is expected to issue some word in the coming days.

If these taxpayers file early anyway, they risk doing their taxes wrong.

Tax software companies and tax professionals are waiting to see what move the IRS takes next, too.

Collins wrote that the impact of this type of delay is “hard to overstate.” She said the IRS has known for months that there is uncertainty about the tax treatment of special state refunds or payments, which were handled in a variety of ways in different states.

Some tax software companies, she wrote, have concluded that some state tax payments are not taxable and have programmed their software so the payments are not reported.

Tax professionals told me that there likely isn’t a one-size-fits-all answer here that can apply to every state. But general guidelines and tax rules will be taken into account to address how states paid out the money.

Collins concluded that there is ample reason to “believe that many of these payments are not taxable for federal income tax purposes — either if the taxpayer did not receive a tax benefit in an earlier year or under the ‘general welfare exclusion.’ “

Virginia provided a one-time tax rebate, for example, she noted, and the state’s department of taxation’s website states that taxpayers who itemized deductions may be required to report the rebate as income received on their federal income tax returns. Virginia says it will send a 1099-G in the mail, the same as if someone received a state tax refund.

Roughly 9 out of 10 taxpayers take the standard deduction; the rest itemize deductions on a federal income tax return.

Payment apps could confuse some ahead

Collins also addressed some confusion on the 1099-K issue involving payment platforms.

Taxpayers across the country will wait and see again how the IRS handles a new reporting requirement involving third-party payments. Payment apps, like Venmo and PayPal, are used for personal reasons — like sending a child birthday money — and business reasons, like money paid to freelancers and others for goods and services.

You’d pay taxes on money received in a gig job or business — not the kid’s birthday cash. But users need to know how to distinguish and separate such payments. You don’t want to be in a situation where you have to dispute a 1099-K and say it is erroneous and ask a payment provider to issue a corrected 1099-K.

Congress wants to make sure that taxable income is taxed and upped the paperwork requirements for when 1099-K forms are issued as part of the American Rescue Plan Act of 2021. New reporting was to apply to transactions made in 2022 and after.

Collins said the IRS made the right decision to pull the plug and delay implementing the new 1099-K threshold until the 2024 filing season. But she said the IRS could have done more by working early on with the tax industry and others to implement the legal requirement. The IRS did issue guidance on Dec. 28 that will be useful ahead.


Courtesy/Source: This article originally appeared on USA TODAY