Are Special State Tax Refunds Taxable? Maybe; It depends!

For COVID relief, both the federal government and some state governments had funds for individuals/households. Congress created Economic Impact Payments (recovery credits) which were specified as not taxable and states followed that. Some states such as California had additional relief such as the Golden State Stimulus payments where were labeled as a one-time tax refund and available only to individuals below $75,000 of income or who received certain aid. California law (R&T 17131.11) was clear the funds were not taxable for California. For federal purposes, as a tax refund they were not taxable and even if not truly a tax refund, they likely fell under the general welfare exclusion to be non-taxable.

Last summer some state lawmakers created additional grants or refunds likely due to a surplus and increased gasoline prices hurting some individuals. California enacted the Better for Families Tax Refund (AB 192, Chapter 51, 6/30/22). This is also called the Middle Class Tax Refund (MCTR).

The preamble to the bill states that “existing law authorizes various forms of relief for low-income Californians.” The relief provided though is available to married couples or head-of-household filers with 2020 income (AGI) up to $500,000 or single up to $250,000. These are not low-income levels because those high levels represent less than 2% of the California population. In addition to being below the stated AGI levels per the 2020 return, recipients had to have filed their 2020 return by 10/15/21 (before AB 192 was enacted) and be a California resident for six or more months of 2020 and not be eligible to be claimed as a dependent.

AB 192 is very clear that the “refund” is not taxable in California (R&T 17131.12(a)). While it sounds like a non-taxable refund for federal, there is a provision in AB 192 at Welfare & Institutions §8161(d) that states that the payment “shall not be a refund of an overpayment of income taxes …”

So, not a non-taxable tax refund.

Well, does the general welfare exception apply to make the MCTR non-taxable? The IRS describes this income exclusion as requiring the income recipient to satisfy the following (see Information Letter 2019-0024):
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