More on California Middle Class Tax Refund

Here is my 3rd post on the payments California issued to probably over 90% of Californians per AB 192 (2022) (1/29/23 + 7/10/22).  And others have blogged on it as well. On February 3, Procedurally Taxing had a post from Bob Kammen asking why the IRS hasn't issued guidance. Bob also makes a comment about the high income range of Californians getting AB 192 "relief" payments, with what I think is sarcasm - that $250,000 of income for single or $500,000 if married is "middle class."

My first post last July raised the issue that some very low income individuals without a filing obligation get no payment if they had not filed a 2020 return by 10/15/21 as required by AB 192 which was enacted in June 2022!

Why would the state provide "relief" to people with income high enough to not need relief while leaving out those who do?

The IRS stated last week that it will try to get guidance out on the taxability of various state payments issued recently.  If they can address the California so-called Middle Class Tax Refund (a term used by the FTB), as AB 192 uses the term Better for Families Tax Refund (although AB 192 includes a specific statement that the payments are not income tax refunds). The IRS can clarify to ensure consistent treatment by recipients, although only those who received $600 or more received a 1099-MISC from the FTB. 

Some additional observations from me:

AB 192 has some oddities, such as:

1. It adds section 8161(d) to the Welfare & Institutions Code to say: "The payment authorized by this section shall not be a refund of overpayment of income taxes". This is likely why FTB is issuing 1099-MISC for payments issued in excess of $600 rather than 1099-G for income tax refunds of $10 or more. 

  Query: Can the payments be viewed as refunds of other California taxes? Likely AB 192 would have to say so explicitly as there are many possible sources of the funds and filing status has no bearing on how much other taxes one pays (excise taxes, sales taxes, property taxes, etc.). AB 192 does imply that the payments are refunds of various taxes but with conflicting language that it is not an income tax refund and it isn't available to people with income too law to be required to file an income tax return even though they pay other CA taxes.  Puzzling as to form and substance and intent. If truly intended as a refund of any CA tax, it should be allowed to all Californians if not claimed as a dependent by someone else. If a tax refund, why issue 1099-MISC?

2. Since COVID is still a federally declared disaster, the payments could have been labeled as for financial needs tied to COVID. Instead, Sec. 10 of AB 192 covers more than COVID, providing that "increased costs for goods, including gas, due to inflation, supply chain disruptions, the effects of the COVID-19 emergency, and other economic pressures have had a significant negative impact on the financial health of many Californians". This seems to make the IRC section 139 exclusion for disaster relief payments not applicable.

  A June 28 Assembly Floor Analysis summary of the bill had better wording stating that the economic disruptions stem from the COVID-19 emergency. I don't think this overrides the AB 192 text though that doesn't pin the payment relief solely on the COVID-19 disaster (if it did, I don't think FTB would be issuing 1099-MISC to recipients of $600 or more).

3. I think in the Procedurally Taxing post, Bob is joking when he says $500,000 is middle class in CA.  It is not. Just like for the rest of the country, that amount of income ($250,000 if single; $500,000 if MFJ  or head-of-household) puts someone in the top 3% of income earners. Why were "relief" payments of $600 ($400 if no dependent) given to a married couple with up to $500,000 of income in 2020?  In prior years, Golden State Stimulus payments were given to individuals with up to $75,000 of income - a much better level indicating someone who may be struggling financially.  The GSS payments certainly qualified for the general welfare exclusion.  But when a program's payments are given to individuals in the top 3% of income levels who have no financial or other need that their high income can't address, the general welfare exclusion seems inapplicable. And there was no requirement in AB 192 for anyone to show a need before receiving a payment - see the following three rulings:

In 2015 in Maines, 144 TC 123, the Tax Court stated: ""Grants from welfare programs that don't require recipients to show need have not qualified for the general-welfare exclusion."

In Rev. Rul. 76-131, the IRS stated: "The Alaska Longevity Bonus is distinguished from welfare program payments in that the benefits are payable to any Alaskan meeting the age and residency requirements regardless of financial status, health, educational background, or employment status."

PLR 200651003, the IRS describes the "needs" part of the general welfare exclusion as "generally based on individual or family needs such as housing, education, and basic sustenance expenses."

3. Also troubling about the AB 192 payments is that those most in need who had income too low to be required to file a California return for 2020, did not get any "relief" payment unless they filed by 10/15/21 yet AB 192 was enacted in June 2022!  When the GSS payments were enacted, they went to people who filed their 2020 return by 10/15/21 but those payments were authorized months before that filing date. Yes, if someone filed to get GSS, they also get AB 192 payments, but there are low-income individuals who did not file. Generally, this is a group that doesn't have a tax adviser. [7/10/22 post]

4. Another unfortunate aspect is that it will be lower income individuals getting a 1099-MISC while higher income individuals who received lower amounts won't and unless they remember to put it on their return, they get to keep their entire relief payment while MFJ and HH with under $150,000 of AGI in 2020 will pay tax on their payments if in the $600 to $1,050 range. And some low income individuals, such as a head-of-household filer with no dependent and AGI under $150,000 only received $350 so won't get a 1099 while the MFJ couple with the same income received $700 and will get a 1099-MISC.

It would be nice if the IRS could help provide relief to those truly in need who received an AB 192 payment, but it seems the general welfare exclusion looks at the entire program, not just to the effect on those with a financial or other need and the payments aren't viewed solely for COVID relief. Might the California lawmakers retroactively amend AB 192 to make it a tax refund? Maybe that is the way to go.

What do you think?

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) on the FTB website (it's not clear where that name came from).

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, perhaps it is not a non-taxable tax refund (although some bill language makes it sound like it is a refund of various California taxes, but why deny it then to someone without a need to file a 2020 California income tax return; everyone in CA certainly pays a variety of taxes including renters who indirectly pay a lot of property taxes, as well as sales and excise taxes).

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):

1. funds paid per a government program - met

2. not a payment for services - met

3. for promotion of the general welfare meaning it is based on need - I think not met

How can funds given to about 97% of Californians be a needs-based program? How can payment given to people well above the federal poverty line be based on need? How can $400 given to a married couple with $499,000 of income or $200 if single with $249,000 of income be based on need? Well, it would appear that the general welfare exception doesn't apply - the refunds/grants are taxable for federal purposes.

The FTB must have reached the same conclusion because they have stated that they are and will be issuing 1099-MISC to anyone receiving an MCTR or $600 or more.  Of course, even if someone received a payment under $600, it is still taxable despite not receiving a 1099. Also note that these are Form 1099-MISC for miscellaneous payments rather than 1099-G for a refund of income tax paid (which makes sense because you could get the payment even if no income tax was owed in 2020).

Oddities:

1. Why were these funds given to people who don't need them? And it is not just the funds, but the costs of issuing so many "refunds."

2. Why were the funds not available to people who do need them, such as people with income below the filing threshold so did not file a 2020 return by 10/15/21? (these folks also lost out on the Golden State Stimulus if they did not file a 2020 return by 1015/21)

3. Why did AB 192 include a law change to say that the "refund" is not an income tax refund?

4. Why do California lawmakers want residents to give some of their payments to the federal government?

5. What about the reality that higher income individuals who get a refund under $600 won't have a 1099-MISC and may just forget to report it on their return, versus the lower-income folks getting a 1099-MISC that they must report? Now the amount might not cause a federal liability for low income taxpayers, but it is likely to result in some tax owed by many recipients.

All recipients should note what they received and put it in their tax records so all recipients report it on their 2022 or 2023 return (refunds are issued in Nov 2022 through January 2023). 

For more:

• My 7/10/22 post on some MCTR issues.
• FTB websites on the MCTR - here and here

What do you think?