Judge Forces Families to Pay Money on Tax Credit

Arizona families will have to pay federal taxes on a rebate they received last year, a federal judge ruled this week.

The state's Attorney General, Kris Mayes, hoped to exempt the rebate, worth up to $750 per family, under the Internal Revenue Service's rules. But the bid was rejected by U.S. District Court Judge Murray Snow..

Now, the $260 million that went back to Arizona families will be taxed under standard IRS rules, since the agency only gives a tax-free option to "legislatively provided social benefit programs for the promotion of the general welfare." According to Snow, the family rebate didn't fit this criteria since they weren't based on individual need for each family.

"The judge's decision in this case is to take IRS rules at their most literal level," Alex Beene, a financial literacy instructor at the University of Tennessee at Martin, told Newsweek. "Typically, funds that get the tax-free treatment are those distributed to a targeted group of residents based on need of assistance.

"The ruling reflected the rebate that was crafted by Arizona legislators that essentially applied to all families in the state and didn't specify further income requirements that would normally lead to payments being tax-free."

Under the rebate program, Republican lawmakers approved the direct payment to go to anyone who had dependents, regardless of specific income status. Recipients also needed to have paid at least $1 in state income taxes in the past few years.

Families earned $250 for every child younger than 17 and $100 for all older dependents, meaning some households got as much as $750. Altogether, 750,000 families benefited from the program.

Snow also said federal law prevents individual states from issuing injunctions saying the federal government isn't permitted to take a tax on a rebate, so Mayes lacked jurisdiction in this matter.

"The court, therefore, believes it unlikely that it has jurisdiction to hear this particular claim wholly apart from whether the state has met its burden to receive a preliminary injunction,'' Snow said in a statement.

Newsweek reached out to Mayes for comment via email.

A spokesperson for the attorney general previously told The Daily Independent that Mayes will continue legal proceedings to get the rebate deemed tax-exempt by the federal government. If Mayes is successful, that would mean many Arizona families could get an extra tax refund.

To date, all families who received a rebate should have gotten a 1099-MISC form in order to inform the federal government of the extra money.

"When Arizona's elected leaders chose to refund tax revenue to Arizona taxpayers last year, their reasonable expectation was therefore that the money would go to Arizona taxpayers, not to the Internal Revenue Service," the lawsuit said. "But the IRS had a different idea.''

Under the lawsuit, the state said it shouldn't be counted for federal taxes because the payments were not "compensation for services" and the checks arrived when inflation had reached an extreme high.

The sting

If the federal government does tax the money, Arizona families are set to lose an estimated $20.8 million in total.

While the specific amount an Arizona resident would have to pay back will depend on their tax bracket, those who are making between $44,726 and $95,375 will be forced to give $110 back.

"This is going to sting for a lot of Arizona families," Michael Ryan, a finance expert and the founder of michaelryanmoney.com, told Newsweek. "Imagine finally getting that rebate check, only to have to turn around and pay federal income tax on it. That's going to mean higher tax bills or way smaller refunds for a whole lot of folks."

Read more: The Child Tax Credit: Who Qualifies and How to Claim It

This has many finance experts shaking their heads, as other rebates similar to this one have sometimes skirted by the federal taxation rule in the past.

"The idea of these payments being taxed does seem like an ill-conceived one, as the original idea was to help families in Arizona with these rebates," Beene said. "The hope is even if families have to pay taxes initially on them, they'll eventually get a refund on what's paid."