Taxing Government Benefits

by Tom Yamachika, President, Tax Foundation Hawaii

We’re still well into the aftermath of the Maui and Hawaii County wildfires.  Our governments have opened up their coffers and have begun doling out lots of money toward disaster relief and emergency assistance.

Legitimate questions now need to be asked about whether the government is going to want to take back some of that money in taxes.  It’s an important issue for people in the midst of the disaster because if the money is taxable and a wildfire victim spends all of it on necessities like food and shelter, is that victim going to have major problems down the line because that person needed to set a bunch of that money aside for taxes and didn’t?

On August 30, 2023, the Internal Revenue Service released Notice 2023-56, a technical document (probably best appreciated by tax geeks and legal wonks) that is supposed to help people make sense out of the different kinds of government payments they may be receiving, and whether they are taxable.  The Service noted that it isn’t always easy to figure out whether a particular payment is subject to tax, and it basically decided to look the other way for 2022 payments; but, since they can’t do that forever, they decided to publish some rules.

Usually, if you receive money and you get to keep it, that money is income for tax purposes.  The Notice discusses three exceptions:  state tax refunds, “general welfare” payments, and disaster relief payments.

State tax refunds aren’t normally taxable, except that if you took an itemized deduction for a state tax payment and then get some or all of the payment back, you might have to walk back your deduction.  The Notice also said that some “refundable credits,” which are paid to you even if you didn’t owe tax, are not considered refunds and need to be analyzed like other payments from the government.

Some payments from the government are considered “general welfare” and aren’t taxed.  These payments have to be based on the need of the individual or family receiving the payments, and they can’t be a payment for services sold to the government.  Many of the refundable credits that Hawaii offers to lower-income families come under that description, so they aren’t taxable. On the other hand, payments to businesses are usually taxable, but there are exceptions; many of the COVID-19 relief programs, for example, included language in the law saying that benefits wouldn’t be taxable.  Businesses also need to be wary of General Excise Tax on payments related to the disaster.

There is also a specific section of the federal income tax law, section 139 of the Internal Revenue Code, that applies specifically to disasters that are declared by the federal government so that FEMA gets involved.  The criteria for tax exemption under this section are similar to those for general welfare payments.  The payments need to be made on the basis of need, and need is presumed if the payments are directed to disaster victims.

In any case, a government entity that is paying benefits needs to give you a Form 1099-G at the end of the year if the benefits are taxable.  Especially if the entity has been paying benefits to other people because of other tough circumstances, it probably has some idea of whether the benefits it is paying are taxable or not.  So it may be a good idea to direct specific questions to the paying entity.