Is the $700 From the State of California Taxable?

In response to rising costs, the state of California issued a one-time payment to millions of residents known as the Middle Class Tax Refund (MCTR). This payment was intended to provide financial relief, with amounts varying up to $1,050 depending on income, filing status, and the number of dependents claimed on the 2020 tax return. These funds were distributed starting in October 2022 and continued into early 2023, leading to questions about how they should be treated for tax purposes.

Federal Tax Treatment of the Payment

The Internal Revenue Service (IRS) has provided guidance regarding the federal taxability of the California Middle Class Tax Refund. After a review, the IRS announced that these payments will not be subject to federal income tax for either the 2022 or 2023 tax year. The agency stated that, in the interest of sound tax administration, it will not challenge the taxability of the MCTR. This determination means the funds are not included in a taxpayer’s federal gross income and are not taxable.

California State Tax Treatment of the Payment

The Middle Class Tax Refund is not considered taxable income by the State of California. This was established by the legislation that created the MCTR program, which contained a provision that excludes these payments from the gross income of recipients for state income tax purposes. As a result, California residents do not need to account for this payment when calculating their state tax liability. The amount received does not increase a taxpayer’s California adjusted gross income.

How to Address the Payment on Tax Filings

When preparing tax returns, the Middle Class Tax Refund payment should not be reported as income. On the federal side, the amount should be omitted from Form 1040 or any associated schedules. Even if you received a Form 1099-MISC for the payment, the IRS has clarified that it is not federally taxable, so you should disregard the form for income reporting purposes. The amount should not be entered as “Other Income” or anywhere else on the federal return.

For state purposes, the MCTR is not included as income on the California Form 540. Since California tax calculations often begin with the federal Adjusted Gross Income (AGI), if the MCTR was correctly excluded from the federal return, no further action is needed on the state return.

Taxpayers who may have already filed their returns and incorrectly included the MCTR payment as taxable income should consider filing an amended return. For federal purposes, this is done using Form 1040-X, Amended U.S. Individual Income Tax Return. For California state purposes, Form 540X, Amended Individual Income Tax Return, would be used to correct the error and claim a refund for any excess tax paid.