IRS Blocks Arizona’s Bid to Contest Federal Tax on Family Rebate

The Internal Revenue Service (IRS) is standing firm on its decision to tax Arizona’s 2023 Family Tax Rebate, filing a motion to dismiss a lawsuit by the state. This case was heard in a Phoenix courtroom before U.S. District Judge G. Murray Snow. Arizona argued that its citizens should be treated equally to residents of 21 other states who received tax refunds last year without having to report those amounts on their federal tax returns.

The rebate, part of Governor Katie Hobbs’ 2023 budget, provided payments to individuals who claimed dependents on their state tax returns in 2019, 2020, and 2021. Eligible taxpayers received $250 per dependent under 17 years and $100 for those aged 17 and older.

“Arizona has been subject to this IRS action when all these similarly situated states were not,” state attorney Clinten Garrett said during the hearing. In response, Judge Snow questioned the rationale behind claiming unequal treatment based on fiscal year variations. Garrett maintained that the IRS shouldn’t use calendar changes as justification for inconsistent guidelines.

The IRS countered that the state’s argument lacks validity, emphasizing the distinct nature of the tax years involved. In February 2023, the IRS declared that rebates from 21 states issued in 2022 were not subject to federal income tax, while the guidelines changed by the time Arizona’s rebate was processed later.

A significant point in the discussion was that the IRS informed Arizona’s Department of Revenue about the tax implications only after most families had already received their refunds. Amy Matchison, representing the IRS, argued that the lawsuit should be dismissed as it’s individual taxpayers, not the state, who are directly affected by the tax liability. She noted that the state’s claim revolves around potential revenue losses rather than actual grievances from individuals.

According to court documents, around 740,000 taxpayers benefited from the rebate program. Following the IRS’s decision to tax these refunds, the state estimates that over $20 million will be redirected to the federal government, alongside a loss of approximately $480,000 in transaction privilege tax revenue.

Judge Snow pointed out that courts typically do not grant states standing to sue the federal government based solely on tax revenue losses. Garrett clarified that this usually applies only when the state has specific claims, not generalized revenue loss complaints.

Matchison reiterated that the state’s estimated losses lacked specificity, suggesting that individuals could file class action lawsuits for their refunds instead. The question of whether the case remains relevant was raised, given that the federal tax on the rebates has already been collected. Garrett still pushed for judicial intervention regarding the IRS’s actions toward refund requests from Arizonans. Snow has yet to indicate when he will rule on the motion to dismiss.