Arizona Attorney General Kris Mayes took decisive action on Thursday, lodging a federal lawsuit against the Internal Revenue Service IRS regarding its decision to levy federal taxes on the Arizona Family Tax Rebate. This legal move comes as a response to what Mayes perceives as a breach of trust and unequal treatment of Arizona taxpayers compared to those in other states by the IRS’s December ruling to tax the rebates.
In the complaint, Mayes asserts that the IRS reneged on its assurances and displayed disparate treatment toward Arizona taxpayers when it opted to tax the rebates, contrary to expectations. The crux of Mayes’ argument is rooted in the notion that when Arizona’s elected officials allocated funds for tax refunds to its taxpayers, it was with the understanding that the money would directly benefit them, not be diverted to federal coffers. This discrepancy in treatment, Mayes contends, constitutes an injustice.
IRS’s stance on Arizona’s family tax rebate: confusion and litigation unfold
The Arizona Family Tax Rebate, a one-time payment embedded in Governor Katie Hobbs’ 2023 budget, sought to reimburse taxpayers who had claimed dependents on their state tax returns for the years 2019, 2020, and 2021. Eligible taxpayers were entitled to $250 per dependent under the age of 17 and $100 per dependent over 17, with a maximum cap of $750 for up to three dependents. This rebate, while specific to individual circumstances, was formulated within the framework of existing IRS guidelines, according to Mayes.
Surprisingly, in February 2023, the IRS delineated that analogous rebates disbursed by 17 other states in 2022 would not be subjected to federal income tax. Mayes highlights the irony of this decision, emphasizing that Arizona’s rebate was designed in alignment with the principles laid out in the IRS guidelines. The IRS’s belated revelation, delivered via video chat to the state Department of Revenue in December, contradicted its own established guidelines, leading to confusion and discontent among Arizona taxpayers.
Mayes asserts that the IRS’s decision runs counter to its own guidelines, which traditionally exempt state tax refunds from federal income taxation, deeming them non-taxable income. This deviation, Mayes argues, unjustly exposes hundreds of thousands of Arizona taxpayers to federal income taxation on a payment that, by precedent, should not be considered taxable income.
Despite efforts to resolve the matter through negotiation, Mayes found litigation to be the only recourse. Characterizing the lawsuit as a defense of Arizona taxpayers’ rights, Mayes pledges to safeguard the intended tax relief provided by the state government.
What is Arizona Expecting From the IRS
According to the complaint, approximately 740,000 individuals either received or are slated to receive tax refunds through the rebate program. However, due to the IRS’s decision to tax these rebates, an estimated sum exceeding $20 million has been diverted from Arizona families to the federal government. Additionally, the state has incurred an estimated loss of $480,000 in transaction privilege tax revenue that would have been generated from untaxed refunds.
The lawsuit, naming the United States and the Department of the Treasury as co-defendants, presents a series of claims, including unlawful denial of general welfare, unlawful taxation of non-income, infringement on Congress’s taxing power, violation of equal sovereignty, and overstepping statutory authority. The state seeks judicial intervention to halt further tax collection on the rebate and to reimburse taxes already collected.
In response to inquiries, the IRS declined to comment on the lawsuit, while the Department of the Treasury has yet to provide a response.