In 2022, the state of Colorado issued a special $750 "tax refund" payment, popularly called "Colorado Cash Back", to every taxpayer in the state (pursuant to SB 22-233). It was not made clear in the bill which tax is being refunded, or from what year.
Generally, if a person deducts a state tax (income, sales, property) on their federal return in one year, and then receives a refund in a later year, the refund is taxable income in the later year. So, if a Colorado taxpayer had taken one of those deductions for 2022, is there any case in which this $750 would be federally taxable income for 2023? Or, when it would reduce the allowable state sales tax or state income tax deduction on the taxpayer's 2023 federal return?
The official Colorado Cash Back web site says flatly that "the Colorado Cash Back refund is not taxable", without explaining why not. But I don't see how the state of Colorado can speak authoritatively about federal tax law.
Section 5(a) of SB 22-233 instructs the Colorado Department of Revenue not to report this payment to the IRS (i.e. no 1099-G). But just because income is not reported, doesn't mean that it's not taxable.
Update: as of Feb 3, 2023, the IRS doesn't know the answer either:
The IRS is aware of questions involving special tax refunds or payments made by states in 2022; we are working with state tax officials as quickly as possible to provide additional information and clarity for taxpayers. There are a variety of state programs that distributed these payments in 2022 and the rules surrounding them are complex. We expect to provide additional clarity for as many states and taxpayers as possible next week.
For taxpayers uncertain about the taxability of their state payments, the IRS recommends they wait until additional guidance is available or consult with a reputable tax professional. For taxpayers and tax preparers with questions, the best course of action is to wait for additional clarification on state payments rather than calling the IRS. We also do not recommend amending a previously filed 2022 return.
