Tax Policy – Alabama, Missouri Bills Would Exempt CARES Relief from Income Tax Calculation

The Alabama Senate is considering legislative language (a substitute to the previously introduced SB 250 tax reform bill) which would exclude the rebate checks provided under the CARES Act from being taxed and exclude it from state income tax calculations. While those two phrases might sound redundant, they are both important in light of the fact that Alabama offers an income tax deduction for federal taxes paid. Missouri, another state with federal deductibility, is considering a similar bill amendment.

The first part of Alabama’s amendment is straightforward: the relief checks, known as Economic Impact Payments, would not be counted as income, and thus would not be taxed by the state’s individual income tax. The second part—excluding them from 2020 income tax calculations—requires a little more context to understand.

Alabama is one of six states which offers a deduction for taxes paid to the federal government. While intended to give taxpayers a break, federal deductibility essentially turns a state income tax code into a mirror image of the federal code. What is favored on the federal side is penalized in the state, and vice versa.

This has implications for CARES Act rebate checks for a specific category of Alabamans. If someone received less of the credit than they were owed, they can list that amount as a refundable credit on their 2020 federal tax return. This seeming oversight might have happened if taxpayers had a higher income in 2019 than they will end up having in 2020, or had a large change happen in 2020, like having a child. Because that rebate would decrease their federal tax liability, it would end up increasing their 2020 Alabama tax liability.

Alabama is not alone in this action; Missouri’s House is also considering a bill aimed at separating CARES rebate checks from state tax liability. The state’s situation is slightly different, given that Missouri has already instituted an income phaseout for federal deductibility, with a $5,000 cap on how much deductibility a person can claim. However, this bill ensures that the rebate checks do not increase state tax liability for those eligible for such deductions.

These proposed amendments are necessary to prevent Alabama and Missouri from unintentionally taxing CARES Act rebates, and other federal deductibility states will need to follow suit if they intend to exempt these rebate checks. In the long run, these bills might serve the dual purpose of opening a broader conversation in the future as to why federal deductibility still exists at all, when it would be far more equitable and straightforward for states to eliminate it in a revenue-neutral trade for lower tax rates.

Separately, the Alabama legislation also ensures that debt forgiveness for small business loans made under the new Paycheck Protection Act, designed to help businesses maintain payroll during the pandemic, does not get treated as taxable income. This too is a matter that many other states may soon take up.

Source: Tax Policy – Alabama, Missouri Bills Would Exempt CARES Relief from Income Tax Calculation