When the state distributed $850 relief checks to Mainers last year, the idea was to lend a no-strings-attached helping hand to people struggling with record inflation largely driven by the pandemic. But now, the Internal Revenue Service is investigating whether economic relief payments by Maine and other states are federally taxable.

This uncertainty threatens to create chaos for Mainers as they prepare their tax returns. Taxpayers and accountants are wondering whether to hold off on filing, how long they can wait and what happens for those who already have filed.

Maine was one of nearly two dozen states that, faced with a budget surplus, sent money to residents in 2022 to help them counter the effects of inflation, supply-chain disruptions and other economic hardships driven by the pandemic.

But last week, the IRS said it needs more time to figure out what to do about that money.

“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,” the agency said. “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.”

For people who have already filed, the agency recommended against amending their returns. More information could be available as soon as this week, the IRS said.

MURKY STATUS

So far, tax professionals say the outcome will depend on what the IRS determines to be the purpose of the checks.

Generally speaking, if the payments were for pandemic relief, for example, they should be considered “qualified disaster relief payments,” and therefore tax-exempt.

Maine’s status remains unclear, however.

“It’s going to be the story that Maine told … that is going to be the deciding factor for the IRS,” said Michael Santo, a senior tax manager at accounting firm Wipfli in Augusta.

If the state presented the funds as simply extra money from the budget surplus to combat inflation, the payments likely would be taxed. If the checks are considered directly linked to the pandemic, they wouldn’t be taxed, Santo said.

Maine’s funds were specifically designated as “pandemic relief payments.”

“These payments are meant to help in navigating rising costs due to global inflation and supply-chain impacts, and other global economic disruptions driven by the pandemic,” the governor’s office said in a program explanation. “The payments are a one-time infusion into Maine families and will position Maine’s economy for continued post-pandemic prosperity.”

Mills intended for the funds to be tax-exempt and is confident that they will remain so.

If the agency does not recognize the money that way, Mills will “consider working with Maine’s congressional delegation to correct any misinterpretation on the part of the IRS,” spokesperson Ben Goodman said.

Sharon Huntley, a spokesperson for Maine Revenue Services, said the state believes the payments will not be taxed.

“The IRS has indicated that it is in the process of reaching its own determination, and we believe that the agency should conclude, too, that the payments are exempt,” she said. “We encourage them to reach this conclusion swiftly so that Maine people, and others across the nation, may have certainty.”

Santo is dubious.

It’s a decent “story,” he said, but could still be a tough sell to say it’s disaster relief when the state of emergency ended in mid-2021.

“The IRS, for better or worse, will follow the law to a T, and doesn’t (often) allow for some wiggle room,” he said.

If the payments are ultimately deemed federally taxable, it could be “kind of a disaster” for tax professionals, said Bryce Morrison, a tax attorney with Bernstein Shur.

People who already have filed will need to amend their filing – once the IRS gives the go-ahead – which could slow things down and clog up the system.

For people who haven’t yet filed, the unanticipated income could result in owing more than they expected, Santo said.

For many low-income Mainers, $850 was a substantial addition to their income. For a married couple, that was an additional $1,700. For households taxed in the 20% range, that could be a few hundred dollars that they already spent and weren’t planning to pay back.

Santo hopes the money will remain tax-exempt.

“Hopefully, it’s not going to create some extra tax burdens on people since the intent was to assist lower-income individuals,” he said. “But the wording of this and the timing that it’s coming out, does give me some doubt.”