The Alabama Senate is considering legislative language (a substitute to the previously introduced SB 250 taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. 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 deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state and local taxes paid, mortgage interest, and charitable contributions. 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 taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. . 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 incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . This too is a matter that many other states may soon take up.
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