Arizona Sues IRS Over ‘Unlawful’ Decision to Tax Rebates

Arizona Sues IRS Over ‘Unlawful’ Decision to Tax Rebates
Kris Mayes, then-candidate for Arizona attorney general, speaks at a rally in Phoenix, Ariz., on Oct. 8, 2022. (Mario Tama/Getty Images)
Katabella Roberts

Arizona is suing the IRS after the agency imposed federal income taxes on the state’s Family Tax Rebate, Attorney General Kris Mayes announced on Feb. 21.

In a statement on Feb. 21, Ms. Mayes said the lawsuit—filed in federal district court on the same day—argues that taxing the rebates is “unlawful and contrary” to the IRS’s treatment of similar tax rebates in dozens of other states.

“This lawsuit is about standing up for Arizona taxpayers,” she said. “The federal government’s decision to tax these rebates is unfair and unlawful–and I will do everything I can to ensure the tax relief provided to Arizonans by their state government remains in the pockets of Arizona taxpayers, as intended.”

The lawsuit comes after the IRS decided in December to tax the state’s rebate, which was initially part of a relief plan enacted in Arizona in 2023 by Gov. Katie Hobbs, a Democrat.

Under the rebate, tax revenue was returned to taxpayers who had dependents, had met the income threshold to claim the Dependent Tax Credit, and had paid state income tax in a year between 2019 and 2021.

Eligible taxpayers received $250 for each dependent under age 17 and $100 for dependents age 17 or older, with the maximum rebate capped at $750 per taxpayer.

Ms. Mayes said the rebate was based on an understanding of IRS guidance at the time that such rebates would not be considered taxable income.

IRS Made ‘Unlawful Determination’

According to the lawsuit, the IRS provided “no written explanation” to Arizona officials as to why or how they had reached the decision in December.
Months later on Feb. 15, the agency responded to a letter from the attorney general challenging the decision, stating that the guidance upon which the state’s rebate program was based “did not reflect a legal determination” for how tax rebates would be considered taxable.

Ms. Mayes’ office said the IRS decision means Arizona taxpayers will be compelled to remit an estimated $20.8 million to the IRS.

Additionally, the state’s Department of Revenue estimates that the IRS’s “unlawful determination” has deprived Arizona of approximately $480,000 in state and local transaction privilege tax revenue that would have been derived from taxpayers’ spending of the initially untaxed refunds.

The lawsuit alleges the IRS’s decision to tax the rebates lacks legal basis, contradicts prior IRS guidance and precedent, is “arbitrary and discriminatory,” and unfairly targets Arizona taxpayers.

The IRS’s actions amount to unlawful denial of general welfare, unlawful taxation of non-income, a violation of Congress’ taxing power, a violation of equal sovereignty, and a violation of statutory authority, according to the lawsuit.

Money ‘Being Siphoned From Arizona’

Additionally, Ms. Mayes’ office claims the agency’s decision to tax the rebates will impact both individual taxpayers and the broader economic well-being of Arizona.

“The State of Arizona, like other states, operates under persistent budgetary constraints and must constantly weigh the relative merits of alternative policy approaches,” the lawsuit states. “When Arizona’s elected leaders chose to refund tax revenue to Arizona taxpayers last year, their reasonable expectation was therefore that the money would go to Arizona taxpayers, not to the Internal Revenue Service—but the IRS had a different idea.”

The Internal Revenue Service (IRS) building in Washington on Jan. 4, 2024. (Madalina Vasiliu/The Epoch Times)
The Internal Revenue Service (IRS) building in Washington on Jan. 4, 2024. (Madalina Vasiliu/The Epoch Times)

“If Arizona’s elected officials had known that the IRS was going to make an unlawful determination that contradicted its guidance from a few months earlier and was contrary to law, the State could have pursued alternate policies that would not have resulted in the Unlawfully Taxed Amount being siphoned from Arizona, to the detriment of the State and its taxpayers,” the lawsuit adds.

Ms. Mayes’ office is asking the court to declare the IRS’s determination unlawful, and for the agency to refund amounts that have been collected from Arizona taxpayers. The lawsuit also seeks additional relief as the court deems just and proper.

The attorney general said she had “attempted in good faith to convince the IRS to reverse its erroneous decision,” prior to filing the lawsuit.

IRS Commissioner Danny Werfel, Treasury Secretary Janet Yellen, the IRS, and the U.S. Department of the Treasury are listed as defendants in the lawsuit.

The Epoch Times has contacted the IRS for comment.