By Howard Fischer
Mail | X: @azcapmedia

PHOENIX — Lawyers for the state are asking a federal appellate court to give them a chance to try to recover more than $20 million they say was taken illegally from about 750,000 Arizona taxpayers.

In legal briefs, members of the Attorney General’s Office contend U.S. District Court Judge Murray Snow erred when he upheld a decision by the Internal Revenue Service that $260 million given out in one-time rebates in 2023 is subject to federal taxes.

Murray did not dispute the IRS reached a contrary decision when it came to one-time payments to residents in 21 other states. But he said what Arizona did was factually different — including the fact the “rebates” in some cases actually exceeded the amount of state taxes that some residents paid.

Snow said only the people who actually contend they were injured by the IRS decision — the individual taxpayers — have the right to sue. And none are named as plaintiffs.

But Assistant Attorney General Josh Bendor is telling the 9th Circuit Court of Appeals the state does have standing to sue. Bendor said the IRS took about $20.8 million from state residents. Had they spent that money, he figures the state would have collected about $480,000 in sales tax.

Snow dismissed any injury to the state as “derivative and speculative.” In fact, he said, even the state, in its lawsuit, admitted the only certainty was if Arizonans had retained the money they would have been free “to spend it as they saw fit.”

But Bendor is telling the appellate judges Snow’s conclusion was “premature,” saying the state is entitled to its day in court, something it did not get when Snow tossed the case without hearing evidence.

All this stems from a provision in the 2023 budget — when the state had a surplus — to provide a rebate to families of $250 for every child younger than 17 and $100 for older dependents, up to a maximum of $750 per family. That generated about $260 million for 750,000 Arizona families, with the average rebate about $370.

What wasn’t known at the time was the IRS would later tell the state Department of Revenue it considers such payments subject to federal income taxes.

Based on that, state revenue officials said they had no choice but to issue a 1099-MISC form to each rebate recipient. That form covers certain types of miscellaneous compensation, including prizes, that are not covered by other documents federal law requires to be issued.

A copy of those forms went to the IRS, just like a W-2 for wages, making the federal government aware of who got the payments — and making the taxpayers liable to report it and pay taxes on it.

A key to Bendor’s argument to the appellate judges is the IRS, in effect, is discriminating against Arizona and its taxpayers. That’s based on his argument the federal agency allowed residents of other states to keep their full rebates without having to pay federal taxes.

“The IRS treated 21 states favorably and then, without a reasoned basis, treated Arizona unfairly — an action that was arbitrary and capricious in violation of the Administrative Procedures Act and that derived Arizona of equal sovereignty under the U.S. Constitution,” Bendor wrote.

“The IRS cannot dispute its disparate treatment of Arizona,” he continued. “It can only attempt to justify it.”

Bendor also hit back at Snow’s conclusion that any loss to Arizona in sales taxes was speculative. He said the state supported that conclusion with declarations from an economist from the Arizona Department of Revenue.

And Bendor said it’s irrelevant if the amount of lost dollars is not as much as the state claims.

“The IRS cannot plausibly dispute that taking over $20 million out of Arizona caused the state to suffer at least (ITALICS) some (ROMAN) tax-loss injury, even if the quantum differs from what Arizona has alleged,” he said.

The 9th Circuit cannot order the IRS to give the money back. Instead, all the appellate court can do — if they agree with Bendor — is order Snow to take another look.

But even if the 9th Circuit sides with the state, and even if Bendor hen can convince Snow to change his mind, that doesn’t mean the Arizonans who had an extra bite taken by the IRS will automatically get a check.

“That would be our preferred relief,” said Richie Taylor, a spokesman for the Attorney General’s Office.

“But the IRS has said that it cannot reliably identify individual taxpayers who paid tax on the tax rebate,” he told Capitol Media Services. “If accurate, taxpayers may need to request refunds from the IRS in the event we ultimately prevail.”

That would mean having to file amended tax returns for the 2023 tax year.

As it turns out, the state, while using its $480,000 claimed loss as the basis for being able to sue, isn’t actually asking the federal government for the money. Richie said the presumption is that if Arizona wins and taxpayers do get their $20 million back, they will spend it and the state treasury will get its sales taxes that way — eventually.