Are state water conservation rebates taxable?

Consumers might be surprised to learn that some of their water conservation rebates from local utilities may be taxable.

Are these incentives subject to federal income tax?

In a letter to Rep. Jared Huffman, D-Calif., the Internal Revenue Service (IRS) said that it considers these payments to be taxable income. According to the IRS, under IRC Sec. 61(a), gross income means all income from all sources, unless otherwise provided by law. Thus, gross income generally includes rebates. Federal law does provide some exceptions. For example, IRC Sec. 136 exempts energy conservation subsidies from tax. But, expansion of IRC Sec. 136 to water conservation rebates would require a legislative change.

What amounts are reportable for federal tax purposes?

Utilities must issue Form 1099-MISC to consumers who receive $600 or more in rebates in a calendar year. Consumers must then report that income on their federal returns.

Do states conform to the federal tax treatment?

Most states have not issued guidance on this issue. But, many states conform to federal law on a rolling basis.

California recently enacted legislation exempting turf replacement rebates from state income tax. The state already provided corporate and personal income tax exemptions for other water conservation rebates, like those for purchasing water-saving toilets and washing machines. 

Will the federal government and other states respond?

A bill introduced in Congress last year proposed that the IRS exempt water conservation rebates the same way it exempts energy conservation rebates. Proponents of the bill noted that the federal tax on water conservation rebates was an obstacle to state and local efforts to promote water conservation.

California is not the only state experiencing drought conditions. According to a recent report, almost 50% of the U.S. is affected by drought. Thus, whether the federal government or other states take action exempting water conservation incentives remains an area to watch.