The Los Angeles Times has an article asking this question. Because of the drought in California, the Metropolitan Water District had a $340 million incentive program so that homeowners would replace grass (which takes a lot of water) with bark, rocks, and other drought tolerant (xeriscape) landscapes. (The Southern Nevada Water Authority has a similar program.) The MWD has no idea if they have to issue 1099s to rebate recipients under federal law. (It is exempt from California taxation, though.) The article notes that the MWD suggests talking to a tax professional, so I’ll helpfully give an answer.
Any accession to wealth is taxable unless Congress has exempted that from taxation. One such exception are rebates on purchases. If you buy, say, a new car for $25,000 and receive a $1,000 rebate, you really bought the car for $24,000. A car rebate isn’t taxable income. Is the MWD (or SNWA) program a rebate?
No, it’s not. There’s nothing being purchased from the water agency. Instead, you’re tearing out grass, and replacing it with something else. The agency paying the “rebate” isn’t the same agency that’s doing the work. You might do it yourself, or you might higher a landscaping firm to do the work. The landscaping firm isn’t giving you a rebate.
If this isn’t a rebate (for tax purposes), then what is it? Well, the IRS could rule it’s not taxable since it is a lowering of the cost of doing the grass replacement and this is good for the environment. However, that’s not likely. There’s nothing in the Tax Code that says if something is done that’s good for the environment it’s not taxable. Instead, this looks like income–“Other Income” that would be reported on line 21 of Form 1040. You’re receiving a reward (income) for doing something. It’s not a rebate of a purchase. It’s not exempt from taxation under any other of the exemptions under the Tax Code. Thus, it’s taxable income.