Tax Implications That Everyone on Unemployment Should Know About
During the 2020 Coronavirus pandemic’s economic fallout, millions of Americans lost their jobs and filed for unemployment benefits. To help keep Americans afloat, the federal government even expanded unemployment benefits, boosting the weekly amount received by $600 (and later by $300), while also extending unemployment protections.
While this significant increase in financial aid benefits helped millions secure food and housing, there are some tax implications that anyone new to unemployment should know about. If you received unemployment insurance benefits in 2020, keep reading to find out how your taxes might be impacted.
How unemployment income is taxed
What most people aren’t aware of is that they’ll actually need to pay taxes on unemployment benefits when reporting this income on IRS tax form 1099-G. No matter where you live, your unemployment income is subject to federal taxes. If you were employed before the pandemic, you might be used to your job handling your tax withholding for you. However, when receiving unemployment compensation, it’s actually your responsibility to ensure taxes are withheld.
Depending on the state you live in, income tax might also be owed. Currently there are five states that do not tax unemployment income (California, Montana, New Jersey, Pennsylvania, and Virginia), two states that offer partial exclusions to unemployment taxes (Indiana and Wisconsin), and seven states that do not collect state income tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming).
If you live in a state other than those mentioned above, you’ll also need to pay state taxes on your unemployment benefits.
Should you withhold taxes on your unemployment benefits?
When you’re on unemployment you have the option of having your taxes withheld, similar to how they would be when working for an employer. This is a voluntary step, however, and because it’s optional, most people aren’t aware of the consequences of not planning for tax withholding.
If you were earning a higher income than what you’re receiving on unemployment, it’s particularly important to withhold money for taxes. Due to your previous salary, you’re more likely to be in a higher income bracket for the year, which means you’ll be taxed at a higher rate.
And, while the boost in unemployment benefits have helped many individuals and families during the pandemic, this increased income also means that you’ll owe more in taxes. Withholding is the best way to minimize your chances of being stuck with a large tax bill come April 15th.
How to have taxes withheld on unemployment income
Setting up automatic tax withholding on your unemployment benefits requires manual intervention. To set up withholding for your unemployment income, you’ll need to request a W-4V form from your state unemployment office. This will allow you to set up federal (a 10% tax rate) and state (if applicable) withholding.
Depending on your state, you may be able to complete this step online or you may need to mail in or bring in your completed form.
If you’re still receiving unemployment in 2021 and did not opt for tax withholding, you can still change your withholding status now using this form and begin having taxes withheld from your future unemployment checks.
Other ways to plan for unemployment taxes
You don’t have to have your tax money withheld to plan for your unemployment taxes. Instead, you can set aside a percentage of your unemployment checks and hold it in a savings account to cover any taxes you might owe.
If you opt for this method, there are two things to keep in mind:
1. You’ll need to pay the IRS quarterly. You’ll be penalized if you do not make quarterly estimated tax payments (similar to the payments a self-employed individual would make). Quarterly tax payments are due on April 15th, June 15th, September 15th, and January 15th of the following year.
You can make quarterly federal tax payments online through IRS Direct Pay. Depending on your state, you may be able to make these payments online or you may need to mail in a check.
2. You’ll need to calculate your taxes based on your expected income bracket. Determining how much to set aside can be tricky, especially if you’re unsure if you’ll be off of unemployment before the year ends.
For instance, if you’re single and made $39,000 from January 1st 2020 until May 31st 2020, and then collected $28,000 in unemployment for the rest of the year, your income for the year would be $67,000. According to the 2020 IRS tax table, you would owe $10,310 (your tax rate would be 22% for all income earned over $40,125 + a flat $4,617.50). Keep in mind that a portion of that tax bill would have already been paid from your employer withholding.
Knowing these numbers can help you determine how much to put away every week to ensure your quarterly payments aren’t too low or too high. You can also use the IRS Withholding Tax Calculator to help you better determine how much to move into a savings account.
Don’t forget about deductions and tax credits
No one loves talking about taxes, particularly when they know they’re going to owe the government money. However, the good news is there are deductions and credits you can take advantage of to offset any taxes you might owe, minimize your tax payment, or even flip your tax payment into a tax refund check.
Earned Income Tax Credit (EITC)
If you earn a low to moderate income or have children, you might be eligible to claim an EITC tax credit. Here are the IRS’s current income qualifications for 2020:
|Number of Children or Dependents||Adjusted Gross Income Maximum (Single, Head of Household, Widowed)||Adjusted Gross Income Maximum (Married, Jointly Filing)||Maximum EITC Credit Amount|
Your investment income must be $3,650 or less to claim this credit
Let’s say your total adjusted gross income or AGI (pre-tax income) was $46,000 in 2020 and you have two children. Now let’s say you owe $1,000 in unemployment taxes. After claiming the EITC credit, you could be eligible for a maximum credit of $5,920, which would mean you could actually pay for your tax bill and still receive $4,920 back.
Don’t forget to take the standard dedication into consideration when planning for your unemployment taxes. Unless you have itemized expenses to claim, this dedication typically helps most Americans save more on their tax bills or bring back a larger income tax return.
The standard deduction will reduce your income by the below amounts (depending on filing status), reducing your taxable income and lowering your unemployment taxes owed.
|Filing status||Standard Deduction|
|Married, filing jointly||$24,800|
|Married, filing separately||$12,400|
|Head of household||$18,650|
Other deductions you might be eligible for
There are many other deductions you might be eligible which could lower your AGI, lessening or even eliminating your tax bill. If any of these deductions will be itemized, however, you won’t be able to take the standard deduction. It’s always best to estimate how much you’ll save both ways before deciding on which route to take.
Additional deductions you might be eligible for include:
- Home office deductions (for self-employed individuals)
- Medical deductions
Education expense deductions
- Lifetime Learning Credit (LLC)
- American Opportunity Tax Credit (AOTC)
- Student loan interest deductions
- Charitable donation deductions
- Child tax credit
- Business deductions
Planning for 2020 tax payments
While tax day (April 15th) for the 2020 tax year is just around the corner, you still have more than a month to plan to pay your taxes. I recommend filing as early as possible, in order to determine the full amount you owe and coming up with a plan to save towards making a full payment by April 15th.
If you’re not able to afford your tax bill by April 15th, you can file for an extension. To do this, you’ll either need to make a partial payment via IRS Direct Pay online by April 15th and ensure you select that the payment is for a tax extension.
You can also fill out and submit IRS form 4868 by April 15th in order to receive a 6-month extension. Tax software like TurboTax and H&R Block also offer ways to apply for a tax extension.
Tax relief for those who collected unemployment in 2020
In addition to extensions, the newly signed Covid relief bill includes additional relief for anyone who received unemployment benefits in 2020. On March 6th, the Senate passed an updated version of the Covid relief package that included a $10,200 income waiver for those who were on unemployment in 2020 and had an AGI under $150,000.
This means, the first $10,200 earned through unemployment income would not be subject to taxes, offering a bit of relief for those struggling financially.
President Biden signed off on the bill, including this provision, which means if you were on unemployment, you’ll be exempt from paying taxes on the first $10,200 received (if you earned less than $150,000 last year). If you and your spouse were both on unemployment in 2020, you can waive income taxes on $10,200 per person earned on unemployment, or $20,400 total.
This does not exclude state income taxes, where applicable — that decision is being left up to state governments to decide.
Are stimulus checks received by anyone collecting unemployment benefits taxable?
While unemployment income is taxable, stimulus checks are not, regardless of whether you received unemployment or not. You’ll be required to pay taxes on your unemployment income if you did not elect to have taxes withheld.
Is unemployment income taxed at a lower rate than traditional income?
If you elect to have federal taxes withheld from your unemployment checks, the IRS will pull 10% of your earnings from every paycheck. Depending on your filing status, income level, and number of children and dependents, this rate may be higher or lower than your income tax rate. Ultimately, unemployment is taxed the same way as income.
Are extended benefits provided via the CARES Act taxable?
The extended unemployment benefits that were provided under the CARES Act are currently subject to federal income tax (and state income tax, where applicable). Stimulus checks are not subject to be taxed. There is currently legislation in the Senate proposing tax relief for those who collected unemployment, excluding the first $10,200 earned in unemployment benefits from being taxed, for qualifying individuals.
Is it better to have taxes withheld from your unemployment benefits?
In many cases, it can be safer to have taxes automatically withheld from your unemployment checks. However, you also have the option of calculating estimated taxes on your own and paying the IRS and state revenue departments quarterly. If you elect not to have taxes withheld from your unemployment benefits and do not put money aside to account for taxes, you’re more likely to have a tax bill when filing your tax return.
The bottom line
Increasing unemployment benefits has helped millions of Americans survive financially during the pandemic and has provided much needed relief for many families experiencing layoffs and salary cuts. If you received unemployment income in 2020, you will need to pay taxes on this income if you did not elect to have taxes automatically withheld.
Be sure to review any deductions and credits you’re eligible for and calculate your total tax bill as soon as possible, so you can assess your next steps before April 15th. You can apply for a tax extension by paying a portion of this bill or filing form 4868. Lastly, if unemployment tax relief efforts pass, you might see your tax bill reduced or eliminated entirely.