How to Handle Taxes If You Received Unemployment in 2020
Unemployment benefits are taxable income
The unemployment rate in the U.S. was 10.2% in July 2020, according to the Bureau of Labor Statistics, and that was actually down almost a percentage point from June. Among other difficulties, that represents a lot of Americans who will find themselves grappling with taxation of their unemployment benefits when the filing season rolls around next year for 2020 tax returns.
Although not every recipient may be aware, the unemployment benefits many taxpayers have been getting for months are taxable. That includes the extra $600 per week that was provided by the federal government in response to the coronavirus pandemic, Chip Capelli, owner of Chip Capelli, Accountant based in Provincetown, Mass., told The Balance via email.
How Taxes on Unemployment Benefits Work
Unemployment benefits are income, just like money you would have earned in a paycheck. You’ll receive a Form 1099-G after the end of the year, reporting in Box 1 how much in the way of benefits you received, and the IRS will receive a copy. Ideally, you knew this was going to happen, so you asked to have income tax withheld from your payments. If so, the amount that was withheld should appear in Box 4.
Unemployment compensation even has its own line (Line 7) on Schedule 1, which accompanies your 1040 tax return. You’ll transfer the amount in Box 1 of Form 1099-G to Line 7 of Schedule 1, then the withholding amount in Box 4 of the 1099-G (if any) goes directly onto your 1040 tax return on Line 17.
You must still report your unemployment compensation on your tax return even if, for some reason, you don’t receive a Form 1099-G.
The Effect on Other Tax Benefits
Not only is unemployment compensation taxable, but as taxable income, it can affect some tax credits you might be eligible for and are counting on to defray some of those 2020 taxes due.
“Something else to consider is if you usually get the Earned Income Credit (EIC) each year,” Capelli said. “While unemployment benefits aren’t considered ‘earned income,’ they do influence your adjusted gross income (AGI), which is used to calculate the EIC.”
Income Taxes vs. FICA Taxes
If there’s any good news here, it’s that unemployment compensation is not subject to FICA taxes (the flat-percentage Social Security and Medicare taxes that normally would be withheld from your paycheck). You’ll catch a bit of a break here if you collected unemployment through a significant part of the year.
State vs. Federal Taxation
You’ll also get some relief if you happen to live in a state that doesn’t tax unemployment benefits. Otherwise, you’ll owe tax on your benefits to both the IRS and your state government. As of June 2020, the states that don’t tax unemployment benefits are:
- New Jersey
An additional seven states don’t tax any income at all:
- South Dakota
Tennessee and New Hampshire have an income tax, but only on investment income, so you’ll dodge the bullet in these states, too. And two more states—Indiana and Wisconsin—may only tax a portion, according to Capelli, but he warns that some cities and counties have local income taxes that will apply to unemployment compensation as well.
Do I Have to Pay Taxes on the Extra $600?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided for the Federal Pandemic Unemployment Compensation (FPUC) program when President Trump signed it into law on March 27, 2020. The FPUC program provided that additional $600 per week in unemployment compensation through July 2020. That extra $600 is also taxable.
You might be alright if you arranged to have income tax withheld from your benefits, but not necessarily, depending on your other income. Federal law caps withholding on benefits at 10%, and that might not be enough to offset all taxes owed. Even worse, not all states were technologically prepared to withhold anything from that extra $600 portion. Their unemployment systems simply weren’t up to the task—many initially collapsed during the first weeks of increased visits to their sites—so it might not have been accomplished even if you asked for withholding on this extra amount of unemployment compensation.
This 10% withholding cap prevents you from having extra money withheld now to try to compensate for not having anything withheld earlier in the year. You can ask for extra withholding from your paychecks, however, if you return to work.
How to Prepare for Your 2020 Tax Bill While on Unemployment
You’re not without options if you’re concerned about the April 15, 2021, tax deadline.
First, contact your unemployment office immediately and start having income tax withheld from your payments if you haven’t already done so and if you’re still collecting.
“If you’re still collecting unemployment benefits, see if you can opt in to having federal and state taxes withheld,” Capelli said.
It probably won’t solve your whole problem with the 10% withholding cap in place, but it will defray somewhat the impact of those benefits being included in your income come April. Ask for Form W-4V, fill it out, and file it with your unemployment office.
You can also still make a couple of quarterly estimated tax payments if you have the money. There are two payment dates left for the 2020 tax year: Sept. 15, 2020, and Jan. 15, 2021. No additional penalties and interest will begin if you can catch up by these dates, although you might still be hit for some interest and penalties that accrued prior.
The CARES Act provided that no interest or penalties on taxes accrued from April 15 until July 15, 2020.
The Bottom Line
Many Americans find themselves in a position now where they need every cent of those unemployment checks for living expenses. There’s no money left to send to the IRS for quarterly estimated tax payments. If that’s you, what should you do?
The IRS suggests paying what you can and reaching out to them to take advantage of one of their various payment options to deal with the balance. You can ask for an installment agreement and pay your tax debt off on balances of up to $50,000 over 72 months, according to Capelli. Making the request is a simple matter of filing Form 9465 with the IRS. This will at least cut the 0.5% per month late-payment penalty to 0.25%, although the interest rate will continue at 3.00%.
You might also look into an offer in compromise to settle your tax debt for less than the full amount you owe, or ask the IRS for a temporary delay in collecting, if your financial situation is particularly difficult. But you’ll almost certainly need the help of a tax professional to exercise either of these options.
The IRS indicates that you might be better off borrowing money to settle your tax debt, but Capelli strongly recommended against this except as a last resort.
“Do not, under any circumstances, borrow money unless it’s interest-free,” Capelli said. “Don’t use a credit card to pay your taxes. The IRS interest rate is lower than most credit cards and the IRS payment plan doesn’t appear on your credit report.”
U.S. Bureau of Labor Statistics. “The Unemployment Situation—July 2020.” Accessed Aug. 25, 2020
NFCC. "Don’t Forget to Pay Income Tax on Your Unemployment Benefits—Here’s How." Accessed Aug. 25, 2020.
Internal Revenue Service. “Topic No. 418 Unemployment Compensation.” Accessed Aug. 25, 2020.
Internal Revenue Service. "IRS: Unemployment Compensation Is Taxable; Have Tax Withheld Now and Avoid a Tax-Time Surprise." Accessed Aug. 25, 2020.
Internal Revenue Service. "Instructions for Form 9465 (12/2019)." Accessed Aug. 25, 2020.
Internal Revenue Service. "Common Penalties for Individuals." Accessed Aug. 25, 2020.