How to Handle Taxes If You Received Unemployment in 2020
Unemployment benefits are taxable income
The U.S. unemployment rate peaked in April 2020 to 14.8%—a level not seen since data collection began in 1948—before declining to a still-high 7.6% in December to close out the year. That represents a lot of Americans who will find themselves grappling with taxation of their unemployment benefits when the filing season rolls around in 2021 for 2020 tax returns.
The unemployment benefits that many taxpayers received for months are taxable income. 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, Massachusetts, 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 how much in the way of benefits you received in Box 1. The IRS will receive a copy as well.
Unemployment compensation 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 25b.
Ideally, you knew this money was taxable, so you asked to have income tax withheld from your unemployment payments. If so, the amount that was withheld will appear in Box 4.
You must still report your unemployment compensation on your tax return even if you don’t receive a Form 1099-G for some reason.
Effect on Other Tax Benefits
Not only is unemployment compensation taxable, but receiving it can affect some tax credits you might be eligible for and are counting on to defray 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 would normally be withheld from your paycheck if you were working. 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 to your state government. As of 2020, the states that don’t tax unemployment benefits are:
- New Jersey
An additional seven states don’t tax any income at all, so you'll catch a break here as well:
- 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 tax only a portion of your benefits, 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 an additional $600 per week in unemployment compensation per recipient through July 2020. That extra $600 is also taxable.
You might be all right if you arranged to have income tax withheld from your benefits, but federal law caps withholding on benefits at 10%. That might not be enough to offset all taxes owed if you had other, additional income during the year.
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
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 might also still be able to make an estimated tax payment if you have the money available. The last estimated payment deadline for the 2020 tax year is January 15, 2021. No additional penalties and interest will begin if you can catch up by this date, although you might still be hit for some interest and penalties that accrued prior to the time you caught up.
The CARES Act provided that no interest or penalties on taxes would accrue from April 15 until July 15, 2020.
The Bottom Line
Many Americans find themselves in a position where they still 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. You might still have options if this is the case.
The IRS suggests paying what you can and reaching out to them to take advantage of one of their 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.”