Receiving unemployment benefits is no different from earning a paycheck when it comes to income taxes, at least under normal circumstances when the U.S. isn’t struggling with a pandemic. Unemployment income is considered taxable income and must be reported on your tax return. It is included in your taxable income for the tax year.
While the federal government tweaked this rule in 2020 in response to COVID-19, those who collected unemployment income in 2021 should expect to pay the full taxes on those benefits. As of Nov. 29, 2021, the federal government and the Internal Revenue Service (IRS) did not say that the rule would be tweaked again.
Here’s what to know about paying taxes on unemployment benefits in tax year 2021, the return you’ll file in 2022.
Unemployment Income Rules for Tax Year 2021
When it went into effect on March 11, 2021, the American Rescue Plan Act (ARPA) gave a tax break on up to $10,200 in unemployment benefits collected in tax year 2020. You had to qualify for the exclusion with a modified adjusted gross income (MAGI) of less than $150,000. The $150,000 limit included benefits plus any other sources of income. You claimed the exclusion when filing your 2020 tax return in the spring of 2021.
The IRS recalculated tax returns that were filed prior to the March 2021 ruling. It then issued refunds to any taxpayers who overpaid before ARPA went into effect.
If you collected unemployment in 2020, there’s a chance you were paid benefits in January 2021 because they accrued late. This means you have to include that income in your 2021 tax return, despite that the money is technically for the unemployment period in 2020. The ARPA exemption does not apply to unemployment income received in 2021. The key ARPA words are “unemployment compensation paid in 2020.”
What Qualifies as Unemployment Benefits?
The term “unemployment benefits” casts a wide net. It includes unemployment insurance benefits paid to you by your state, as well as railroad unemployment compensation benefits. It also includes any payments made to you by the Federal Unemployment Trust Fund and Federal Pandemic Unemployment Compensation.
How Taxes on Unemployment Benefits Work
You should receive a Form 1099-G from your state or the payor of your unemployment benefits early in 2022 for unemployment income you received in 2021. The full amount of your benefits should appear in box 1 of the form. The IRS will receive a copy of your Form 1099-G as well, so it will know how much you received. You don’t have to include the form when you file your return.
Unemployment benefits aren’t subject to Medicare or Social Security taxes, only to income tax. This may help reduce your overall tax burden in the year you claim them.
When you’re ready to file your tax return for 2021, write the amount stated in box 1 of your Form 1099-G on line 7 of Schedule 1, Additional Income, and Adjustments to Income. You must file Schedule 1 with your Form 1040 or 1040-SR tax return. Line 7 is clearly labeled, “Unemployment compensation.” The total amount from the Additional Income section of Schedule 1 is then entered on line 8 of your tax return.
You must report your unemployment benefits on your tax return even if you don’t receive a Form 1099-G. Go to your state’s website if you didn't receive one and think you should have—some states may not mail out paper versions of the form. The form is usually available electronically, but you can also call your state unemployment office.
If you receive a Form 1099-G but did not collect unemployment benefits in 2021, report it to the paying authority as soon as possible.
How To Prepare for Your 2021 Tax Bill
You have the option of having income tax withheld from your unemployment benefits so you don’t have to pay it all at once when you file your tax return—but it won’t happen automatically. You must complete and submit Form W-4V to the authority that’s paying your benefits. Withheld amounts appear in box 4 of your Form 1099-G.
Federal law limits the amount you can have withheld from benefits to 10%. This may not be enough to adequately cover taxes on the benefits you received. If you’ve returned to work, you can opt to have extra tax withheld from your paychecks through the end of the year to help cover taxes owed on your unemployment benefits as well as your regular pay.
Your other option is to make advance estimated quarterly payments of any tax you think you might owe on your benefits. You have until Jan. 15, to make estimated tax payments on any benefits you receive between September and December the prior tax year. In fact, you must do so if sufficient tax wasn’t withheld from your unemployment benefit payments. You could be charged a tax penalty if you don’t “pay as you go” through either additional withholding or estimated payments during the tax year.
The tax you owe on your unemployment benefits might be minimal depending on how much you received. This is because unemployment doesn't replace 100% of your previously earned compensation.
If you don't have taxes withheld from your unemployment benefits and you fail to make estimated payments, you’ll have to pay any lump sums and penalties by tax day (usually April 15), when your tax return is due.
If You Owe Tax That You Can't Pay
If you’re receiving unemployment benefits, it’s likely because you’re out of work, and that could cause a hardship if you realize you have a lump sum of tax due when you file your return. For some taxpayers, this could mean deciding between paying the rent and buying groceries, or sending estimated tax payments to the IRS. If you find yourself in this situation, there are some options.
You can apply for a short-term or long-term installment agreement with the IRS to satisfy your tax debt in monthly payments made over a period of time, up to 72 months. Just file Form 9465 with the IRS.
You can also file Form 2210 with the IRS to ask the agency to waive any underpayment penalty that’s been assessed against you if you feel it would be inequitable to require you to pay the penalty. You might also qualify for a waiver if you became disabled during the year you collected unemployment, or you retired during that year and were at least 62 years old.
State Income Taxes on Unemployment Benefits
It may not be just the IRS you have to worry about. Many states tax unemployment benefits, too. There are several that do not, though; California, Montana, New Jersey, Pennsylvania, and Virginia do not charge taxes on unemployment benefits. Arkansas and Maryland will not charge state taxes on unemployment benefits received in tax year 2021.
Eight states don’t tax any income at all, so you’ll be spared if you live in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming. New Hampshire doesn’t tax regular income; it only taxes investment income.
Frequently Asked Questions (FAQs)
How much tax is taken out of unemployment compensation?
If you collect unemployment benefits, you can choose whether or not to withhold federal taxes at a rate of 10%. Some states may allow you to withhold 5%. If you do not have taxes taken out of your unemployment checks, you may have to pay quarterly estimated payments or pay taxes when you file your annual tax return. Either way, your unemployment income is considered taxable income just like any other wages or salaries you receive.
What happens to the amount of tax money the government collects if unemployment is high?
A period of high unemployment may reduce the amount of money the government collects in taxes. Of course, national taxation is a complex system that's always subject to political and economic changes. For example, if a government doesn't collect enough revenue from taxes, it could potentially increase taxes the next tax year to make up for those losses.
Who pays unemployment taxes?
Taxes on unemployment income are paid by the person receiving the benefits. However, "unemployment taxes" can also refer to taxes imposed by the Federal Unemployment Tax Act (FUTA). FUTA taxes are paid by employers.