Unemployment Compensation Benefits and Income Taxes
It's a natural question if you lost your job last year and now you're faced with preparing your taxes: Is unemployment taxable income? It is for federal income tax purposes. The Internal Revenue Service takes the position that this money is the same as income you earn through work. States usually exempt unemployment benefits from taxation, however.
Withholding Taxes From Unemployment Compensation
You can elect to have federal income tax withheld from your unemployment compensation benefits, something like income tax would be withheld from a regular paycheck. But federal income tax is withheld at a flat rate of 10 percent. Depending on the number of dependents you have, this might be more or less than what your employer withheld from your pay.
Run the numbers both ways to determine your best option, keeping in mind that unemployment benefits are only a percentage of the income you brought in when you were working—usually about 60 percent of your average weekly earnings. You might want to make estimated tax payments instead if you need every one of those unemployment dollars to make ends meet. You'll still owe the tax, but you can defer it a little. If you don't pay anything, you may end up owing the IRS taxes plus a penalty at tax time.
You can use Form W-4V, Voluntary Withholding Request, to have taxes withheld from your benefits. Complete it and give it to your unemployment office.
Making Estimated Tax Payments
Technically, if you elect not to have taxes withheld from your unemployment benefits, you're required to personally make those payments to the IRS as quarterly estimated tax payments during the time you collect unemployment. It comes out to once every three months instead of every unemployment check, so it gives you a little bit of wiggle room when money is tight.
You might even have to make quarterly payments in addition to withholding from your benefits. In most cases, you're obligated to make estimated payments if you expect to owe at least $1,000 after accounting for taxes withheld from all your sources of income, and if you expect that your withheld taxes plus refundable tax credits you're eligible for will be less than 90 percent of what you'll owe or 100 percent of the total taxes you paid last year.
Yes, it's complicated, so you might want to consult with an accountant. If you don't pay enough tax, either through withholding or estimated tax payments, you may accrue additional penalties for paying late.
Reporting Unemployment Income
Your state's unemployment agency reports the amount of benefits you receive for the year on Form 1099-G. The IRS gets a copy, and so do you. The form will also show any taxes you had withheld. You would then report these amounts on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040-EZ when you file your tax return. Your unemployment income is taxed right along with any other income you earned during the year.
What the IRS Has to Say About Unemployment Compensation
"Unemployment compensation generally includes any amounts received under the unemployment compensation laws of the United States or of a state. It includes state unemployment insurance benefits and benefits paid to you by a state or the District of Columbia from the Federal Unemployment Trust Fund. It also includes railroad unemployment compensation benefits and disability benefits paid as a substitute for unemployment compensation, but not worker's compensation." (From IRS.gov, Tax Topic 418).