Do You Have To Pay Taxes on Unemployment Income?

The answer is usually yes

People standing in line at Job and Training Fair

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If you lost your job in 2020 and you're faced with preparing your tax return for that year, it's important to know which of your unemployment benefits are considered taxable income. The American Rescue Plan Act (ARPA), passed in March 2021, includes a provision that makes $10,200 of unemployment compensation earned in 2020 tax-free for taxpayers with modified adjusted gross incomes of less than $150,000.

Those who filed their 2020 return and reported their unemployment compensation as income before the ARPA passed do not have to file amended returns to set things right. The Internal Revenue Service (IRS) has announced that it will recalculate all tax returns submitted by eligible taxpayers to omit the appropriate amount of unemployment income and expects to issue any resulting refunds to taxpayers in the spring and summer.

The ARPA also extended the weekly federal supplement of $300 through Sept. 6, 2021. However, some states chose to opt out of the program before Sept. 6. To learn whether your state chose to end supplemental benefits early, contact your state's unemployment office.

While the ARPA allows $10,200 of unemployment compensation received in 2020 to be tax-free, unemployment benefits received in 2021 remain taxable on the return you'll file in 2022 unless some future relief measure is enacted. It makes sense to withhold tax upfront to avoid surprises. 

The IRS reminds taxpayers there are different types of unemployment compensation in non-pandemic years, and most are taxable. The IRS offers an interactive tool on its website to help you determine whether the income you receive while you're unemployed must be reported on your return. You can take some steps to pay throughout the year if it is, so you can avoid owing the IRS taxes or penalties at tax time.

The federal government expanded access to unemployment insurance in March 2020 through the CARES Act to cover workers such as independent contractors and part-timers who were previously ineligible.

How Do Unemployment Benefits Work?

Unemployment is a benefit paid by state or federal governments to help people who have lost their jobs through no fault of their own. It doesn't apply if you quit or were fired for cause.

You would contact your state's unemployment insurance program to apply for unemployment benefits. Certain limitations apply as to the amount you're eligible to receive, and they can vary by state. For example, New Jersey provides benefits of up to 60% of your average pay, capping out at $713 a week as of 2020, not including the extra $600 provided for under the Coronavirus Aid, Relief, and Economic Security (CARES) Act or the $300 provided for under the American Rescue Plan Act.

Unemployment taxes are paid by employers and these taxes go into a state fund to aid workers who have lost their jobs. The U.S. Department of Labor monitors the system.

Withholding Taxes From Unemployment Compensation

The IRS views unemployment compensation as income, and it generally taxes it accordingly. You can elect to have federal income tax withheld from your unemployment compensation benefits, much like income tax would be withheld from a regular paycheck.

Unfortunately, you don't have a choice as to how much you want to be withheld. Federal income tax is withheld from unemployment benefits at a flat rate of 10%. Depending on the number of dependents you have, this might be more or less than what an employer would have withheld from your pay.

You can use Form W-4V, Voluntary Withholding Request, to have taxes withheld from your benefits. Complete the form and give it to your unemployment office.

Making Estimated Tax Payments

You might be required to make payments directly to the IRS as quarterly estimated tax payments if you elect not to have taxes withheld from your unemployment benefits. This works out to a payment once every three months. You can elect to do this instead of having 10% withheld from every unemployment check, giving yourself 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. You're obligated to make estimated payments if you expect that you'll owe at least $1,000 after accounting for all taxes withheld from all your sources of income, and if you expect that your withheld taxes plus any refundable tax credits you're eligible for will be less than 90% of what you'll owe, or 100% of the total taxes you paid last year.

You might want to consult with a tax professional because the whole equation can be complicated. You could accrue additional penalties if you don't pay enough tax, either through withholding or estimated tax payments.

Reporting Unemployment Income for Taxes

Your state's unemployment agency will report the amount of your benefits on Form 1099-G. The IRS gets a copy, and so do you. The form will also show any taxes you had withheld.

You must report these amounts on line 7 of the 2020 Schedule 1, then total all your sources of additional income in Part I of the schedule and transfer the number to line 8 of the 2020 Form 1040.

The economic impact payment or stimulus checks that you might have received are not considered to be unemployment compensation. You do not have to pay taxes on this money.

The Bottom Line

Ultimately, your unemployment income will be taxed right along with any other income you might have earned during the year, except for the first $10,200 in 2020 if you're eligible for relief under the terms of the ARPA.

Use Form W-4V to withhold any tax from your unemployment income, or pay quarterly taxes to ensure you don't owe the government any penalties come tax season. And always consider working with a tax professional if you have questions about your specific situation.

Frequently Asked Questions (FAQs)

How do you claim unemployment benefits?

Unemployment benefits are offered at the state level. You'll need to contact your state's unemployment insurance program and follow its instructions for applying. In general, you'll need to complete an application that explains your situation and details where you worked, how long you worked there, how much you made, and why you're no longer employed. Your state's unemployment program will review your application and approve it, request additional information or an interview, or deny it. You can appeal if your claim is denied.

What can disqualify you from receiving unemployment benefits?

Each state has its own unemployment criteria and rules. Unemployment programs typically require you to be unemployed through no fault of your own and meet work and wage requirements. If you quit or were fired for cause, you usually don't qualify for unemployment. Self-employed people and contract workers usually aren't eligible for unemployment benefits, but the CARES Act allowed states to extend unemployment benefits to these individuals.