Do You Have to Pay Taxes on Unemployment Compensation Benefits?

Unemployment benefits are usually taxable

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It's a natural question if you've lost your job and now you're faced with preparing your tax return: Are unemployment benefits taxable income?

Yes, in most cases. The Internal Revenue Service takes the position that this money is typically the same as income you earn through work, although states often exempt unemployment benefits from taxation.

The IRS offers an interactive tool on its website to help you determine for sure if income received while you're unemployed is taxable, but you can probably count on it. You can take some steps, however, to avoid owing the IRS any money when you file your return.

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. Unfortunately, you don't have a choice as to how much you want 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.

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. If you don't pay anything, you could end up owing the IRS taxes plus a penalty at tax time. 

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

If you elect not to have taxes withheld from your unemployment benefits, you're technically required to make payments directly to the IRS instead as quarterly estimated tax payments. This works out to once every three months while you're collecting unemployment benefits instead of 10% withheld from every unemployment check, so this can give 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 that you'll 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 any 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 a tax professional. If you don't pay enough tax, either through withholding or estimated tax payments, you could accrue additional penalties for paying late. 

Reporting Unemployment Income 

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.

The IRS issued a whole new Form 1040 in 2018, so now you'll have to do a little more work to report this income and any taxes you paid.

You would then report these amounts on line 19 of Form 1040 when you file your tax return—at least through tax year 2017. In tax years 2018 and going forward, you must use the new Schedule 1 that goes with the revised 1040. Enter the amount of your benefits on line 19 of Schedule 1, and the amount of any withholding from those benefits on line 16. Then transfer the total of Schedule 1 to line 6 of the new 1040.

Ultimately, your unemployment income will be 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, Tax Topic 418).​​