Are Your Unemployment Benefits Taxable?

With the passage of the CARES Act stimulus package early in 2020, the federal government began supplementing the normal state weekly unemployment benefits by adding $600 per week through the end of July 2020. When this provision ran out, and with Congress at a stalemate, President Trump issued an executive order in early August that extended the supplement, but at $400 per week, with the federal government providing $300 and the state the other $100. Then, the COVID Tax Relief Act that was enacted in late December of 2020 extended the federal unemployment supplement through March 14, 2021, but at $300 per week. Now, President Biden’s American Rescue Plan that Congress enacted in March of 2021 has extended the $300 benefit through September 9, 2021, and increased the number of weeks an individual can qualify for the benefits from 50 to 74.

The American Rescue Plan Act originally slated the weekly amount to be $400. That was before a provision to treat the first $10,200 of unemployment income received by each individual as tax-exempt was included, at which point the weekly supplemental amount was reduced to $300. However, the tax exemption of the first $10,200 of unemployment compensation will only apply to taxpayers with modified AGIs less than $150,000. Prior to this change, unemployment benefits were fully taxable income for federal purposes.

This change is retroactive to 2020, and if you have already filed your 2020 tax return, on which you included unemployment compensation and didn’t take an exclusion, and you qualify for the income exclusion, the IRS will take steps in the spring and summer to make the appropriate change to the returns of these individuals. The adjustment may result in a refund and the amount will be refunded or applied to other outstanding taxes owed. The first refunds are expected to be made in May and will continue into the summer.

For those who have already filed, the IRS will do these recalculations in two phases, starting with those taxpayers eligible for the up to $10,200 exclusion. The IRS will then adjust returns for those married filing jointly taxpayers who are eligible for the up to $20,400 exclusion and others with more complex returns.

There is no need for taxpayers to file an amended return unless the calculations make the taxpayer newly eligible for additional federal credits and deductions not already included on the original tax return.

For example, the IRS can adjust returns for those taxpayers who claimed the Earned Income Tax Credit (EITC) and, because the exclusion changed the income level, may now be eligible for an increase in the EITC amount which may result in a larger refund. However, taxpayers would have to file an amended return if they did not originally claim the EITC or other credits but now are eligible because the exclusion changed their income.

Those who received unemployment benefits will be sent a Form 1099-G (Certain Government Payments) from the state that paid the benefits. This tax form shows the amount of unemployment benefits paid to the individual during 2020 and the amount of income tax withheld, if any.

There have been reports of people receiving Form 1099-G when they never applied for and didn’t collect any unemployment benefits for 2020. In these cases, the individual’s personal information was apparently used fraudulently by someone else to claim the unemployment benefits. If this happens to you, you should contact the government office that issued the erroneous form to request a correction.

Also, be aware that children under age 19, or full-time students over age 18 and under age 24 with unearned income in excess of $2,200, are subject to what is referred to as the kiddie tax. The kiddie tax taxes the child’s unearned income at the parent’s rate. Normally, we think of unearned income as being interest, dividends and capital gains, but certain other types of income, including unemployment benefits, are considered to be unearned income. This can lead to some unpleasant tax surprises, as those who have already filed their 2020 tax returns may have discovered. But the $10,200 retroactive exclusion should eliminate the unemployment tax for most kiddie tax returns. 

There are several states where unemployment benefits are not taxable.  Of those, seven states do not have a state income tax so obviously, unemployment benefits are not taxable in those states, which are the following:

• Alaska 
• Florida 
• Nevada 
• South Dakota 
• Texas 
• Washington 
• Wyoming 

Several states have state income tax but do not tax unemployment benefits:

• California 
• Montana 
• New Hampshire 
• New Jersey 
• Oregon 
• Pennsylvania 
• Tennessee 
• Virginia 

Two states exempt 50% of amounts above $12,000 (single taxpayer) or $18,000 (married taxpayers):

• Indiana 
• Wisconsin 

The remaining states fully tax unemployment benefits.

A word of caution:  Some states may pass laws to conform to the federal treatment, or even automatically conform.  Unfortunately, that information was not available when this article was prepared.

If you’ve collected unemployment compensation, the benefits’ impact on your tax bill will depend on a number of factors, including the amount of unemployment income you received, whether your benefits are covered by the $10,200 exclusion, what other income you have, whether you are single or married (and, if married, whether you and your spouse are both receiving unemployment benefits), and whether you had or have income tax withheld from benefit payments.

If you have questions about the taxation of unemployment compensation, please give this office a call.