Federal and state income taxes apply to unemployment benefits, but the process isn’t always straightforward. In this article, we at SCL Tax Services have explained everything you need to know about taxes on unemployment benefits to help you avoid an unexpected tax bill.
The collapse of the economy caused by the pandemic in March 2020 means that many Americans have filed their taxes after receiving substantial income from unemployment benefits.
They are. Both federal and state taxes apply to unemployment insurance benefits. Until 2021, unemployment benefits were taxable at rates determined by the IRS’s tax brackets and counted as income. A portion of that money was exempt from federal income taxes for the tax year 2020 under the American Rescue Plan Act of 2021 (also called the stimulus bill).
With the American Rescue Plan Act of 2021, you will no longer be taxed on the first $10,200 of unemployment benefits you received in 2020. This means that only the money you received over $10,200 applies to your taxable income. If you file jointly, each person gets up to $10,200 in tax-free unemployment benefits before they have to start paying federal income taxes.
Individuals and joint filers who made up to $150,000 in 2020 are eligible for this exemption. This is known as a “hard cliff,” and it applies regardless of whether you file as a single person, married person, or any other filing status. Accordingly, if your household’s adjusted gross income in 2020 totaled $150,001, you’ll have to pay taxes on all your unemployment benefits.
Keep in mind that all states have followed the federal government’s lead. In many states, like New York, all unemployment benefits are subject to state income taxes. In other states, such as California, unemployment benefits are exempt from state taxes. Some states do not have state income taxes at all. We will discuss briefly how each state issues taxes on unemployment benefits at the end of the article.
Important: Remember that this exemption does not apply to unemployment benefits in 2021, and those benefits are fully taxable when you file your tax return this year. The regular rules will apply for 2021, and unemployment benefits received will be taxed as ordinary income (just like wages).
As long as your overall tax situation doesn’t change, the IRS will automatically recalculate the taxes due and refund you if you overpaid. Then you’ll get an IRS unemployment refund in a short time.
If a new law makes you eligible for an unemployment tax break like the Earned Income Tax Credit, you would need to amend your return. If this is the case for you, you can amend your return using Form 1040X.
Those states that provided unemployment insurance benefits should send you Form 1099-G. You will see how much (if any) of your unemployment income has been withheld for taxes on this form. This will help you calculate your income when you file your taxes.
Those taxpayers who receive a Form 1099-G showing they received unemployment benefits when they did not should contact the issuing state agency to receive a revised form showing they did not receive these benefits. Taxpayers who cannot obtain a timely, corrected form from states should still file an accurate tax return, reporting only the income earned.
An incorrect 1099-G form may indicate that you’re the victim of unemployment fraud, which has been increasing.
Yes. The IRS recommends that you take out federal and state taxes from your unemployment checks so that you do not get surprised by a bill. If you wish to do this, you can do so when you first apply for unemployment, or at any time while you are receiving benefits, by filing Form W-4V. You can do this online in most states, and their unemployment websites are listed in the Department of Labor’s directory.
With the $10,200 exemption, you may be able to receive tax refunds for unemployment benefits if federal taxes were withheld from your benefits throughout the year. If necessary, the IRS will calculate this automatically and refund you.
Also, keep in mind that the unemployment tax exemption of $10,200 is only valid through 2020. If you received unemployment benefits in 2021, setting up a withholding now may save you from being surprised by your next year’s tax bill.
Not at all. The unemployment insurance benefits you receive are yours to keep, except for any taxes you may owe. Just be sure you get the right amount.
Additionally, you may be required to pay state income taxes on your unemployment insurance benefits. This is another area that can be tricky because each state has its own laws. Some states don’t have a state income tax, and others don’t tax unemployment compensation. Others tax unemployment benefits in full, while there are states that tax only a portion of them.
Suppose you live in one of the eight states without a state income tax (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming). In that case, your benefits are not subject to state income tax. New Hampshire taxpayers are also free of tax because their state only taxes interest and dividend income.
Unemployment insurance benefits aren’t taxed in California, New Jersey, Pennsylvania, and Virginia, so taxpayers in those states don’t have to worry about state taxes either.
If you live in one of the 37 other states or in the District of Columbia, you’d better check with a tax professional or your state’s tax agency to find out how unemployment benefits are taxed. Here’s a detailed look at how various states issue unemployment benefits.
The state of New York generally taxes unemployment compensation at the same rate as the federal government. The state, however, does not follow changes made by the federal government after March 1, 2020. Therefore, New York has not adopted the federal exemption for unemployment compensation up to $10,200 in 2020. For those who have not yet filed their New York tax returns, you must add back any federal unemployment compensation you excluded on your federal return. You must file an amended unemployment benefits tax return if you already filed your New York return, but you didn’t add back unemployment compensation that was excluded from your federal gross income. Do not file an amended return if you did not exclude unemployment compensation from your federal gross income.
In any case, if you live in and near Bronx, NY, and have questions about unemployment compensation, count on us. Over the years, we’ve helped taxpayers in and near the Bronx, Mount Vernon, Eastchester, Westchester, and Yonkers with accounting, bookkeeping, and tax preparation.
Give us a call to our tax office in Bronx, NY and we’ll set you up for a free 15-minute tax consultation or fill the form below.
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