Millions of people received unemployment benefits in 2020, and many are in tax limbo now. The federal government usually taxes unemployment benefits as ordinary income (like wages), although you don’t have to pay Social Security and Medicare taxes on this income. But the American Rescue Plan Act of 2021, the stimulus bill that was signed into law on March 11, 2021, changed the rules.
People whose adjusted gross income was less than $150,000 can exclude up to $10,200 of unemployment benefits from taxes in 2020. If two spouses both received unemployment benefits, they can each exclude $10,200 from their income as long as they are under the $150,000 adjusted gross income cutoff on their joint return, says Mark Luscombe, principal federal tax analyst at Wolters Kluwer Tax & Accounting. “The $150,000 is a cliff, not a phaseout, and is the same for all tax returns, whether single filers or joint filers,” he says.
People who received unemployment benefits and already filed their 2020 income tax returns may need to file an amended return to take advantage of the exclusion and receive an extra refund. But it’s a good idea to wait for more details from the IRS. “Taxpayers may need to file an amended return, but should consult a tax professional to see if they should wait for IRS guidance to see if the IRS comes up with an alternative, such as the IRS making the adjustment on eligible filed returns,” says Luscombe.
People who haven’t filed their income-tax returns should consider waiting to file their return until the IRS provides more guidance on taking the exclusion. “I think it’s a great idea to wait a little bit because the Treasury Department and the IRS are going to have to put out some guidance,” says Oscar Vives Ortiz, a CPA financial planner in Tampa, Florida, and member of the American Institute of CPAs personal financial specialist credential committee.
Tax-filing software will also need to be updated to accommodate the changes. Check in with your tax preparer or tax-filing company for updates. For example, H&R Block is awaiting guidance from the IRS on how the changes will be implemented and will provide updates at its Coronavirus tax resource center.
The AICPA has asked officials at the Treasury and the IRS for a tax filing and payment deadline extension until June 15 because of the challenges created by COVID-19 and the existing backlog at the IRS on tax returns filed last year, but no change has been made yet and the tax-filing deadline currently remains April 15.
Some states that usually tax unemployment benefits are likely to follow the federal exclusion for 2020. “Some states start their state tax return preparation with the federal adjusted gross income figure,” says Luscombe. “In those states the exclusion would automatically be taken into account also for state income tax purposes. Those states would have to adopt a specific provision to elect out of allowing the exclusion. Other states may have to take specific action to allow the exclusion.” Taxpayers who already filed their state income-tax return and qualify for the exclusion may need to file an amended return, he says. Check with your tax professional or your state’s department of revenue as guidance becomes available.
How Unemployment Benefits Are Usually Taxed
Unemployment benefits are usually taxable as income – and are still subject to federal income taxes above the exclusion, or if you earned more than $150,000 in 2020. Depending on the maximum benefit size in your state and the amount of time you were receiving unemployment benefits, you may still have to pay income taxes on a portion of the payouts you received – even if you qualify for the exclusion. In California, for example, the maximum unemployment benefit is usually $450 per week, and rose to as much as $1,050 when the $600 federal benefit was added. “So if someone received the benefit for 26 weeks, they will have received $27,300 in benefits,” says Mitchell Freedman, a CPA financial planner in Westlake Village, California. After the exclusion, they’d still have $17,100 in taxable benefits.
You should have received a Form 1099-G from your state unemployment division by the end of January reporting the total unemployment compensation you received for 2020 (and whether you had any state or federal tax withheld from your payments), which you usually report on Schedule 1 of your 1040 form when you file your federal income taxes.
The $10,200 exclusion currently only applies to 2020. If you’re receiving unemployment benefits now, consider whether or not you want to have income taxes withheld from your unemployment benefits, like you would from your salary, to help avoid a potential surprise at tax time next year. You can ask to have taxes withheld from your payments when you apply for benefits, or you can file IRS Form W-4V, Voluntary Withholding with your state unemployment office. You can only request that 10% of each payment be withheld from your unemployment benefits for federal income taxes.
But you may decide not to have taxes withheld if you need to stretch your benefits as much as possible now. “If you are strapped for cash and need every dollar for living expenses, I would take out minimal taxes now and deal with the shortage at tax time,” says Morris Armstrong, an enrolled agent in Cheshire, Connecticut. You may also have to pay a penalty because you didn’t pay taxes throughout the year. “If your stint is short-lived, or you expect it to be, and you do have a nest egg, then I would recommend that you withhold adequately.”
You may also have some other options. Instead of having income taxes withheld from your benefits, you could pay estimated taxes each quarter, which adds more flexibility. Or you could have more money withheld from your paychecks if you return to work later in the year, says Vives.
And it’s also a good idea to watch out for any changes to the law for 2021. The $10,200 exclusion only applies to unemployment benefits paid in 2020, but the rules could change. “It does appear to be the type of provision that Congress may include in the next round of tax legislation later this year for 2021,” says Luscombe.
Taxes and Stimulus Payments
The tax situation is different for the stimulus payments people received in 2020. Those payments were considered a refundable income tax credit and were never taxable.
The stimulus payments were technically an advanced payment of a special 2020 tax credit, based on your 2018 or 2019 income (your most recent tax return on file when they calculated the stimulus payments). If your income was higher in 2020, you didn’t have to pay back the stimulus payment. However, if your income was too high in 2018-2019 to qualify for the stimulus but then it dropped to within the adjusted gross income thresholds in 2020, you will receive the credit when you file your 2020 tax return. Also, you may receive additional stimulus money when you file your return if you had a baby in 2020. You’ll claim the additional money, called the “recovery rebate credit,” on line 30 of your 1040.