Unemployment + Taxes

If 2020’s economic downturn put you in the position of needing to apply for unemployment benefits, you may have been under the impression that those benefits were not subject to state or federal taxes. Unfortunately, that’s not the case, and the same is true for independent contractors and the self-employed individuals who applied for and received Pandemic Unemployment Assistance under the CARES Act. Just as you have to pay taxes on work income, you’re expected to do the same for unemployment payments, whether by having the taxes withheld or by setting aside the money yourself. With tax time coming up, you (and many other people) are probably going to see a smaller refund than you’d hoped  – and you may even end up owing the IRS money.

States and Federal Taxes are Handled Differently

Anybody who receives unemployment income gets mailed a Form 1099-G,  which will indicate exactly how much you received during 2020 from either state unemployment insurance or the CARES Act’s pandemic unemployment compensation. That information is specifically for use in preparing your tax return. What you may not have realized at the time that you signed up to receive those payments is that you had the option to file Form W-V4 to your state unemployment agency so that you could have 10% of your benefits automatically withheld, just as employers withhold taxes on employees’ wages. Alternatively, you could voluntarily send quarterly estimated tax payments to the IRS in the same way that the self-employed do for their income.

But keep in mind that unless you live in Alabama, California, Montana, New Jersey, Pennsylvania or Virginia, you also owe income tax to your state for the money you were sent as an unemployment benefit. If you live in Indiana or Wisconsin you’re entitled to a partial exclusion and depending on where you live those taxes may have been withheld for you specifically to avoid unpleasant tax-time surprises.

The taxes for 2020 unemployment benefits are due on April 15^th, 2021, which means that you still have time to set some money aside and send it in.

Unemployment May Lead to Tax Credits

On the flip side of the equation, there are certain tax credits that you may be able to take advantage of if your family received unemployment income during 2020. The child tax credit provides up to $1,400 per qualifying child, and is refundable, and the earned income tax credit also may help with your tax liability, as it is worth as much as $6,600 for families with three or more qualifying children and that qualify as low-income households. While in a normal year your unemployment benefit would not be considered earned income, and therefore would reduce the amount that these two credits could offset your tax liability, the COVID relief act temporarily adjusted this, so that people who earned wages prior to 2020 but who needed unemployment last year can use their 2019 income to determine whether they are eligible for the credit.