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Millions of Americans have filed for unemployment since the coronavirus pandemic started shutting down huge swaths of the U.S. economy in mid-March. If you’ve lost your job and are receiving unemployment, pay attention to the tax rules — they can help you maximize the cash you get right now or minimize the bill you might face later. And if you're wondering, "Is unemployment taxable?" we have answers for that, too.
Is unemployment taxable?
Yes, unemployment benefits are taxable.
At the federal level, the IRS views unemployment benefits as income. Some states also tax these benefits, while others tax some or none of it. Check with your state tax authority to see if unemployment is taxable in your state.
The American Rescue Plan Act of 2021, which became law in March 2021, made some significant changes to how unemployment is taxed.
If your adjusted gross income (AGI) is $150,000 or less, the first $10,200 of any unemployment income is not taxable (the portion of your unemployment income over $10,200 is still taxable). If you're married and filing jointly, the first $20,400 of any unemployment income is not taxable.
If your AGI was over $150,000 in 2020, all of your unemployment income is taxable.
This rule is retroactive to 2020. If you've already filed your 2020 tax return, you don't need to file an amended tax return (Form 1040-X) to exclude your unemployment compensation. The IRS says it will refigure your taxes, adjust your account accordingly and send any refund directly to you.
How much tax will I pay on unemployment benefits?
Here's a basic rundown of how it works.
Decide whether you want taxes withheld from your unemployment checks
When you sign up to receive unemployment benefits, you can choose whether to have a flat 10% withheld for federal taxes.
If you want to go this route, fill out IRS Form W-4V (“Voluntary Withholding Request”) and turn it in at your local unemployment office. You can only have a flat 10% withheld; you can’t customize the amount.
You can also choose not to have taxes withheld, in order to have more money in your pocket, but know that either way early in 2021 both you and the IRS will receive Form 1099-G showing how much unemployment compensation you were paid.
You include your unemployment benefits in your income when you file your tax return. So having taxes withheld from your unemployment checks can help you pay as you go and help prevent or reduce a surprise tax bill when you file your tax return in May 2021.
If as an employee you voluntarily contributed to a private fund for unemployment benefits — this may be the case for some union members, for example — the benefits you receive likely are taxable if you get more than you put in.
If you've already signed up to receive unemployment benefits, or are already receiving benefits and have a better sense of whether you can afford to pay taxes as you go, you can change your withholding preference by filing a new Form W-4V with your local unemployment office.
Prepare to make quarterly estimated tax payments
If you’re not having taxes withheld from your unemployment checks, the IRS would like you to make quarterly estimated tax payments. Why? Because income taxes are a pay-as-you-go arrangement in the United States, which means that when you get your unemployment check, the IRS wants its cut as soon as possible.
To pay quarterly estimated taxes, basically you’ll need to estimate your tax liability for the whole year and then make payments on that estimated bill over the course of the year.
You can have tax withheld from your checks and pay estimated quarterly taxes at the same time. This combo approach might be a good idea if you think a flat 10% withholding won’t be enough to cover your tax bill later.
If you miss a deadline to make a quarterly estimated tax payment, you can certainly "catch up" later and the IRS will gladly accept your money. But you may owe a penalty on that late payment.
You may need to file a tax return
Generally speaking, if your income is above a certain level — including your unemployment benefits — you need to file a tax return with the IRS. But what that income threshold is depends on your gross income, your filing status, your age and whether someone can claim you as a tax dependent. This article explains who has to file.
If you do need to file a tax return, that may actually be a good thing. You may also qualify for tax credits and deductions that can get you a tax refund.
What if I can't pay the tax bill?
If unemployment income creates a tax bill you can't pay right away, here are a few options to keep in mind.
Still file your tax return on time. The IRS issues penalties for paying late, but it also issues penalties for filing late. You can help keep the penalties to a minimum by filing your tax return on time, even if you can't send any money. If you need more time to file your tax return, you can get an extension, but remember that getting an extension only gives you more time to file, not more time to pay.
The IRS lets people pay in installments over time. Signing up for an installment plan can let you pay your tax bill over the course of several weeks or months, and you can sign yourself up directly with the IRS. There are a few different plans to choose from depending on how much you owe and how long you need. (Learn how to do it here.)