The federal government threw a safety net out to millions of Americans in 2020 in response to the coronavirus pandemic. According to AARP, 10.7 million workers were still unemployed as of December 2020, largely due to COVID-19. The government responded by tweaking unemployment insurance provisions for those who found themselves out of work.
Unfortunately, this gift didn’t initially come without a string attached: Unemployment compensation is normally taxable income under the terms of the U.S. tax code. You would have to have reported this income on your 2020 tax return if you received it. But the IRS had your back here, too. The federal government ruled in a subsequent action that up to $10,200 in benefits could be excluded from taxable income by taxpayers with adjusted gross incomes of less than $150,000.
Unfortunately, these COVID provisions have expired and they weren't renewed for the 2021 tax year. You most likely have to include this income on your 2021 tax return when you prepare and file it in 2022, and you'll have to pay taxes on it.
Unemployment Compensation That’s Taxable
The Coronavirus Aid, Relief and Economic Security (CARES) Act was passed on March 27, 2020, and it provided for legislation that would beef up benefits for the unemployed. The Act provided unemployed Americans with an additional $600 a week in unemployment compensation. Then additional legislation passed in December provided for an additional $300 a week through March 14, 2021.
The CARES Act created the Pandemic Unemployment Assistance (PUA) program to extend unemployment eligibility to individuals who wouldn’t otherwise have qualified for assistance, namely the self-employed. The Pandemic Emergency Unemployment Compensation (PUEC) program gave taxpayers an additional 13 weeks of benefits.
All this income is normally taxable, and taxation isn’t limited to these extra federal provisions. Regular unemployment compensation provided by states from the Federal Unemployment Trust Fund or from their own programs, railroad unemployment benefits, and disability benefits paid in lieu of unemployment compensation are all considered taxable income, too. This is the case every year, regardless of a pandemic.
Benefits are only subject to income tax, however. You don’t have to pay FICA taxes on it – Social Security and Medicare.
Some Exceptions to the Rule
A few slim loopholes exist to the rules regarding what compensation is taxable. According to the IRS, your benefits aren’t taxable if you contributed to a government unemployment program, and you received no tax break in return. You paid in with after-tax dollars, and you didn't claim a tax deduction for the sum.
The same rule applies to private, nonunion compensation funds and to special union funds. Benefits received up to the amount of your contributions are tax free, but they’re included in your taxable income otherwise.
Benefits received from a fund financed by your employer are also taxable. This isn’t considered unemployment compensation, although it is income, so it’s subject to income tax, Social Security tax, and Medicare tax, just as regular wages would be.
How to Report Benefits
You should receive a Form 1099-G, “Certain Government Payments,” from your state sometime during the month of January for unemployment compensation you received in 2021. The amount of benefits you received appears in Box 1. This is the amount you should report on Line 7 of Schedule 1 that goes with your tax return. The total of Schedule 1, which also includes other forms of compensation, is then transferred to Line 8 on your 2021 Form 1040 tax return.
The IRS warns that it doesn’t mean that your benefits aren't taxable if you don’t receive a Form 1099-G for some reason. Go to your state’s website and access an electronic copy of the form from there if you don't receive one in the mail.
Options for Payment: Withholding
You have the option of having income tax withheld from your benefits, just as your employer would withhold taxes from your paycheck, if you’re still collecting unemployment compensation and you want to protect yourself against having to pay a lump sum in taxes for the 2022 tax year when you file that tax return. Just ask the paying office for a Form W-4V, complete it and return it to them. Not all states are set up to provide this service, however, and you have to ask. They won’t withhold taxes automatically.
It might turn out that you had enough withheld from your regular earnings before you were laid off to cover both that and at least a portion of your unemployment benefits, particularly if you were laid off toward the end of the tax year. These withholdings would cover both types of income. Withholding doesn't have to come directly from your benefits.
But keep in mind that withholding from unemployment is capped at 10 percent. You can’t have 20 or 30 percent withheld to compensate retroactively for unemployment income you received before you knew this was an option. The total amount withheld appears in Box 4 of your Form 1099-G. Withholding amounts and estimated payments you made are entered on the second page of Form 1040, subtracting from the amount of tax that’s due on the return.
Read More: What Taxes Are Withheld From My Paycheck?
Quarterly Estimated Tax Payments
You also have the option of making estimated tax payments to the IRS, sending in more than the allowed 10 percent instead of having the state withhold taxes on your behalf. You can make payments on the IRS Direct Pay website – just note on the drop-down menu that you’re making an estimated tax payment and indicate the year for which you’re paying. You can also print out vouchers provided on Form 1040-ES and send them in with paper checks.
And, of course, you can have extra sums withheld from your paychecks if you should return to work before the end of the tax year in question. The important thing is that you get your tax payments to the IRS as early as possible because late payment penalties and added interest can apply to tax debts that linger.
If You Simply Can’t Pay
Ideally, you already knew all this and took steps to pay as you were battling your way through the nightmare of being unemployed. But all’s not lost if you find yourself faced with a nasty, unexpected tax bill when you prepare your tax return in 2022. You were collecting unemployment compensation for a reason, so you might not have a healthy savings account to fall back on.
Contact the IRS and ask about an installment payment program. You can also apply on the IRS website. The agency provides a few payment options when taxpayers simply can’t afford to pay in a timely manner. You’ll have to pay interest, but it will be less than if you simply didn’t pay, and any financial penalties might be forgiven. The worst thing you can do is ignore the dilemma. The IRS will work with you if you have no other reasonable options.
Be sure to at least file your 2021 tax return on time, even if you can’t come up with the money right away. The financial penalties for failure to file are worse than the penalties for failure to pay.
Read More: What Happens If You Can't Make Federal Tax Payments?
Most States Tax Unemployment, Too
The unfortunate reality is that you might not be done with all this when you figure out what you owe the IRS. Most states tax unemployment compensation as well. Only Oregon, California, Pennsylvania, New Jersey and Virginia do not, according to AARP.
Of course, it’s also possible that you live in one of the states that don't have an income tax at all. As of 2022, these states are:
- South Dakota
Additionally, New Hampshire taxes only interest and dividend income.
- IRS: Unemployment Compensation Is Taxable; Have Tax Withheld Now and Avoid a Tax-Time Surprise.
- IRS: Publication 525 (2021), Taxable and Nontaxable Income.
- AARP: Are Unemployment Benefits Taxable During the Coronavirus Outbreak?
- Jackson Hewitt: How Unemployment Can Affect Your Tax Return
- TaxAct: COVID-19 Unemployment Benefits and Your Taxes
- IRS: Form 1040 U.S. Individual Income Tax Return 2021
- IRS: Schedule 1 Additional Income and Adjustments to Income 2021
- Tax Foundation: State Individual Income Tax Rates and Brackets for 2021
- IRS: Direct Pay
- IRS: Additional Information on Payment Plans
- IRS: New Exclusion of up to $10,200 of Unemployment Compensation
- IRS: Form 1099-G Certain Government Payments
- IRS: 2021 Form 1040-ES Estimated Tax for Individuals
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.