In late March 2020, under the CARES Act, unemployed Americans began receiving an average weekly unemployment benefit of close to $1,000. If you're collecting unemployment benefits and you're smart, the amount you're receiving is an after-tax amount. Yes, unemployment benefits are a form of unearned income that's taxable and reportable on federal and state returns. Here is some more information about unemployment benefits of which you may be unaware.
Revenue Act of 1978
The Revenue Act of 1978 stipulated that the unemployment compensation of a single taxpayer would be taxed if the person's adjusted gross income was greater than $20,000. The same was true for joint filers whose income was more than $25,000.
Legislator reasoning was that the tax burden would discourage people from relying on the benefits as a long-term income solution, rather than a short-term one. A 2015 report by the Congressional Research Service indicated that Congress believed that to do otherwise would incentivize the failure to look for work.
Some believe the assumption is an illogical one in that an extended period of unemployment can negatively affect a person's subsequent wage and earnings, according to Richard W. Johnson and Alice Feng, authors of “Financial Consequences of Long-Term Unemployment during the Great Recession and Recovery.”
Taxable Unearned Income
Both corporations and uber-wealthy Americans take advantage of tax breaks that reduce their tax liability. This fact may seem unfair when people receiving unemployment compensation have their payments tapped for taxes after an economic event crushes them financially. To make things worse, in addition to a federal tax burden, some unemployed are hampered with state tax on their unemployment benefits as well.
Under the Tax Reform Act of 1986, unemployment income became fully taxable. The benefits are not, however, subject to Social Security and Medicare taxes, because they're not earned wages.
Federal and State Taxes
At both the state and federal levels, tax collection is a pay-as-you-go system. This means taxes should be paid when the unemployment benefits are received, through withholding or estimated tax payments. If you don’t pay enough tax throughout the year, you may have to pay an underpayment penalty.
In regards to federal taxes, the IRS says federal law allows you to elect that a flat 10 percent be deducted from your benefit checks. To do so, you complete the Form W-4V, Voluntary Withholding Request. If you're required, however, to make quarterly estimated tax payments, use the IRS tool to determine the amount.
In turn, in 2020, some states waive income taxes on unemployment checks. If you live in Alabama, California, Montana, New Jersey, Oregon, Pennsylvania and Virginia, your unemployment benefits are tax-exempt. Additionally, nine states – Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming – do not levy any state income taxes.
For the other 35 states that are currently taxing unemployment benefits, the amounts vary. For instance, the Hawaii and Vermont rates are 1.4 to 11 percent for 2020 and 3.35 to 8.75 percent for 2019 respectively.
Tax Withholding Option
It's tempting to kick the tax obligation down the road when overwhelmed by the prospect of finding a new job. But if, when factoring in your income and withholding from income sources during the year, it's likely taxes will be due at years' end, the tax withholding option is a good one.
Although federal and state tax entities remind unemployment benefit claimants of their responsibility to pay income tax on their unemployment benefits, some claimants don't elect to do so. Perhaps, stressed by their financial situation, they don't realize they must have taxes withheld or file estimated quarterly tax payments.
You should complete IRS Form W-4V to have taxes withheld from your unemployment benefits. Alternatively, you may be required to make estimated tax payments. The IRS makes available a tool to determine if you're required to do the latter.
Read More: Unearned Income & Social Security
When you're out of work, you spend part of your day contacting potential employers and another portion seeking assurance your cash will carry you from this month to the next. While your unemployment benefits ease the cash issue, they also add to your to-do list. You'll need to complete a W-4V or arrange for estimated quarterly tax payments to avoid an IRS penalty.
- Washington Post: The Controversial $600 Aid Debate Explained
- Cornell: § 416.1121 Types of unearned income
- IRS: Unemployment compensation is taxable; have tax withheld now and avoid a tax-time surprise
- CNBC: Here’s what you need to know about paying taxes on unemployment benefits
- Senate.gov: The Revenue Act of 1978
- FAS: Taxation of Unemployment Benefits
- Urban.org: Financial Consequences of Long-Term Unemployment During the Great Recession and Recovery
- Forbes: Wandering Tax Pro Remembers the Tax Reform Act of 1986
- Senate.gov: Revenue Act of 1978
- Nolo: Is Unemployment Insurance Taxable Income?
- Kiplinger: 15 States That Don't Tax Unemployment Benefits
- IRS: Tax Withholding Calculator
- IRS: Form W-4V Voluntary Withholding Request
- IRS: Topic No.419 Unemployment Compensation
- Kiplinger: The Kiplinger Tax Map Guide
- Vermont.gov: VermontRate Schedule 2019
- Tax-Brackets.org: Hawaii Income Tax Brackets 2020
- IRS: Form W-4V
- IRS. "Publication 525: Taxable and Nontaxable Income," Page 27. Accessed April 17, 2020.
- IRS. "Five Tax Tips on Unemployment Benefits." Accessed April 17, 2020.
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- USA.gov. "Unemployment Help." Accessed April 17, 2020.
- CareerOneStop.org. "Learn More About Unemployment Benefits." Accessed April 17, 2020.
- IRS. "Form W-4V: Voluntary Withholding Request." Accessed April 17, 2020.
- IRS. "Topic No. 418 Unemployment Compensation." Accessed April 17, 2020.
- IRS. "Estimated Taxes." Accessed April 17, 2020.
- Center on Budget and Policy Priorities. "Introduction to Unemployment Insurance." Accessed April 17, 2020.
- IRS. "Instructions for Form 1099-G," Page 4. Accessed April 17, 2020.
Billie Nordmeyer is an IT consultant of 25 years standing. As a senior technical consultant for SAP America and Deloitte Touche DRT Systems, a business analyst, senior staff, and independent consultant, Billie has worked across the retail, oil and gas, pharmaceutical, aeronautics and banking industries. Billie holds a BSBA accounting, MBA finance, MA international management as well as the Business Analyst and Software Project Management certificates from the Cockrell School of Engineering at the University of Texas at Austin.