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Are Unemployment Benefits Taxable During the Coronavirus Outbreak?

The IRS wants its cut, but a few states will offer you a break

spinner image Closeup of overlapping tax forms, Form 1099G Certain Government Payments, Federal Income Tax Withheld $0.00, with stack of cash, blank form boxes.
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| If you’ve lost your job because of the coronavirus, you’re not alone: Ten million people, or 6.2 percent of the U.S. workforce, were unemployed in February. The good news: You may not owe as much in federal and state income taxes on your 2020 unemployment compensation as you would have in previous years.

More unemployment benefits than usual in 2020

Unemployment soared in 2020 because of the pandemic and, because of that, many people received unemployment compensation who had never done so before. And unemployment compensation was generous in 2020.

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That’s not normally the case. Many states cap their highest unemployment insurance (UI) payment at half the state’s average weekly wage, and some have even lower benefit caps. In February 2020, when the recession started, average weekly UI benefits were about $387 nationwide but ranged from a low of $215 in Mississippi to $550 in Massachusetts, according to the Center on Budget and Policy Priorities, a nonpartisan think tank. About 4.1 million people have been unemployed for more than 26 weeks, which is when state unemployment insurance typically runs out. 

Under the CARES Act, enacted March 27, 2020, people who were laid off because of the coronavirus pandemic were eligible to get an additional $600 per week until July 31, 2020. This federally funded benefit extended to people who weren’t traditionally covered by state unemployment insurance. Under what’s called the Pandemic Unemployment Assistance (PUA) program, the self-employed, independent contractors and so-called gig workers were covered by unemployment for up to 39 weeks if they lost their jobs as a direct result of the pandemic. Another program, the Pandemic Emergency Unemployment Compensation (PEUC) program, gave an additional 13 weeks of federally funded unemployment insurance payments.

In December 2020, Congress authorized a $900 billion relief package that included an extra $300 per week in unemployment benefits through March 14 — half the amount in the CARES Act. The legislation also extended the PUA and the PEUC programs for an additional 11 weeks. Under the American Rescue Plan Act, signed into law March 11, the $300 weekly payments to eligible workers will continue until Sept. 6.

Enjoy the windfall, but don't forget the tax man

The federally funded $300 weekly payments, like state unemployment insurance benefits, are normally taxable at the federal level. Early this year, you probably received a Form 1099-G, which told you the amount of UI benefits you received in 2020, and how much was withheld for taxes. You have to report that income on your 2020 federal tax return (and state return, if applicable).

For the 2020 tax year, however, the American Rescue Plan Act allows single taxpayers with modified adjusted gross income of less than $150,000 to exclude up to $10,200 in unemployment insurance from income. Married couples can exclude up to $10,200 per person, or a maximum $20,400.

This news probably came as a surprise to the 66 million taxpayers who had already filed their taxes as of March 12. The IRS says those people should not file amended returns: The agency will make the appropriate changes on their returns for them and send refunds, if any, in the spring and summer. Returns for those eligible for a maximum $10,200 will be recalculated first.

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Most states tax UI benefits as well. Of the 41 states that tax income, only six — Alabama, California, Montana, New Jersey, Pennsylvania and Virginia — normally exempt UI benefits. Because of the pandemic, however, many states are offering limited tax reductions on unemployment insurance payments, so be sure to check with your state’s tax department.  

If you’re currently on unemployment, be mindful that 2020’s exclusions may not be available when you file taxes for 2021. “When filing for the benefit, strongly consider choosing to have tax withheld so you aren’t blindsided when you file your income tax return,” says Logan D. Howard, a certified public accountant in Masontown, Pennsylvania. “In most cases, the tax withheld should be sufficient to cover the tax liability.”

You do have the option of setting aside money yourself instead of having it withheld, or of paying estimated taxes. “Keep in mind that a taxpayer’s 2020 income may be down substantially due to the COVID-19 pandemic,” says John A. Madison, a certified public accountant in Ashland, Virginia. The Tax Cuts and Jobs Act, passed in 2017, increased the standard deduction, meaning many low- to middle-income taxpayers receiving UI may end up owing little or no federal taxes.

“My advice would be to know yourself,” Madison says. If you have the willpower to reserve some of your UI benefit for next year — and you can avoid underpayment penalties — you’ll have more flexibility than if you had those taxes withheld. If not, he says, have the money withheld as you deal with looking for work, managing your budget and self-quarantining.