How are unemployment benefits taxed?

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If you receive unemployment benefits, you must pay taxes on that income. Because laws vary by state, it can be complex to determine the tax liability.

Are unemployment benefits taxable?

Your unemployment qualifies as taxable income subject to federal and state taxes, depending on where you live. In some states like Florida, Alaska, Nevada, South Dakota, Wyoming, Texas and Washington, residents do not have state income taxes. And in others like Arkansas, they do not collect tax on unemployment income for the 2020 and 2021 tax years.

While you might have to pay federal and state taxes, the government deems you do not have to pay Social Security or Medicare taxes. It also instituted exclusions during COVID-19 to help people minimize their tax liability if they had to take unemployment benefits.

COVID-19 stimulus and taxes

For the 2020 tax season, the American Rescue Plan helped reduce Americans’ tax liability by making the $10,200 received from unemployment benefits federal tax-free for those with an adjusted income of $150,000 or less. If you made more than $150,000, you do not qualify for any exclusions under the plan.

For married couples where both received unemployment benefits, each would receive federal tax-free the first $10,200, provided you didn’t make more than $150,000 each. While this applied to the 2020 tax season, financial experts say this might not carry over to the 2021 tax season.

Those who received stimulus payments do not have to report them as taxable income. And if you did report them as income, you can file an amended return to receive a refund on the taxes paid.

Does taxable income vary by state?

While federal income taxes are easier to understand, state taxes are another story.

Taxable income varies wildly from state to state. California will not tax its residents for unemployment income. Meanwhile, Colorado assesses a tax on all unemployment benefits received. Contact the department of revenue in your state to find out if it taxes unemployment income.

Paperwork you need to file for taxes if you received unemployment

In January, you will receive Form 1099-G for unemployment benefits. It contains information like wages, federal taxes withheld (box 4) and state taxes paid (box 11). States can send this through the mail. You can also access it online, especially if that is how you file for benefits.

You can report your unemployment through the added income section on your tax return. If you use a software program, it will walk you through it. The IRS also has filing instructions.

How to have taxes withheld from unemployment benefits

It is tempting to forgo paying taxes on unemployment benefits until it comes time to file. However, doing this could leave you with a serious tax liability. States allow you to have taxes withheld for federal and state (if applicable) when you receive approval for benefits.

How it works is you fill out form W-4V, known as the Voluntary Withholding Request. On it, you can choose between 7 percent, 10 percent, 12 percent or 22 percent of your income to pay federal taxes. The IRS withholds 10 percent for unemployment, meaning you should choose that unless you have a special circumstance.

Meanwhile, if your state collects income taxes, you also want to pay them. Since each state varies with laws and rates, you can speak with your unemployment office and see what you need to do to have the proper percentage withheld from each check.

What happens if I filed my taxes before the rescue plan went into effect?

Keep in mind, the goal of the American Rescue Plan was to reduce the tax liability of those on unemployment, not eliminate it. If you did not have taxes withheld on a federal level, that exclusion would apply to only the first $10,200 received. Any amount exceeding this will require you to owe taxes. And if you do owe, the IRS sends you a statement for you to settle.

Conversely, if you had taxes withheld before the American Rescue Plan went into effect, you might receive a refund on the taxes paid. The IRS reviews these on a periodic basis. Provided you do not have any other taxes owed to them, they will issue you a refund.

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Written by
Sean Jackson
Contributing writer
Sean Jackson is a contributing writer at Bankrate. Sean writes about budgeting, saving money and more.
Edited by
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