Do You Owe Taxes on Unemployment Benefits? You Could Get Hit With a Big Tax Bill

Form 1099G for Unemployment Benefits
Tax form 1099G details the total unemployment benefits you receive in a given year. Darylann Elmi/Getty

Unemployment benefits provided a much-needed lifeline for thousands of Americans dealing with pandemic furloughs and layoffs in 2020. But on April 15 an unpleasant surprise might be waiting for people who got such aid.

According to Kathy Pickering, H&R Block's chief tax officer, many first-time unemployment recipients don't know those payments count as taxable income for both federal and state returns.

Thanks to extended benefits that stretched up to 39 weeks in some states and additional weekly federal support payments, first of $600 and then $300, unemployment benefit recipients could be facing hefty tax bills they're unprepared for and ill-able to afford, particularly if they are still out of work.

Legislation proposed by two Democratic Senators on February 2 hopes to prevent this by waiving taxes on the first $10,200 of unemployment benefits a person received last year. However, the bill has yet to be passed and no changes have been made to the existing tax code. So for now, it's best to brace for a possible hit from Uncle Sam.

If you relied on unemployment compensation last year, here's what you need to know when you file your 2020 return: how that aid will be taxed; ways to reduce your tax bill; and your options if you can't pay in full by the deadline.

How Much Tax Will You Owe on Unemployment Benefits?

While you may need to consult with a CPA or tax planning software to get the exact amount you'll owe on unemployment benefits, you should know that those payments won't be treated quite the same way earned income paid out by an employer is.

For instance, you don't have to pay Social Security or Medicare taxes, typically about 7.65 percent combined, on unemployment benefits. And If your total income for the year, including unemployment benefits, was less than the standard deduction--the set amount the government lets every American deduct from their taxable income each year--you are in the clear for owing any federal taxes, says CPA Oscar Vives Ortiz, a member of the American Institute of CPAs' Personal Financial Specialist Committee. The standard deduction for 2020 was $12,400 for singles, $24,800 for married couples and $18,650 for those filing as head of household.

Any income above those levels will fall into one of the following federal tax brackets:

Rate

For Single Individuals

For Married Individuals Filing Joint Returns

For Heads of Households

10%

Up to $9,875

Up to $19,750

Up to $14,100

12%

$9,876 to $40,125

$19,751 to $80,250

$14,101 to $53,700

22%

$40,126 to $85,525

$80,251 to $171,050

$53,701 to $85,500

24%

$85,526 to $163,300

$171,051 to $326,600

$85,501 to $163,300

32%

$163,301 to $207,350

$326,601 to $414,700

$163,301 to $207,350

35%

$207,351 to $518,400

$414,701 to $622,050

$207,351 to $518,400

37%

$518,401 or more

$622,051 or more

$518,401 or more

Source: Internal Revenue Service

Most states, however, charge income tax on unemployment benefits, says Lisa Greene-Lewis, CPA and tax expert for TurboTax. A few don't (Alabama, California, Montana, New Jersey, Pennsylvania, and Virginia) and two tax a portion of total benefits received (Indiana and Wisconsin). If you live in a state that has no state income tax, or none on earned income—such as Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, or Wyoming—you will also not owe anything.

Can Taxes Be Withheld from Unemployment Benefits?

While you're not required to have taxes withheld from your unemployment benefit checks, you do have the option to take that tax hit upfront if you feel you don't need every penny of your aid immediately for pressing bills.

Those still receiving unemployment benefits can change their withholding status by filling out form W-4V, Voluntary Withholding Request. Remember, though, advises H&R Block's Pickering, that you'll need to hand this form over to your state unemployment agency or whoever is administering your unemployment benefits, not the IRS. If you're just signing up for benefits now, there should be an option on your initial registration form to indicate you want taxes withheld. Then 10 percent of each benefit payment will be kept back to cover federal taxes.

Alternatively, you can put that same 10 percent or more if you wish, into a savings account to await the tax deadline day or to make estimated quarterly tax payments.

How Do I Reduce the Taxes I Owe?

More than half of all Americans are worried about having tax debt in 2021, but among those who were laid off at some point during the pandemic, that figure jumps to 76 percent, according to a survey from LendEDU conducted in December.

Even if you did not have taxes withheld from your unemployment benefits, there are still ways to reduce your tax bill or even wind up with a refund.

There are dozens of different tax credits and deductions available based on a range of life events and activities you may have experienced in 2020. Here are just three examples:

Earned Income Tax Credit

If you lost work in 2020 and had a much lower income than normal as a result, you may qualify for the Earned Income Tax Credit, which can knock up to $6,660 off your taxes if you have three or more children, says TurboTax's Greene-Lewis. You must have earned some income from an employer or self-employment last year, however. Unemployment benefits income alone won't count.

Your income and number of dependents will determine whether you met the threshold for claiming the EITC and just how large it will be. For 2020, the credit is worth $538 if your income was below $15,820 for single filers or $21,710 for those married filing jointly who do not have children. If you have two children, you're eligible for a credit of $5,920 if your income was less than $47,440 for singles and $53,330 for married couples. To find the income parameters specific to your family situation, you can review IRS Publication 596.

Greene-Lewis adds you can also use your 2019 income in calculating whether you qualify this tax year, thanks to the Consolidated Appropriations Act, passed at the end of December, which aimed to provide relief to those struggling because of the pandemic.

Saver's Credit

People who were contributing to a retirement savings account before becoming unemployed or while still unemployed, may also now be eligible for The Saver's Credit. According to Greene-Lewis, the credit is worth up to $1,000 for singles who earned less than $32,500 and $2,000 for married couples who earned less than $65,000. Depending on your income, the credit will be either 50 percent, 20 percent or 10 percent of the amount you contributed to an IRA, Roth IRA, 401(k), 403(b) or other retirement plan.

If you're employed again now and have some spare funds, you can contribute to a traditional or Roth IRA until the filing deadline, April 15, and have it count on your 2020 tax return. That could help reduce your overall taxable income and boost the value of your Saver's Credit.

Charitable Deduction

And for this tax year only, you can deduct up to $300 in charitable donations made in 2020 from your taxable income without having to itemize.

Finally, you may not owe as much as you think thanks to the W-4 withholding form you filed with your employer when you were working in 2020.

"Many Americans over-withhold taxes on employment income so that they have a refund when they file, so it is possible that this over-withholding may offset the taxes due on the unemployment benefits you received," says the AICPAs' Vives Ortiz.

What Should I Do if I Can't Pay My Tax Bill?

Even if you can't afford to fully pay your tax bill by April 15, you need to file your return by that day. The IRS charges a stiff penalty for failing to file on time that is ten times worse than the penalty they'll hit you with for failing to pay, says H&R Block's Pickering.

The failure-to-file penalty equals 5 percent of the amount of unpaid taxes for each month your return is late, up to 25 percent of the total. The failure-to-pay penalty is only 0.5 percent of the unpaid taxes you owe for each month you carry a balance, again up to 25 percent.

"If you think you owe, don't freak out, that's when a lot of bad decisions get made," says Pickering. "There are so many options for paying if you have a balance due. And the most important thing is to file your taxes."

Last year, a third of taxpayers who couldn't pay their full tax bill didn't file their return by the deadline, according to a survey conducted by LendEDU. And with 53 percent of Americans worried about having to go into debt over their taxes for this year, it seems likely a few more may be scared into making the same mistake.

The good news: it's easy to avoid that failure-to-file penalty. You can even file electronically for free if your income was less than $72,000 using the IRS Free File program.

In fact, it is probably in your best interest, if you think you'll owe, to complete your return as early as you can. The payment still won't be due until April 15, regardless of when you file, and doing it in advance can give you time to save up for the tax payment, says AICPA's Vives Ortiz.

If you can't pay in full by the deadline, try to pay as much of the bill as possible and then contact the IRS at 1-800-829-1040 to discuss your options. You may be able to get a short-term extension to pay or an installment payment agreement. In some situations, the agency may also waive penalties, though it will still charge interest on your unpaid taxes.