The $ 1.9 trillion US bailout plan Signed into law last week includes a welcome tax break for unemployed workers. The law abolishes federal income taxes of up to $ 10,200 in unemployment insurance benefits for people who earn less than $ 150,000 per year, potentially saving employees thousands of dollars. States that currently tax unemployment benefits have yet to decide whether to also allow those state taxes to be waived.
The change is good news for many taxpayers, who could save as much as $ 25 billion, according to the Wall Street Journal. But it also impacts an already complex tax season for a debt collection agency that is already lagging behind due to understaffing and pandemic-fueled malfunctions.
Wait, unemployment is taxable?
In most years, yes. The federal government considers unemployment benefits taxable income, although taxes are not automatically withheld from benefits, as an employer might deduct taxes from your paycheck. Instead, unemployment recipients must request that tax be withheld from their benefits, and the withholding is limited to 10%.
This led to confusion and fear for the unprecedented number of workers who received unemployment benefits for part of 2020 and their taxes for the year only served to reduce their typical payback – or in some cases be told they owe money.
Michigan resident Bridget Harwood got a three-month leave of absence from her job as a medical assistant last year when many businesses in her town closed down. The unemployment benefit she received at the time also resulted in a smaller tax refund this year. Instead of the roughly $ 1,500 refund she normally receives, she only got $ 72 back.
“It was definitely a shock,” said Harwood.
It was worse for Harwood’s eldest daughter, who worked in a fast-food restaurant before the pandemic put her out of work. Harwood filled out her daughter’s tax return and found that she owed $ 1,000 in federal and state taxes. When Harwood explained the situation to her daughter – who had been expecting a refund for a new car – she “started crying,” Harwood said.
If you’ve received benefits and filed your 2020 taxes, wait
Taxpayers who received unemployment income last year and have already filed their 2020 tax returns should hold off filing an amended return, the IRS says.
“For those who received unemployment benefits last year and have already filed their 2020 tax returns, the IRS insists that they should not file an amended return at this point until the IRS issues additional guidance,” the tax authorities said on March 12.
Many advocates have called on the IRS to proactively issue refunds to overpaid taxpayers. Among those advocates are Senator Dick Durbin of Illinois and Representative Cindy Axne of Iowa, who along with 19 members of the House and Senate insisted the IRS to issue automatic refunds without the need for amended tax returns.
Nina Olson, the former National Taxpayer Advocate, told Politico that such an automatic correction of already filed returns was well within the capabilities of the IRS. The alternative – by digging a mountain of modified yields – “really creates more processing burden for the IRS,” which started this season lagging behind last year, Olson said.
While the tax change is welcome news, it is also confusing for many.
“People ask so many questions about how it works – people who have filed their taxes and want to know if they need to adjust their returns,” said Stephanie Freed, founder of ExtendPUA.org, a group founded last year to advocate for unemployed people. Freed estimated that the small group has asked hundreds of people for advice on their tax returns since last week.
If you haven’t filed your taxes yet, wait
“Hold on and wait” is also the IRS’s message to taxpayers who have yet to file.
The IRS said it will “provide a worksheet for paper records and work with the software industry to update current tax software” to make it easier for people to report unemployment benefits. Tax professionals say it will take at least a few days, if not longer, for tax software to reflect recent legislative changes.
“I have two piles of tax returns that I am currently unable to file,” said Rob Seltzer, a CPA based in Los Angeles. “I have a client who got $ 15,000 in unemployment. If I reported her, it wouldn’t work,” he said.
Will states also waive taxes?
Some states are expected to change their tax laws to follow federal guidelines. States like Alabama, California, Montana, New Jersey, Pennsylvania and Virginia already exempt unemployment benefits from tax. Other states that typically tax unemployment may decide not to do so this year.
ExtendPUA.org urges all states to follow the example of the federal government and exempt unemployment benefits from tax, Freed said.
“I am a New Yorker and I still have a significant tax bill from state and local taxes,” she said. “Many states follow federal guidelines, so they will accept that forgiveness, but there are about 12 that don’t. New York is one of them and it has some of the highest taxes in the country.”
A monkey wrench in tax season
Under the changes to the new law, a person who was unemployed for part or all of 2020 could potentially save thousands in taxes. Someone who received $ 10,200 or more in unemployment benefits and is in the 10% tax bracket could save $ 1,200 on federal income taxes, assuming their adjusted gross income for the year was less than $ 150,000. (Taxpayers in higher tax brackets would save more.)
The fact that the tax law was amended a month after the IRS began accepting tax promises further complicates an already challenging filing season.
The law “is going to place a wrench in the 2020 filings,” said Jonathan Medows, a CPA based in Manhattan. “It’s a cascade – backing the IRS, backing software companies, backing practitioners.”
Medows also waits to file its clients’ returns until the IRS clarifies its rules.
“My customers are impatient to get refunds and incentive payments, but I’m waiting,” said Medows. “I have to file amended declarations and I am personally delaying things now. I will not complete the cases until we have guidance.”
More time to archive?
All of these changes are an incentive for the IRS to extend the 2020 tax filing deadline this year. The National Conference of CPA Practitioners has called on the agency to postpone the deadline and wait to collect fines until it is through the accumulation. Democrats in Congress, including House Ways and Means Chairman Richard Neal and Oversight Subcommittee Chairman Bill Pascrell, have also called for an extension of the tax filing deadline.
The IRS has thus far adhered to the April 15 deadline for most Americans, although about 10% of taxpayers living in Texas already have a two months extension