The 2020 tax season has officially begun, and the millions of Americans who received unemployment benefits last year due to the coronavirus pandemic may be in for a surprise.
That unemployment income is taxable, and if you didn’t have money set aside or withheld for those taxes, it could reduce your refund or even lead to an account.
This can be especially unexpected for independent contractors and self-employed workers who are not normally eligible for government benefits, but who may have received pandemic unemployment assistance through the CARES Act.
“There will be many people this year who have unemployment insurance and don’t normally receive unemployment benefits,” said Elaine Maag, principal investigator at the Urban-Brookings Tax Policy Center. “So it’s going to be something new that they have to watch out for.”
Differences in State and Federal Treatment
If you had unemployment income last year, it will be subject to taxes and should be listed on your 2020 income tax return. By January, those with unemployment income should have received a Form 1099-G stating the amount paid out during the year.
Federal income taxes apply to these benefits – be it state unemployment insurance or the pandemic unemployment benefit paid out under the CARES Act.
The catch is that withholding the correct amount of income tax is voluntary. You can choose to withhold a fixed amount of 10% from your benefit to cover the tax liability.
To do this, you must submit Form W-V4 to the government agency that manages your unemployment.
You can also choose to make quarterly estimated tax payments to the IRS.
Uncle Sam isn’t the only entity looking for a slice of your unemployment income. Most states will also tax these benefits.
A handful of states – Alabama California, Montana, New Jersey, Pennsylvania and Virginia – do not tax these payments. Indiana and Wisconsin offer a partial exclusion from unemployment income, according to Andy Phillips, director of the tax institute at H&R Block.
“Some states have withheld taxes and others require it to ease surprises when tax time arrives,” said Jared Walczak, vice president of state projects at the Tax Foundation.
While it’s too late to get rid of the taxes you may owe before 2020, those who complete their returns early may at least plan to pay the amount due by April 15 – the due date for tax returns and liabilities due.
“You don’t have to make a payment until April 15, but it’s better to know in late January or early February to figure out the dollar amount by then,” said Phillips of the H&R Block tax institute.
Unemployment and tax credits
Families who received unemployment income in 2020 should also look out for two major credits when filing their tax returns: the employed person’s tax credit and the child tax credit.
Both credits add up to significant dollars – the earned income tax credit is worth up to $ 6,600 for a low-income household with three or more eligible children. And the refundable portion of the child discount is worth up to $ 1,400 per eligible child.
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The catch? While unemployment benefits are taxable, they are not considered a labor income.
Under normal circumstances, receiving unemployment would result in a reduction in both credits when you file your tax return.
Lawmakers have solved this problem in the Covid year-end emergency response. This year, when you file your 2020 taxes, you have the option to use your 2019 income to calculate whether you qualify for the credit.
“If you’ve gone from being a salaried worker to applying for unemployment, you can get into it,” said Phillips. “Using your 2019 earned income alone to calculate the number of credits can be a huge benefit to the taxpayer.”