Yes, Unemployment Compensation Is Taxable. Here’s How to Avoid a Surprise Next Tax Season

It’s no secret that the employment situation in America is dire right now. As of July 2020, the Bureau of Labor Statistics estimates that 16.3 million people are currently unemployed – nearly 10% of the adult population – and since the start of the pandemic, roughly 1 million (or more) of them have filed new claims for state unemployment benefits each week.

This means there’s a large group of Americans who are now receiving unemployment compensation for the first time. While the weekly benefits a financial relief to those struggling to find work, they may not be so relieved come next tax season when they find they owe income taxes to the IRS.

On August 18, 2020, the Internal Revenue Service issued a press release reminding those on unemployment that their benefits are, in fact, considered taxable income and must be reported on a federal tax return. This includes special unemployment compensation authorized under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

The good news is, you can opt to have taxes withheld from your unemployment compensation so there are no surprises when you file your 2020 taxes.

What types of unemployment payments are subject to withholdings?

The IRS recommends that taxpayers who receive the following unemployment compensation should calculate their estimated tax withholdings:

• State benefits paid from the Federal Unemployment Trust Fund
• Railroad unemployment compensation benefits
• Disability benefits paid in lieu of unemployment compensation
• Trade readjustment allowances under the Trade Act of 1974
• Unemployment assistance under the Disaster Relief and Emergency Assistance Act of 1974
• Unemployment assistance under the Airline Deregulation Act of 1978 Program 

If you’re currently receiving any of these payments, you will receive IRS Form 1099-G from the agency paying your unemployment benefits in January 2021. This form will show the amount of unemployment compensation you received and any federal income tax withheld during 2020. Hold onto it, as you will need it when you file your 2020 federal tax return. 

Do I have to withhold taxes from my unemployment benefits? 

Withholding is completely voluntary. However, if you can afford to do so, it’s a good idea to take this option to avoid owing a large tax bill next April. 

According to federal law, recipients of unemployment compensation can elect to have a flat 10% withheld from their benefits to cover part or all of their tax liability by filling out IRS Form W-4V, (Voluntary Withholding Request).

If you opt for this voluntary withholding, be sure to submit it to the agency paying your benefits, not the IRS. If the agency has its own withholding request form, you should use that instead. 

What if I can’t afford to take the withholding? 

For many Americans, stretching unemployment benefits to cover their family’s needs can be a challenge, and a 10% withholding may create an additional financial strain. In other cases, that withholding may not be enough to meet your full tax obligation. 

If this is the case for you, you can make quarterly estimated tax payments instead, just like businesses and self-employed individuals. The IRS provides additional details on quarterly estimated taxes and calculation worksheets on Form 1040-ES and Publication 505. Once you calculate the total amount you will owe (based on your weekly unemployment compensation), you can divide that number by 4 and pay the quarterly amounts on September 15, 2020 (for Q3) and January 15, 2021 (for Q4). 

If you’ve been receiving unemployment benefits and haven’t had taxes withheld or paid quarterly estimated taxes for Q1 or Q2, consult with a trusted financial professional to determine your best options for meeting your tax obligations. 

What happens if I go back to work and stop receiving unemployment? 

If you begin earning regular wages or self-employment income and are able to go off unemployment benefits before the end of 2020, make sure you’re having enough taxes taken out of your pay by using the IRS’s tax withholding estimator. This online tool can help you avoid or lessen your year-end tax bill or adjust your income to receive more money up front with a smaller refund at tax time. 

Still have questions about unemployment and your tax bill? Contact Miller & Company. 

If you’re unsure of how your current unemployment obligations will impact your 2020 taxes, schedule a consultation with the experienced CPAs at Miller & Company LLP. We’ll help you understand what you might owe and assist you with setting up voluntary withholdings or making estimated tax payments.

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