Millions of Americans have applied for unemployement benefits or unemployment insurance ever since the wave of unfavourable economic condition hit the world. And while it's important to file for one as soon as you get the chance, it's equally imperative to understand how you'll be taxed to avoid a long tax bill when the time comes to file. As a major factor in American government's response to COVID-19, typically the insurance offers up to 26 weeks of benefits to unemployed workers.
Although any unemployment benefit is treated like ordinary income by the Federal government, the cherry on top is that you are exempt from paying medicare and social security as part of taxes. While most states will require you to pay taxes on these benefits, there are a few exceptions that don't expect you to such as Montana, California, Pennsylvania, New Jersey and Virginia.
In terms of how much benefit you can receive, payments vary by state, with Massachusetts distributing the highest weekly benefit of $823 and Mississippi the lowest amount set at $235.
As a result of COVID-19, and the economic havoc that led to a steep rise in unemployed workers, the U.S. government passed the Coronavirus Aid, Relief, and Economic Security Act — more commonly referred to as the CARES Act — to help support both the economy and the workforce. Approved by Congress on March 27, 2020, and signed into law by President Trump, this act pumped $2.2 trillion into the economy. In addition, the act helped provided an extra $600 in financial relief on top of the unemployment compensation states are offering to those who have lost their jobs during this period. (These extra payments provided by the U.S. government are set to expire at the end of July 2020.)
Additionally, the act created the Pandemic Unemployment Assistance (PUA) Program, allowing independent contractors and self-employed Americans who run a business such as an LLC, C Corp or S Corp to apply for and collect these added federal unemployment benefits.
Are Unemployment Benefits Taxable?
Unemployment benefits are taxed like ordinary income. Your state and the government will report any unemployment amounts paid to you via Form 1099-G. You will receive a copy of this form, which will show your total unemployment compensation received. When filing taxes, you will report this information on Schedule 1 of your 1040, along with any other income earned.
If you've received unemployment insurance money, you are responsible for federal and state taxes. Taxes can be deducted from your weekly benefit or paid through quarterly estimated tax payments. If you do not pay estimated taxes, you'll need to pay your full tax liability when you file your 2020 taxes, though you may be subject to interest and penalties.
Even though you may be responsible for your federal tax, recipients of unemployment insurance do not need to make tax payments to Medicare or Social Security. And if you're located in these 15 states, you will not need to pay state taxes on your UI: Alabama, Nevada, Tennessee, Alaska, New Hampshire, Texas, California, New Jersey, Virginia, Florida, Pennsylvania, Washington, Montana, South Dakota and Wyoming.
How to Pay Unemployment Benefits Taxes
Automatically Withhold Taxes from Your Check
The best way to avoid having any problems come tax time is to have taxes automatically deducted from your weekly UI payments. Applicants for UI can put this deduction in place when applying for their unemployment benefits. The deduction for federal taxes is set at 10 percent. Depending on your total income for the year, you may owe more or less when it comes time to file your annual taxes. If you’ve neglected to request your income tax withholdings, you can file for an IRS W-4V Voluntary Withholding Request.
Pay Estimated Taxes
If you opt not to withhold taxes, another alternative is to submit estimated quarterly taxes by making payments directly to the IRS online portal. Estimated first and second quarter taxes are due by July 15, 2020, which is also the extended new filing deadline for 2019 taxes. The third-quarter estimated tax payment is due by September 15.
Make sure to keep a record and a printout or receipt confirming you made a payment. At the very least, you won’t get surprised by a huge tax hit at the end of the year. Depending on what your yearly income will amount to, you may even receive a refund.
What If I Can't Pay Taxes on My Unemployment Benefits?
If you are collecting UI benefits, you have likely suffered a significant reduction in income. If that's the case, you may be eligible for an Earned Income Tax Credit (EITC). The EITC reduces the amount you owe, and there is even a chance that you will receive money in a refund.
You may also be eligible for the IRS program OIC - Offers in Compromise, which allows you to settle your tax liabilities for an amount lower than what is owed.
Getting Tax Filing Help
Losing a job, applying for unemployment and navigating through an economy and job market affected by a worldwide pandemic can be very stressful. For many, unemployment insurance is a lifeline that will help feed their family, pay the rent and keep the lights on.
When it comes to getting tax help, Incfile is here for you. Our small business accountants can help you prepare and file your tax return to ensure you're correctly paying unemployment benefits taxes. Check out our free tax consultation to have Incfile give you the guidance you may need.