By: Brandon Caine, CPA
The coronavirus pandemic has affected our nation’s economy in many ways. Most notably, millions of citizens applied for and received unemployment compensation during 2020. As we head into the 2020 tax filing season, today we will provide a summary of the tax impact of receiving unemployment compensation.
Unemployment compensation is paid by states to provide an income source for workers who have lost their jobs. In 2020 state benefits were amplified with supplemental federal benefits provided under the Coronavirus Aid, Relief and Economic Security (CARES) Act.
All unemployment benefits are taxable at the federal level. If you received unemployment benefits during 2020 you will receive a Form 1099-G which will report the benefits you received in Box 1 and, if applicable, federal income tax withheld from those benefits in Box 4.
You should provide this document to your tax advisor or input the applicable data in your return if you are self-preparing. Unemployment compensation is reported on Line 7 of Form 1040 Schedule 1.
If you experienced unemployment and your overall income decreased as a result, your tax rate may be lower than 2019. If your overall income increased due to the federal supplemental benefits, your tax rate may have increased from 2019.
States vary on the taxability of unemployment benefits, as each state has their own tax laws. For example, California, New Jersey, and Pennsylvania do not tax unemployment benefits, while New York does. Here is a link to a useful article from April 2020 summarizing the taxation of unemployment taxes by state.
CAUTION - Some states are considering changing their laws in 2020 to address the economic hardship their residents are facing due to the pandemic. For example, Delaware legislators unveiled a proposal earlier this week to exempt benefits paid in 2020 from Delaware state income tax.
Unlike unemployment compensation, stimulus payments received in 2020 and 2021 are not taxable for federal or state purposes.
There are three (3) options to remit federal taxes on unemployment benefits:
- When filing for unemployment, you can elect to have a flat ten percent (10%) federal tax withheld from your benefits by submitting IRS Form W-4V.
- Quarterly estimated tax payments can be remitted using Form 1040-ES.
- Remit any balance due when you file your tax return
- Underpayment of estimated tax penalties may apply if you choose this option.
Many states, even those who tax unemployment compensation, do not allow for state tax withholding. You should confirm if your benefits are taxable for state purposes and inquire with your state unemployment office if they will allow you to elect state tax withholding, where applicable.
Unfortunately, many in the U.S. remain unemployed because of the pandemic. The Consolidated Appropriations Act of 2021, which became law on December 27, 2020, expanded federal supplemental unemployment benefits into 2021. If you continue to receive unemployment benefits in 2021, you should consider the tax impact and provision cash from those benefits to cover any projected 2021 taxes due.