Is My Client’s Unemployment Income Taxable?

Many of your clients may have received unemployment compensation for the first time in 2020 due to COVID-19. They may be wondering if it is taxable or if it will affect their refund. We answer those questions and more in this article.  

Is my client’s unemployment compensation taxable?  

Yes, your client’s unemployment income will be taxed at the federal level and probably at the state level if their total income is more than the minimum required to file. It’s important to note that taxable benefits for tax year 2020 include any special unemployment compensation authorized under the CARES Act or under the second stimulus package bill.  

How does the second stimulus bill impact unemployment compensation and taxes?

The second stimulus bill extended and modified some of the unemployment benefits covered under the CARES Act. Whereas the CARES Act granted an extra $600 per week of federal unemployment benefits on top of regular state unemployment payments, the second stimulus bill continues the additional federal benefits but at a lower $300 per week. 

It also extends unemployment eligibility and the The Pandemic Unemployment Assistance program, so many who would have lost their benefits once the original extension expired can continue to collect payments for an additional 11 weeks.

Unemployment benefits received under the second stimulus package will be taxed exactly the same as normal unemployment compensation (see below). Because this bill only applies to weeks of unemployment that began after December 26, 2020, most of these benefits will apply to your clients’ 2021 income and not their 2020 income.

How is unemployment compensation taxed?  

The federal government taxes unemployment income like regular wages. However, unemployment income is exempt from Social Security and Medicare taxes.  

Most states also tax unemployment wages with some exceptions. For example, California, Montana, New Jersey, Pennsylvania, and Virginia do not tax unemployment.  

Your client should receive Form 1099-G from their state reporting their total unemployment compensation for 2020. Help them report this income on Schedule 1 of their 1040.  

How can my client reduce what they owe on their unemployment?  

Help your client check their withholding on their unemployment compensation. To avoid a large amount due on their taxes, have them withhold income taxes just like they would from their regular wages. They will need to fill out Form W-4V, Voluntary Withholding. The maximum amount they can withhold is 10%.  

Specific benefits that you can help them fill out Form W-4V for include: 

  • Benefits paid by a state from the Federal Unemployment Trust Fund  
  • Railroad unemployment compensation   
  • Disability benefits paid instead of unemployment  
  • Trade allowances made by the Trade Act of 1974  
  • Unemployment that falls under the Disaster Relief and Emergency Assistance Act of 1974 
  • Unemployment that falls under the Airline Deregulation Act of 1978 Program