The information in this article was last updated on May 14, 2021. This article relates to the tax laws enacted during the COVID-19 pandemic. These laws may have expired or reverted to their original state. For the most recent updates on unemployment benefits, see Unemployment Compensation from the IRS.
Many of America’s taxpayers received unemployment compensation for the first time in 2020 due to COVID-19. This article explains how unemployment benefits are taxed in general, and includes information about the Unemployment Exclusion for 2020 tax returns.
Is my client’s unemployment compensation taxable?
Yes, unemployment income is taxed at the federal level and probably at the state level if your client’s 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 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.
What is the unemployment exclusion for tax year 2020?
The American Rescue Plan states that the first $10,200 of unemployment income received in 2020 for those who make less than $150,000 per year is not taxable on 2020 returns. If your client is married, each spouse is eligible for this exclusion, for a combined total of $20,400. If your client’s AGI is $150,000 or more, they are not eligible for this exclusion.
How do I take this exclusion in TaxSlayer Pro?
The exclusion is located on Schedule 1 (Form 1040), line 8 for tax year 2020. TaxSlayer Pro automatically calculates the exclusion based on the AGI entered.
For a detailed look at how this exclusion is handled in the software, read our support article: 2020 Unemployment Compensation Exclusion.
What if my client has already filed and did not take the exclusion?
If you have already filed a return for your client, the IRS will refigure their taxes beginning this spring. There is most likely no need to file an amended return for your clients who need to take the exclusion. If your client overpaid on their taxes, they will either receive an additional refund or the amount will be applied to what they owed. The IRS will send any additional refund directly to your clients. They have begun correcting returns and the first payments should be sent out this weekend.
The IRS will complete these recalculations in two phases. First, they will work on single and married taxpayers who qualified for the $10,200 exclusion. Then they will work on returns for taxpayers who filed married filing jointly and who are eligible for the $20,400 exclusion.
For more information, read this IRS press release.
What if the new exclusion qualifies my client for an additional tax credit?
If your client qualifies for an additional tax credit due to the exclusion, you will need to file an amendment for them. If your client already claimed the credit but needs to adjust the amount based on the exclusion, the IRS will calculate this. But if your client did not claim the credit or deduction and now qualifies, they must file an amendment to claim the tax break.
How did 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 continued the additional federal benefits but at a lower $300 per week.
It also extended unemployment eligibility and the The Pandemic Unemployment Assistance program, so many who would have lost their benefits once the original extension expired were able to collect payments for an additional 11 weeks.
Unemployment benefits received under the second stimulus package are 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 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%.
By completing Form W-4V, your clients may become eligible for these special benefits:
- 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
