Unemployment Benefits – Taxable or Not?

Ordinarily, unemployment compensation is taxable and must be reported on your federal income tax return, including the additional unemployment compensation authorized under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act that was passed on March 27, 2000. Another concern is that many states also tax unemployment compensation. If you are one of the fortunate ones that lives in a state where there is no state income tax, then this will not apply. Additionally, there are a few states, however, where unemployment benefits are tax-exempt – California, Montana, New Jersey, Pennsylvania and Virginia. New York residents, unfortunately, are subject to state income taxes on unemployment compensation.

That was the bad news -- it is now time for some good news.  On March 11, 2021, President Biden signed into law the American Rescue Plan Act (“ARPA”). There are many provisions in this bill that are aimed at assisting taxpayers with reduced adjusted gross income (‘AGI”) levels, one of which provides a new exclusion of up to $10,200 of unemployment compensation for certain taxpayers.

For what years does this apply?

This applies retroactively to tax year 2020 only. As of now, this does not apply to unemployment compensation received in 2021.

How does it work?

Taxpayers whose modified AGI is less than $150,000 will be able to exclude $10,200 of unemployment compensation received in 2020.

Married filing joint taxpayers who both earned unemployment compensation and meet the modified AGI threshold would EACH be eligible to exclude $10,200.

The IRS has provided a worksheet where you can calculate this exclusion amount.

The amount of unemployment compensation paid to you is generally reported on Form 1099-G. However, there are instances where you might not receive the form or the amount is incorrect. In these situations, it is important to include the actual amount of unemployment compensation paid to you in 2020.

What if I already filed my 2020 taxes?

If you have not yet filed your 2020 taxes, use the worksheet from the link above to calculate the correct taxable unemployment compensation and include it on Form 1040, Schedule 1, line 7. If you paper file your tax return, you will be able to manually enter the correct taxable unemployment compensation based on the worksheet. However, for the many that use online tax programs, the IRS is working with the industry to update current tax software to assist the taxpayer in determining how to report the correct unemployment compensation on their 2020 tax returns.

Many taxpayers have already filed their 2020 tax returns and included all of their unemployment compensation as taxable income and are now eager to recover the taxes already paid on the $10,200 of unemployment compensation.

The IRS issued a statement on Friday, March 12, 2021, that included the line “For those who received unemployment benefits last year and have already filed their 2020 tax return, the IRS emphasizes they should not file an amended return at this time, until the IRS issues additional guidance.”

Having the IRS proactively issue refunds to taxpayers who would have been eligible for this exclusion is one suggestion that is being tossed around.

More good news for some: By excluding the $10,200 of unemployment compensation, your AGI will also be lower due to this exclusion, which may permit you to claim many of the other tax benefits such as the earned income credit, child tax credit, the tuition credits offered or student loan interest deduction.