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How Unemployment Benefits Can Affect Your Federal and State Income Tax Return
Tax season can be stressful for many Americans, especially those who have struggled to make ends meet or find consistent work throughout the COVID-19 pandemic.
While Unemployment Insurance (UI) aided millions of Americans throughout the pandemic, it’s important to understand that unemployment benefits are a form of taxable income at the federal level. However, these tax amounts aren’t always cut and dry.
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It may be helpful to take a closer look at how unemployment benefits could impact your tax liability. Continue reading to learn more about this relationship, including how to pay federal taxes on unemployment benefits and what you can do if you can’t afford to pay.
What Are Unemployment Insurance Benefits?
Unemployment Insurance (UI) benefits provide monetary assistance to qualifying workers who have lost their jobs through no fault of their own. Employers are the main contributor to these benefit payments.
Typically, a worker may be able to receive unemployment compensation based on the following factors:
- The reason for unemployment – It must be through no fault of your own, such as being laid off or let go. If you were fired for misconduct or another reason, you typically won’t qualify for UI.
- The amount of time they worked for their employer(s) – States have different employment length requirements that you must usually meet before receiving UI benefits.
- The amount they earned while working – If you qualify for UI payments, your benefit amount is typically a percentage of what you were previously earning.
Every state has an unemployment insurance program, and specific rules can vary between states. For example, the maximum amount of money you can receive every week through UI payments can range from less than $200 to over $750 depending on where you live.
The Federal Tax Impact of Unemployment Benefits
Unemployment benefits are considered a form of taxable income. As a result, these benefits are generally taxed in the same way that income from employment is taxed, and benefit amounts must be reported on your tax return.
American Rescue Plan
The American Rescue Plan was signed into law in 2021 to help combat the financial hardship that many Americans faced during the COVID-19 pandemic.
Under the American Rescue Plan, workers who received unemployment benefits had reduced taxes for their UI compensation. Up to the first $10,200 of unemployment benefits were waived on federal income taxes for the 2020 tax year.
That being said, several states chose not to apply leniency on state unemployment benefit taxes:
- Colorado
- Georgia
- Hawaii
- Idaho
- Kentucky
- Massachusetts
- Minnesota
- North Carolina
- New York
- Rhode Island
- South Carolina
- West Virginia
The federal tax break for UI benefits expired following the 2020 tax year. As a result, unemployment benefit recipients are expected to pay the full federal income tax amount for future taxes, including the 2021 tax year.
The State Tax impact of Unemployment Benefits
While unemployment benefits are considered taxable income for federal taxes, the same cannot be said about all state taxes. There are currently nine states that do not levy income taxes, including on unemployment benefits. These states include:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
Residents living in these states are only expected to pay unemployment taxes as part of federal income tax, not state income tax.
However, there are four more states that do not tax unemployment benefits, even though they do impose income taxes. Those four states are:
- California
- New Jersey
- Pennsylvania
- Virginia
If you live in one of these states, you are not expected to pay state taxes for unemployment insurance benefits when you file your tax return.
Additionally, two states – Indiana and Wisconsin – only tax a portion of the unemployment benefits you receive.
How to Pay Taxes on Unemployment Benefits
There are several ways you can pay your unemployment benefits taxes.
Tax Withholdings on Unemployment Benefits
State unemployment insurance agencies provide unemployment benefit recipients with the choice to withhold state and federal taxes from their unemployment checks. If you can afford a 10% flat rate from each of your unemployment checks, this might be the easiest option.
With this option, taxes are automatically withheld, similar to when you’re working for an employer. You can choose this option when you first apply for unemployment insurance benefits, or you can change it later by contacting your state agency.
Making Quarterly Estimated Tax Payments
If you need your full benefit amount to cover your monthly expenses, you can choose to pay a portion of your unemployment insurance benefit taxes each quarter. Doing so can help you avoid a large bill come tax season. Unlike automatic withholdings, you’ll need to actively choose to make these payments every three months.
Paying Your Unemployment Benefits Taxes in Full at Tax Season
Your last option for paying taxes on your unemployment benefits is to pay your taxes in full when you file your tax return. However, you may be charged a penalty for failing to pay enough taxes throughout the tax year.
In some cases, the IRS may waive this penalty. You may be eligible for a waiver if you:
- Did not pay quarterly taxes due to a disaster, casualty, or other unusual event, or
- You retired after turning 62 or became disabled during the tax year or the previous tax year, and the failure to pay taxes was due to a reasonable cause.
You can request a waiver for the penalty by completing IRS Form 2210. That being said, you’ll usually still be responsible for taxes on your unemployment benefits, even if the penalty for failing to pay sooner is waived.
The Unemployment Benefit Tax Form
Most states provide you with Form 1099-G if you received unemployment benefits during a tax year. This form is typically mailed to you by your state’s unemployment insurance office. If you do not receive your form, contact your state office or access your form online.
The following states do not mail Form 1099-G:
- Connecticut
- Indiana
- Missouri
- New Jersey
- New York
- Wisconsin
States that allow you to opt to receive your 1099-G electronically include:
- Florida
- Illinois
- Michigan
- North Carolina
- Rhode Island
- Tennessee
- Utah
Similar to other tax documents, such as W2s, you’ll need to input information from your 1099-G onto your income tax return.
What if You Can’t Afford the Taxes Owed on Unemployment?
Despite their best efforts, some Americans cannot afford to pay their unemployment taxes. If you are in a similar situation, it’s still important to file an income tax return by the deadline or request an extension.
If you are unable to pay your owed taxes in full, it may be helpful to pay as much as possible to avoid some of the interest that will accrue. Additionally, you can request a payment plan from the IRS to pay your owed taxes in installments. You can request an installment agreement online by completing Form 9565 or by contacting the IRS directly for assistance.
