The 2020 tax season is officially underway, and the millions of Americans who received unemployment insurance last year due to the coronavirus pandemic may be in for a surprise.
This unemployment income is taxable, and if you had no money set aside or withheld for these taxes, it could reduce your repayment or even generate an account.
This may be particularly unexpected for independent and self-employed contractors who are not normally entitled to state benefits, but may have received Pandemic Unemployment Assistance under the CARES Act.
“This year, many people will have unemployment insurance and will not normally receive unemployment insurance benefits,” said Elaine Maag, associate principal researcher at Urban-Brookings Tax Policy Center. “So it will be something new that they will have to pay attention to.”
Differences in state and federal treatment
If you had any unemployment income in the past year, it is subject to tax and needs to be reported in your 2020 income tax return. In January, anyone who had unemployment income should have received a 1099-G form that specifies the amount of money paid during the year.
Federal income tax applies to these benefits – be it state unemployment insurance or unemployment pandemic compensation paid under the CARES Act.
The problem is that withholding the appropriate amount of income tax is voluntary. You can choose to retain only 10% of your benefits to cover your tax obligations.
To do this, you would have to complete Form W-V4 with the state agency that manages your unemployment.
You can also choose to make estimated tax payments quarterly to the IRS.
Uncle Sam is not the only entity seeking a share of his unemployment income. Most states will also tax these benefits.
Some States – Alabama, California, Montana, New Jersey, Pennsylvania and Virginia – do not tax these payments. Indiana and Wisconsin offer a partial exclusion from unemployment income, according to Andy Phillips, director of the Tax Institute at H&R Block.
“Some states have withholding tax and others require it to ease surprises when tax time comes,” said Jared Walczak, vice president for state projects at the Tax Foundation.
Although it is too late to avoid the taxes that you may owe for 2020, individuals who complete their returns in advance can at least plan to pay the amount due by April 15 – the due date for tax returns and due obligations.
“You don’t have to make a payment until April 15, but it is better to know in late January or early February that you will have to present the dollar amount by then,” said Phillips of the Tax Institute at H&R Block.
Unemployment and tax credits
Families who received income from unemployment in 2020 must also be looking for two main credits when making their taxes: the income tax credit and the child tax credit.
Both credits add up to significant dollars – the income tax credit is worth up to $ 6,600 for a low-income family with three or more qualified children. And the refundable portion of the child tax credit is worth up to $ 1,400 per eligible child.
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The footprint? Although unemployment benefits are taxable, they are not considered income from work.
Under normal circumstances, receiving unemployment would result in a reduction in both credits when you file your income tax return.
Lawmakers solved this problem in Covid’s year-end relief law. This year, when declaring your 2020 taxes, you will have the option of using your 2019 income to calculate credit eligibility.
“If you went from being a wage earner to applying for unemployment, you could be affected,” said Phillips. “Using your 2019 revenue just to calculate the amount of credits can be a big benefit for taxpayers.”