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Congress may soon offer a tax break for unemployed Americans. States may not be so generous.
The Senate passed a $ 1.9 trillion Covid relief bill on Saturday, which exempts tax on up to $ 10,200 in unemployment benefits per person received in 2020.
President Joe Biden is expected to sign the legislation this week after it passed the Democratic-led House of Representatives.
But the tax policy, which applies to families earning less than $ 150,000, is just a reduction in workers’ federal income taxes.
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More than half of the states levy income tax on unemployment insurance. If Congress waives the federal income tax, states must decide whether to offer the discount as well.
Some may still choose to tax unemployment benefits, experts say.
For example, say a worker received $ 10,000 in benefits last year. That person would still pay a $ 500 tax bill in the states with a 5% income tax (if we assume a flat tax rate).
“It’s complex,” said Jared Walczak, vice president for state projects at the Tax Foundation. “Even many state officials are probably uncertain about what will happen next.”
State taxes
Federal policy aims to avoid a surprise tax collection for the unemployed.
About 40 million people received unemployment benefits last year, and the average person received $ 14,000 in aid, according to a report by The Century Foundation.
However, less than half of the recipients had taxes withheld, the report said. In some cases, states do not offer this option.
But the relief bill now changes the rules in the middle of the tax season, which began on February 12 and ends on April 15.
This created confusion for taxpayers, accountants and legislators.
Thirty-five states and the District of Columbia typically tax unemployment benefits as income, according to Walczak.
Three states – Maryland, Arkansas and Delaware – generally do, but waived tax on benefits received in 2020.
The other states do not tax unemployment insurance – because they do not charge income tax or exempt unemployment insurance.
State lawmakers must decide how to proceed, and their decision is urgent. Many laid-off workers may be waiting to complete their taxes until there is more clarity.
There is a precedent policy for exemption from taxes on income from unemployment. In 2009, during the Great Recession, Congress exempted the first $ 2,400 from unemployment benefits from the tax, and many states followed suit, said Walczak.
However, this rule change did not occur during the tax season, he said.
‘Difficult’
Many state legislatures may find it difficult to adopt the change, as they have already incorporated tax revenues into budget estimates for the current fiscal year, said Verenda Smith, deputy director of the Federation of Tax Administrators, who works with state tax officials.
States may have to pull money from other areas of the budget, such as education, to compensate, she said.
“It is not easy to agree with that,” said Smith. “It is a difficult and difficult budget decision for them to make.”
However, it would not be surprising if many states adopted federal tax policy, given the level of financial suffering among Americans, she added.
More than 18 million people are still receiving unemployment insurance, according to data from the Department of Labor.
“In something like that, it pulls on people’s hearts,” said Smith. “It would be very difficult for an elected official to vote against something like that.
“This is just political reality,” she added.
Changed tax declarations and extensions
It is likely that taxpayers who received unemployment insurance last year and have already filed their tax returns will have to file an amended tax return in the future.
But they must wait to do so until the American Rescue Plan becomes law and there is more clarity from the IRS, the Treasury Department and their respective states, experts said.
The IRS allows up to three years after the original filing date to submit a corrected statement and request a refund.
Workers who have not yet filed a return request should consider the possibility of requesting an extension, according to experts.
This does not exempt them from paying taxes until the April 15 deadline. They must estimate and pay any tax due to avoid penalties.
But it allows more time to see what state and federal lawmakers decide to do.
If the unemployment tax exemption becomes law, those applying for an extension can omit unemployment benefits (up to $ 10,200) from their income when estimating their federal tax obligations for 2020, according to Walczak.
But in states that collect unemployment income taxes and have yet to offer guidance on new federal rules, workers should not deduct benefits when estimating state tax if they want to be conservative, he added.