Do You Pay Taxes on Unemployment Benefits?

Approved unemployment benefit claim paperworkWith unemployment claims on the rise, many Americans have found themselves receiving their very first unemployment checks. Having never received this kind of income before, you may find yourself uncertain about how taxes on this income are handled. Is this income taxed? And if so, how are you expected to pay those taxes? It’s important that you understand what your tax obligations are in regards to your unemployment benefits. Keep reading to learn more about this.

Taxes on CARES Unemployment Income

In the wake of COVID-19 and its devastating toll on the economy, the federal government implemented the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. This act included the distribution of relief checks of $1,200 to every American, as well as $500 for each dependent child. Though there was some initial confusion on this matter, it was made clear eventually that this income was not taxed.

However, the CARES Act also instituted a new, specialized form of unemployment income for COVID-related job loss—and this income is taxed. Please do not confuse the untaxed relief checks with your taxable unemployment income. If you are receiving unemployment through the CARES Act, you will have to pay taxes on it.

Other Types of Unemployment Income

There are actually several types of unemployment income paid to American citizens. The most common type of income is unemployment compensation paid by the state or from the Federal Unemployment Trust Fund. However, unemployment can also be paid through railroad unemployment compensation, the Airline Deregulation Act, the Disaster Relief and Emergency Assistance Act, and more.

It’s important that you know what type of unemployment income you’re receiving. Not only will knowing this help you to know if your income is taxable, but it will also help you to identify which agency is paying out your benefits; this is important information for paying taxes on this income.

What Percentage of Unemployment Is Taxable?

Unlike with Social Security Income, which may only have a percentage of that income subject to tax, all of your unemployment income is considered taxable income. Your unemployment benefits will be taxed at your standard tax rate based on your adjusted gross income for the year.

How Are Taxes Paid on Unemployment Income?

Unlike with W-2 income, which have taxes and other withholdings already taken out of your checks, unemployment income is not taxed upfront. This means that, unless you take the proper steps to pay your taxes on this income as you receive it, you’ll owe a large lump sum of unpaid taxes for your unemployment income when you file your return. To avoid this, you’ll need to either make quarterly estimated tax payments or opt for automatic withholdings.

Making Quarterly Tax Payments

Estimated quarterly tax payments are a familiar process for those who own a business or are otherwise self-employed. This process is used for paying taxes on otherwise untaxed income throughout the year. Not only does this help you avoid owing an excessively large amount in taxes when you file, but it also helps you avoid additional fines for unpaid taxes.

To make quarterly tax payments, you’ll need to estimate the total you’ll owe in taxes based on your income throughout the year, then submit a payment each quarter to the IRS. This must be done by each quarter’s deadline. The due dates for the third and fourth quarters are September 15, 2020, and January 15, 2021.

Opting for Automatic Withholdings

Your W-2 income automatically has some tax withheld, but you’re able to adjust those withholdings at any time. Similarly, you can adjust the automatic “zero” withholding on your unemployment income by filling out and submitting Form W-4V to whichever agency is paying your benefits (this is where knowing that information comes in handy). Sending in this form will cause a flat 10% withholding to be applied to your unemployment checks.

Some agencies will have their own withholding forms, so be sure to ask before you fill out Form W-4V. And remember, these forms must be sent to the agency that is sending you your unemployment checks. Do not submit them to the IRS.

Reporting Unemployment Income

As with any income, your unemployment income must be reported when you file your tax return. For this type of income, you’ll receive tax Form 1099-G, which will show you the amount you received in unemployment benefits, as well as the amount of tax already withheld from that income. Report both amounts on your taxes when filing your return.

If you need assistance filing your tax return, submitting estimated tax payments, or opting for withholdings from your unemployment income, please feel free to reach out to one of our tax accountants today.