While many people are finally beginning to receive unemployment benefits it is important to consider the tax consequences of those benefits so there are no surprises at tax time. As you receive your unemployment funds you should note that they are taxable income for federal purposes as well as for most states. Although everyone’s situation is different, you don’t we want to be surprised to find out you owe taxes on the benefits you received.
The following article by Kimberly Lankford, in the U.S. News and World Report does an excellent job of explaining these consequenes. It’s important to note that you do have the option of having federal taxes withheld.
How are unemployment benefits taxed?
MORE THAN 22 MILLION Americans have filed for unemployment benefits in the past four weeks. They may be eager to get the money, but they may not be thinking about how the benefits are taxed.
The federal government taxes unemployment benefits as ordinary income (like wages), but you don’t have to pay Social Security and Medicare taxes on this income, says Oscar Vives Ortiz, a certified public accountant and member of the American Institute of CPAs Personal Financial Specialist Committee.
Most states tax unemployment benefits, too, although there are a few exceptions. A few states that have a state income tax do not tax unemployment benefits, such as California, Montana, New Jersey, Pennsylvania and Virginia. A portion of unemployment benefits can be taxable in Wisconsin, based on a complicated formula.
You’ll receive a Form 1099-G from your state unemployment division next January reporting the total unemployment compensation you received for 2020 (and whether or not you had any state or federal tax withheld from your payments), which you’ll report on Schedule 1 of your 1040 when you file your federal income taxes.
Tax Withholding Strategies
You can avoid a surprise bill at tax time if you choose to have income taxes withheld from your unemployment benefits, like you would from your salary. You can ask to have taxes withheld from your payments when you apply for benefits, or you can file IRS Form W-4V, Voluntary Withholding with your state unemployment office. You can only request that 10% of each payment be withheld from your unemployment benefits for federal income taxes.
But you may decide not to have taxes withheld if you need to stretch your benefits as much as possible now. “If you are strapped for cash and need every dollar for living expenses, I would take out minimal taxes now and deal with the shortage at tax time,” says Morris Armstrong, an enrolled agent in Cheshire, Connecticut. You may also have to pay a penalty because you didn’t pay taxes throughout the year. “If your stint is short-lived, or you expect it to be, and you do have a nest egg, then I would recommend that you withhold adequately.”
You may have some other options. Instead of having income taxes withheld from your benefits, you could pay estimated taxes each quarter, which adds more flexibility. Of you could have more money withheld from your paychecks if you return to work later in the year, says Ortiz.
Also keep in mind that if you end up earning more income this year, you may fall into a higher marginal tax bracket and the 10% withholding may not be enough, says Ortiz. “Revisit this throughout the year,” he says. “Again, this can be done through paycheck withholdings once you are back to work. You can also consider making estimated quarterly payments throughout the year.”
Taxes and Stimulus Payments
The tax situation is different for the $1,200 stimulus payments that people are receiving now – those payments are not taxable. “The stimulus payments that are being received are considered a refundable income tax credit, so this is not income that will be taxed at the end of the year,” says Ortiz.
To view the cull article by Kimberly Lankford please click here.