If you received unemployment benefits in 2020, you just got a tax break thanks to the US $ 1.9 trillion relief plan that President Joe Biden signed on Friday. This is how the latest tax relief bill could affect your taxes.
How the relief bill will affect your taxes when you are unemployed
Let’s step back: is unemployment taxable? Unfortunately, the answer is yes – and it can seem like Uncle Sam is kicking you while you’re downstairs.
The American relief plan offers a small amount of relief: the first US $ 10,200 unemployment benefits will be shielded from taxes in 2020 for households with an income below US $ 150,000.
The IRS has not yet issued guidelines for anyone who received benefits in 2020 but has already filed a tax return. In this situation, you will likely need to file an amended tax return to adjust your debt.
Note that this exemption only applies to 2020 taxes. If you are still unemployed, you should still expect to pay tax on the full amount when you file your 2021 return next year.
How are unemployment benefits taxed?
Many people are surprised to learn that they have to pay taxes on their unemployment benefits. A Jackson Hewitt survey found that 39% of adults did not know that unemployment was taxable. Here’s a breakdown of how taxes on unemployment benefits work.
Federal income taxes
If you receive unemployment benefits, these are taxed as ordinary income at the federal level.
That is, if in a typical year you made $ 15,000 from unemployment, it would be taxed in the same income tax brackets as if you had made $ 15,000 from a job. But you wouldn’t owe any wage taxes, i.e. Social Security and Medicare taxes, on your benefits.
Because the new relief bill exempts the first $ 10,200 from tax, you would only be taxed at $ 4,800 if you received the same $ 15,000 in unemployment benefits in 2020.
Unemployment benefit can affect your tax bill in other ways. Up to two-thirds of the people who got the $ 600 weekly CARES Act supplements that ended in July made more money than what they did for work. If your income was higher than normal in 2020 because of your unemployment benefit, you may no longer be eligible for tax credits such as the Earned Income Tax Credit.
State income taxes
At the state level it looks a little different. If your state is one of the nine states that don’t have income taxes, it’s simple: you won’t owe any state taxes on your unemployment. Of the remaining 41 states, the following five exempt unemployment from taxes:
- New Jersey
Some others partially tax unemployment, but in most states your unemployment is fully taxable.
How do I pay taxes on my unemployment?
There are two basic ways to pay federal taxes on your unemployment. Since the US has a pay-as-you-go tax system, there is no “pay for everything” answer – although the ramifications for this, as we are about to discuss, are not too harsh.
Automatic hold back
This is how it works when you are employed and your employer automatically takes part of your check out for tax. You can choose to have 10% of your benefits withheld automatically, but you do not have the choice of having more or less withheld.
The first time you are applying for benefits, you have the option to complete the IRS Voluntary Withholding Form W-4V. If you are already receiving benefits, you can still submit Form W-4V to your state office to change your withholding tax.
Estimated quarterly payments
According to the IRS, if you believe you owe at least $ 1,000 in taxes from all of your sources of income and have not received at least 90% of the debt withheld for the year, make estimated quarterly payments. Alternatively, it is clear if you withheld 100% of the previous year’s tax charge if your Adjusted Gross Income is less than $ 150,000, or 110% if your AGI is above $ 150,000.
What if I haven’t withheld any taxes?
Don’t panic if you didn’t withhold taxes on your unemployment benefits.
Many people are in this situation. Either they weren’t withheld taxes because they needed their entire check to survive, or they just didn’t know they had to pay taxes on their services.
If you are still receiving benefits and withholding 10% would not jeopardize your solvency for your basic needs, we recommend that you submit the W4-V form to your state employment office as soon as possible.
Worst scenario: you owe money on April 15th and can’t afford the bill.
While the IRS has a reputation for making adults cry, owing money at tax time isn’t as terrible as it sounds, as long as you file a tax return on time. (You may have more time to file your tax return if you apply for an extension, but the tax bill is still due April 15th.)
In most situations, you can automatically get approval for a payment plan that costs you only 0.5% interest per month, up to 25% of your total bill. If you can afford to pay the entire bill within 120 days, there are no additional charges. Otherwise, you’ll pay $ 31 to set up an online direct deposit payment plan or $ 107 to set it up by phone, email, or in person.
Of course, the IRS will encourage you to pay as much as you can afford, but you can choose a monthly payment that is as low as the total amount you owe divided by 72.
Apart from the fees, 0.5% per month corresponds to 6% per year. By comparison, the average credit card interest rate is over 17%, which makes the IRS look like a pretty generous creditor. For this reason, if you can’t afford a tax bill, instead of taking it off a credit card, we recommend creating a payment plan.
You can also qualify for specific tax credits that offset the amount you owe.
Just make sure to file a tax return next year even if you can’t afford to pay. Failure to file a fine is quite high at 5% per month up to 25% of your tax bill.
Conclusion: you pay taxes on your unemployment benefit. Pay them up either automatically or quarterly if you can. But know that if you owe taxes on your services the next year, it will not end the world for your finances.
Robin Hartill is a certified financial planner and senior writer at The Penny Hoarder. She writes the Dear Penny personal finance advisory column. Send your tricky money questions to [email protected]