Unemployment benefits and tax impacts

Published on Mar 14, 2022

Unemployment benefits and tax impacts

In 2020, one of the most complicated aspects of tax filing was unemployment benefits. Usually taxable, Congress changed the rules temporarily after millions lost their jobs due to the coronavirus outbreak and filed for unemployment.

On March 11, 2021, the American Rescue Plan Act of 2021 (ARPA) was signed into law. It excluded up to $10,200 in unemployment benefits from 2020 taxes – after many people had filed their returns.

This tax year, 2021, won’t have the same break. Unemployment benefits are fully taxable once again.

What qualifies as unemployment benefits?

“Unemployment benefits” can cover a lot of ground. They are funds paid to you through the unemployment insurance fund through your state, but they are also funds received through railroad unemployment compensation benefits. They also include payments made to you by the federal Unemployment Trust Fund and federal Pandemic Unemployment Compensation.

How unemployment benefits are taxed

Any unemployment benefits received in 2021 will be taxed as ordinary income (think wages or salaries). They are not, however, subject to Social Security and Medicare taxes.

Since unemployment benefits are paid out by the state, you should receive Form 1099-G from the state unemployment division of the local department of labor. The form, which would have been sent out in January, will show the total unemployment compensation you earned last year. If you had any money withheld from your benefits, that will show, too. (If you didn’t receive your 1099-G, you still need to report the total amount received on your return.)

Not all states tax unemployment benefits. States that do not tax unemployment benefits are:

Arkansas and Delaware will continue their exemptions for 2021 unemployment benefits but will return to taxing them for 2022.

Indiana and Wisconsin tax unemployment benefits, but the tax may be partially deductible.

For 2020 and 2021 only, Maryland will not tax unemployment compensation for those with a federal adjusted gross income of $75,000 or less for single filers, $100,000 or less for married couples, and head-of-household filers.

Montana does not currently tax unemployment compensation but will begin to do so in 2024.

Oregon doesn’t tax unemployment benefits only for benefits received from work performed on federally recognized Indian reservations.

Options for paying taxes on unemployment benefits

Just like you would for your regular income, when you file for unemployment, you have the option to have taxes withheld from your payments so there’s no surprise at tax time. If you didn’t ask when you signed up, the IRS has Form W-4V, Voluntary Withholding, which you can file with your state unemployment office. You can request up to 10 percent of each payment be withheld.

Other options include paying quarterly estimated taxes, or you could have additional money withheld from your paychecks once you return to work.

If you owe tax that you can’t pay

It’s difficult to save money for taxes when you’re on unemployment. When it comes time to file, you may find you don’t have enough money to pay your bill. Don’t worry, there are some options.

You can apply for a short- or long-term installment agreement with the IRS. These payments can be stretched out over a period of up to 72 months (6 years). All you need to do is file Form 9465 with the IRS.

Another option is to ask the IRS to waive any underpayment penalties assessed against you if you believe it would be inequitable to require you to pay the penalty.

You might also qualify for a waiver if you became disabled during the year you collected unemployment, or you retired during that year and were at least 62 years old.

For more information on how unemployment benefits affect your tax filing for 2021, visit the IRS newsroom website. For state-specific information, contact your state’s department of revenue.