For many, it’s the first time they’ve been out of work, and they’re not familiar with how unemployment benefits are taxed.
So here’s a quick refresher course on how that benefit lifeline may impact your bottom line.
Will I owe tax on the benefits I receive?
As odd as it sounds, yes, you may be taxed on the unemployment benefits you receive.
Unemployment benefits replace your wages and count as taxable income on your federal tax return, just like the wages, salary or bonuses you were paid while working. That means they’re subject to federal income tax. The main difference is you won’t pay Social Security, Medicare or other payroll taxes on your benefits.
How about paying state income tax?
In Florida, where our firm is located, there is no state income tax, so you’re in the clear. But your state may have different rules.
In most states – like Maryland, for example – your benefits are fully taxable, just like any other workplace salary or bonus. Other states exclude some or all of your unemployment benefits from state income tax. For example, California and New Jersey give you a free pass on unemployment benefits.
Tip: For a handy guide to tax rules state-by-state, check out this recently updated tax summary from Kiplinger’s.
How do I know how much income to report?
Next year, you’ll receive information telling you what benefits you received in 2020, and what to report on your 2020 tax return that’s due April 2021.
“Early in 2021, recipients will receive a Form 1099-G reporting unemployment compensation to them and to the IRS,” writes financial journalist Laura Saunders in the Wall Street Journal.
What if I don’t want to owe taxes next April?
If you’re worried about getting a bad tax surprise next April, there are steps you can take now. For example, you can decide to withhold taxes from your unemployment benefits, just like you would on your regular paycheck.
You can request that 10% of each payment be withheld from your unemployment benefits for federal income taxes by filing IRS Form W-4V – Voluntary Withholding with your state unemployment office, says Kimberly Lankford, contributor to U.S. News and World Report.
Tip: Keep in mind that if you’re out of work for several months in 2020, and your income is lower than normal, you may not owe much tax, even if unemployment benefits are included in the total. Check with your tax preparer for a more accurate estimate of your 2020 tax obligations.