Do You Pay Taxes on Unemployment?

The answer is probably yes. Ouch.

Yes, it's true. You still have to pay taxes on unemployment. Though it doesn't make much sense, you need to understand more about unemployment taxes so you don't undergo shock when you file your tax return.

Unemployment benefits were designed to provide enough income to help the unemployed person to make the transition from one job to another. The unemployment checks can provide a welcome relief from the financial strain of losing a job.

FEDERAL TAXES ON UNEMPLOYMENT

When every cent of the unemployment check has been used for basic living needs, it can come as quite a shock to learn that yes, you must pay taxes on unemployment benefits. For Federal income tax purposes, most unemployment compensation is considered ordinary income.

If your unemployment benefits are paid through your regular state unemployment channels, then the benefits are taxable. You will receive a yearly Form 1099-G that reports the paid benefits. You will calculate the taxes on the unemployment compensation by reporting the amount from 1099-G on Form 1040 (line 19) or Form 1040A (line 13) or 1040EZ (line 3).

In a few, much less common cases, the unemployment will actually be a benefit paid through a fund directly from your union or your prior employer. In most of these cases, the benefit is still taxable income, but will generally be reported as supplemental wage income on a yearly Form W-2. It will therefore be reported as regular wage income on your tax return.

In other even less frequent cases, you may have paid your own money into a government, employer, or other fund which has benefits payable during times of unemployment. In these cases, the benefits are not taxable until you receive more in benefits than you paid into the fund.

In general, however, you should expect that you will pay Federal income taxes on your unemployment benefits. Regular benefits are not subject to Social Security or Medicare taxes. You may elect to have Federal income taxes withheld from the weekly check, or you may elect to make quarterly estimated payments. If you choose to wait until you file your tax return to pay any taxes due on your unemployment benefits, then you may also owe penalty and interest on the balance due.

LEGISLATION (EXPIRED NOW) AFFECTED 2009 TAXES ON UNEMPLOYMENT BENEFITS

The American Recovery and Reinvestment Act of 2009 provided that the first $2400.00 of unemployment benefits was not taxable on your Federal tax return. Amounts received above $2400.00 are still taxable. This was in effect for 2009 only. Benefits received in 2010 and later are taxed on the Federal return at the full amount received.

Note that if you did not take the $2400.00 deduction from your 2009 taxable unemployment benefits and the IRS did not adjust this for you, that you still have time to file an amended 2009 tax return to claim the deduction.

CALCULATING TAXES ON YOUR UNEMPLOYMENT BENEFITS

For most unemployment benefits, figuring the Federal taxes on unemployment benefits is not a separate calculation. The tax will be determined as part of the entire tax return and the exact amount therefore will not be known until the tax return for the year is prepared. A good rule of thumb, however, is to estimate your total taxable income for the year and then determine your tax bracket for the year. This can be used as an estimate for how much to have withheld or to set aside for estimated payments.

For example, assume that this year you will have taxable wage income of $20,000.00, interest income of $100.00 and total unemployment benefits of $9,500.00. You are single with no dependents and you do not itemize deductions. Your total income is therefore $29,600.00. Subtract $5700.00 as a standard deduction and $3650.00 as your personal exemption. (Note these are 2010 amounts; the 2011 amounts will be slightly higher) The estimated taxable income is therefore $20250.00. Using the IRS charts, you find that this amount falls in a 15% tax bracket. You can therefore estimate that your rate of tax on the unemployment benefits is 15% of the benefit. For every $100.00 in benefits, you should have $15.00 withheld or set aside for Federal taxes.

STATE TAXES ON UNEMPLOYMENT

The majority of states that have income taxes will follow the Federal rules for taxing unemployment benefits. Therefore, in 2011 most statest tax your unemployment benefits. Some states do not have a tax on unemployment benefits. Others have special calculations. Once you determine whether your state has a tax on unemployment benefits and how it is calculated, then you can use a similar procedure as the one above to estimate your state taxes on the unemployment benefits.

TAX ADJUSTMENT FOR REPAID UNEMPLOYMENT BENEFITS

If you repaid unemployment benefits in the same year as you received them, then the amount repaid is subtracted from the amount paid and the net is reported on your tax return. It gets a little trickier if you repaid benefits in a later year for benefits received in a prior year. In this case, the procedure is to subtract the repaid benefits as an itemized deduction on your Schedule A. (Yes, that does sound unfair.) If you have repaid benefits from a prior year, it is strongly advised that you seek advice from a tax professional for determining how to report this.

Patricia Tokar, CPA - call us or contact us for financial consulting, individual tax return preparation, small business tax help, small business tax preparation, QuickBooks assistance, and small business tax advice

Legal and IRS required notice:

This article is not intended to be specific tax advice. It is intended as a general guideline only. Any specific advice should be sought from your tax professional.

CIRCULAR 230 DISCLOSURE: Pursuant to Treasury Department guidelines, any federal tax information contained in this article, or any attachment, does not constitute a formal tax opinion. Accordingly, any federal tax advice contained in this communication, or any attachment, is not intended or written to be used, and cannot be used, by you or any other recipient for the purpose of avoiding penalties

Certified Public Accountant

Useful Resources

IRS Topic 418 - Unemployment Compensation

This is a link to the IRS.gov site

Publication 525 - Taxable and Nontaxable Income