Unemployment benefits are designed to replace a portion of your lost wages during a period of unemployment. As such, the Internal Revenue Service (IRS) considers unemployment benefits as taxable income. The tax rate you owe on your unemployment benefits depends on your overall tax situation and tax bracket.

When you receive unemployment benefits during the tax year, you’ll be provided with a Form 1099-G. This form is also known as the “Certain Government Payments” form and it outlines the total amount of compensation you received during a specific time period. It’s crucial to keep this form for your records and to include the total amount listed on it when completing your tax return.

It’s important to note that some state governments also consider unemployment compensation as taxable income and must be reported on your tax return. Failure to report this income on your tax return could result in penalties or fines from the IRS or the state tax authority.

What is Unemployment Compensation?

Unemployment compensation is financial aid provided by the federal and state governments to individuals who are unemployed or underemployed. This type of aid is primarily funded through taxes paid by employers, both at the federal and state levels.

Employees who are terminated or have lost their job involuntarily are usually eligible for unemployment benefits. Individuals seeking these benefits can apply through their respective state program.
The amount you receive is dependent on several factors. These include your prior working period, past income, and the maximum benefit limit set by the state.

Impact of Taxes on Benefits

Unemployment benefits are considered part of your total income. For the tax year 2020, the first $10,200 of unemployment income was tax-exempt for taxpayers with an AGI under $150,000, regardless of their filing status. Your total income, including unemployment benefits, and your filing status will determine if you must file a tax return.

Form 1099-G

The state unemployment division will provide an IRS Form 1099-G to each individual who receives unemployment benefits in a year. The total amount of your benefits will be reported in Box 1 of this form.

You can opt to have income taxes deducted from your benefits to avoid a large tax bill when you file your tax returns. If you choose to do so, the federal tax withheld will be shown in Box 4 and the state tax withheld will be listed in Box 11.

Reporting Benefits on Tax Return

Your unemployment compensation should be reported on Schedule 1 of your federal tax return under the “Additional Income” section. The amount will then be transferred to the main Form 1040. It’s important to keep all relevant forms, including any 1099-G forms, with your tax records.

How Paying Taxes on Unemployment Compensation Works

The easiest way to pay taxes on unemployment benefits is to have federal taxes withheld from your weekly payments. To do this, file Form W-4V with your state’s unemployment office. The state will withhold 10% of each payment and no other amounts or percentages are allowed.

Alternatively, you can make estimated quarterly payments using IRS Form 1040-ES by mailing a check or using IRS Direct Pay online. This option requires estimating the tax owed using tax software or the worksheet with Form 1040-ES, and making four quarterly payments due April 15, June 15, Sept. 15, and Jan. 15 of the following year.

However, waiting until you file your tax return to pay the taxes owed can be risky and lead to a large tax bill and underpayment penalties come April. 

Tax Requirement Varies by State

Additionally, unemployment benefits may be subject to state income taxes, which vary by state. 

• Eight states (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming) have no state income tax. 
• New Hampshire only taxes interest and dividends. California, New Jersey, Pennsylvania, and Virginia do not tax unemployment benefits. 
• In the remaining 37 states and the District of Columbia, consult a tax advisor or the state tax agency for information on unemployment benefits taxation. 

State withholding can usually be set up online when applying for unemployment or at any time while receiving benefits.

Bottom Line

The bottom line is that it’s essential to be aware of the tax implications of unemployment benefits. The IRS and some state governments consider unemployment compensation as taxable income, making it crucial to accurately report it on your return to avoid penalties or fines. 

Withholding taxes from your benefits is an easy way to pay the taxes owed. You can opt to do so by filing Form W-4V with your state’s unemployment office. Remember to keep all relevant forms, including any 1099-G forms, with your tax records, and to report the benefits on Schedule 1 of your federal tax return. 

To find out if your state taxes unemployment benefits, you can consult a tax advisor or the state tax agency. With this information in mind, you’ll be able to manage your unemployment benefits and taxes effectively.