There’s no denying that the coronavirus turned the lives of millions of Americans upside down. Some folks saw their jobs disappear after their companies closed their doors for good. Others were furloughed and left in limbo without a paycheck, unsure when their bosses would call them back into the office.
As a result, Americans applied for unemployment insurance in record numbers in the early days of the pandemic.1 Maybe you were one of them, turning to unemployment benefits to help you weather the storm for weeks—or months—while you were on the hunt for a new job or waiting for your old job to come back.
Now with tax season on the horizon, you might be wondering whether or not you’ll have to pay taxes on those unemployment benefits you received. Don’t worry! We’ve got some answers that will help you figure it all out.
What Is Unemployment Insurance?
When you find yourself out of a job, unemployment insurance is a joint federal-state government program that might provide a safety net to break your fall. The unemployment benefits you get from unemployment insurance are designed to replace some of the income you lost while you search for a new job. It’s not going to replace all of the money you used to make, but it’s something to help you out while you’re on the hunt for a new job.
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In response to the coronavirus pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law back in March 2020 and expanded unemployment benefits in a couple ways. First, it beefed up the amount of money people received with an extra $600 benefit each week. And second, it increased the amount of time someone could receive unemployment benefits (from 26 weeks to 39 weeks, in most cases).2
Many of those benefits were about to ride off into the sunset by the end of the year . . . before Congress swooped in again with the Continued Assistance Act, which extended many of these benefits into 2021.3
Who Is Eligible to Receive Unemployment Benefits?
Each state sets its own guidelines to determine who is eligible to receive unemployment benefits. But in most states, you’ll qualify for those benefits if you became unemployed through “no fault of your own.”4
So if your job was cut in a round of layoffs or you resigned because of unsafe working conditions, you should have no problem applying for and receiving unemployment benefits. But if you just quit or you were fired with cause for “gross misconduct”—maybe because you were caught stealing office supplies (or worse)—you might be out of luck.
Some states also say you must have worked a certain amount of time at your last job or received a minimum amount of earnings from your previous employer to qualify for benefits. It all depends on where you live!
Usually, self-employed workers like independent contractors and freelancers are not eligible for unemployment benefits. But because of the coronavirus, the CARES Act opened the door for states to extend benefits to some of those workers, at least for now.5
Are Unemployment Benefits Taxable?
The short answer is: Yes. Everyone needs to pay federal income taxes on any unemployment benefits they get.6 Any money you receive from unemployment benefit programs will be taxed as ordinary income according to the tax bracket you’re in. Uncle Sam wants his cut!
All the extra weekly unemployment benefits that were given thanks to the CARES Act and the Continued Assistance Act will also be counted as taxable income. (It’s worth mentioning that the money from the stimulus checks you received though will not be taxed.)
On top of those federal income taxes, unemployment benefits are also subject to most state income taxes too. There are a few states, however, that either don’t have a state income tax or don’t tax unemployment benefits at all.
Here’s a state-by-state breakdown of states that do and don’t tax unemployment benefits:
You’ll want to check your state’s unemployment office to find out more information about how your unemployment benefits will be taxed and whether or not you are eligible for those benefits.
For more information about this year's taxes, watch Chris Hogan's webinar!
How Do I Pay Taxes on My Unemployment Benefits?
Alright, so you know you have to pay taxes on those unemployment benefits. Now what? It’s time to look at how you can pay those taxes! There are three different ways to pay those taxes, so let’s look at each of them and which option is best:
- Withhold your taxes from your unemployment benefits. When you first sign up for unemployment benefits, you can choose to have 10% of each payment withheld to cover all or some of what you owe in federal income taxes—you can’t withhold more or less.7 This is the best (and easiest) option since it’s just one less thing to worry about later! Depending on the size of your unemployment checks, withholding might not cover all the taxes you owe . . . but it will still give you a nice head start when tax season rolls around.
- Pay estimated taxes. Your second option if you chose not to have taxes withheld from your benefits is to send quarterly estimated taxes on that money over to the IRS.
- Wait until tax season. You could pay it all at once when tax season rolls around . . . but you might want to rethink that move. You see, America has a “pay-as-you-go” tax system, which means you’re technically supposed to pay taxes on income as you get it throughout the year. On top of a bigger tax bill in April, Uncle Sam might slap you with a penalty for not paying your estimated taxes if they’ve piled up. If you failed to have any taxes taken out at the start, however, and haven’t been paying quarterly, you’ll fall in this bucket.
Get Your Taxes Done Right
So how should you pay taxes on unemployment? We definitely recommend having those taxes withheld from your unemployment checks! But if you forgot to pick that option and you’re facing a huge tax bill, you might want to reach out to a tax advisor for help.
Nothing takes the stress out of Tax Day like having a tax advisor in your corner who eats, sleeps and breathes all this tax stuff on a daily basis. So if you still have questions about the taxes on your unemployment benefits, get in touch with one of our tax Endorsed Local Providers (ELPs) in your area!
Would you rather file your taxes on your own? We’ve got you covered there too. Ramsey SmartTax makes filing your taxes feel like a walk in the park!