How to Claim the Unemployment Tax Break: It’s Complicated, and You May Need to Wait

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The latest stimulus bill signed into law on Thursday allows tax exemptions for up to $10,200 in unemployment benefits paid in 2020. This only applies to taxpayers whose Adjusted Gross Income (AGI) for 2020 is less than $150,000.

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  • Unemployed workers can waive up to $10,200 in unemployment benefits received in 2020 from their taxable income.
  • The IRS has issued guidance for eligible taxpayers who haven't filed yet, but "strongly urges" those who already filed to wait for more guidance before amending an existing return.
  • Read more about the American Rescue Plan, the latest stimulus bill recently signed into law.

Millions of Americans who received unemployment benefits last year are in for big-time tax relief thanks to the $1.9 trillion stimulus package that passed this week. You just might have to amend your taxes to get it.

In addition to extending federal $300 unemployment benefits through September, the American Rescue Plan allows tax exemptions for up to $10,200 in unemployment benefits paid in 2020. This applies only to taxpayers whose Adjusted Gross Income (AGI) for 2020 is less than $150,000. 

This provision could save the average claimant hundreds of dollars when they file their taxes. But the law’s mid-March passage complicates the current tax season for eligible taxpayers who already filed their 2020 returns. And for those who haven’t, these new provisions may lead to more confusion about when the best time is to file. The IRS hasn’t yet issued full guidance for how these changes will be accounted for, and on Wednesday announced the deadline to file is extended to May 17.

If you received unemployment benefits in 2020, here’s what you need to know about filing your return — or amending a previously filed return to account for the new exemption:

Unemployment Benefits and 2020 Tax Returns

Without this new tax exemption, many people who claimed unemployment benefits in 2020 could have faced an unwelcome tax bill.

Generally, unemployment benefits are taxable income. That includes standard state unemployment benefits as well as 2020 federal benefits expansions, like PUA, PEUC, and other federal relief measures.

But millions of claimants did not have federal taxes withheld from their benefits last year, whether because they didn’t know they were taxable or because they couldn’t afford to have some amount of benefits withheld, according to analysis by the Century Foundation

To further complicate things, while state unemployment offices are supposed to offer standard 10% federal tax withholding, not all states offered withholding consistently across different CARES Act programs. 

Researchers estimate fewer than 40% of unemployment insurance payments issued in 2020 had taxes withheld.

The average unemployed worker received $14,000 in unemployment benefits in 2020, the Century Foundation estimates. Now, with $10,200 of that income tax-exempt, the average claimant will owe taxes on just $3,800 of the money they took in.

What to Do if You Have Filed Already

If you collected unemployment insurance in 2020 but you already filed your tax return, you are still eligible for the exemption under the American Rescue Plan. But claiming the money you’re owed may require some patience.

Over the next few weeks, you may need to amend your tax return by completing Form 1040-X. However, the IRS has not issued guidance for those claiming the exemption after filing. It’s not yet clear whether this form will be updated or how tax software companies may implement the guidance. 

In fact, the agency “strongly urges” taxpayers to not file amended returns at this time, until more guidance is available.  

After you are able to file again with the exemption, you can track your amended return’s status using the IRS’ Where’s My Amended Return? tool.  

What to Do if You Have Not Filed Taxes 

If you haven’t already filed your 2020 tax return, you can claim the exemption allowed by the American Rescue Plan when you file.

You can find all the information about what benefits you were paid and how much (if any) was withheld using Form 1099-G, which you should have received from your state unemployment office by mail or electronically. You may receive separate forms for state unemployment compensation and any federal benefits you received, but you should report all benefits you were paid on your return, according to the IRS. 

If you qualify, you’ll report your total benefits from Form 1099-G separately from the exclusion. Here’s how:

Generally, you report your taxes using Form 1040. But when you claim unemployment insurance, you must also complete a Schedule 1 form to report this additional income. Under the new exemption, you should report the total amount of unemployment compensation you received on line 7 of Schedule 1. Then, use the Unemployment Compensation Exclusion Worksheet to determine the exclusion amount you’re eligible for, which you’ll report on line 8 of Schedule 1. 

If you work with a tax preparer to file, they should be able to assist you in working out what to report on these forms using IRS guidance. If you file using a tax software, you may still need to wait for guidance to be implemented in the programs before filing. TurboTax and H&R Block did not immediately respond to requests for comment on whether filers using their products should wait or file now, but we will update this piece with any new information.

Should You Wait or File 2020 Taxes Now to Get a Stimulus Payment?

The bill’s mid-tax season passage could cause a lot of confusion for unemployed taxpayers trying to determine the best time to file, predicts Janet Holtzblatt, senior fellow at the Urban-Brookings Tax Policy Center. 

On one hand, if you had stable income in 2019 but were unemployed in 2020, you may want to file as quickly as possible to ensure you receive the full stimulus payment you’re owed. But if you file before the IRS issues guidance about claiming the new exemption for 2020 unemployment benefits, you could miss out on the tax break and still have to file an amendment later on. 

The most important factor in coming days will be how quickly the IRS can issue guidance. It may be a good idea to wait at least a few days for the agency to direct taxpayers and tax professionals on how to navigate the bill’s provisions. 

But the good news, Holtzblatt says, is that you will receive the full amount you’re owed, even if there is a delay.

For taxpayers whose stimulus eligibility is processed based on 2019 returns, “at some point — possibly later this year, but definitely when they file a tax return next year — the IRS will bump up the money and send an additional amount or what they would have received based on 2020 income.” 

In other words, you may have to reconcile your payment using a similar claim to the Recovery Rebate Credit for the previous two stimulus payments.  

Planning for 2021 Taxes if You’re Still Unemployed

The tax exemption for $10,200 in unemployment benefits currently only applies to unemployment income you collected in 2020, even though the bill also extended weekly $300 federal unemployment benefits payments through September. 

You should consider any unemployment benefits you receive in 2021 as fully taxable. If you can afford to do so, avoid a surprise bill and penalties next tax season by electing to have taxes withheld from your weekly benefits payments or by paying quarterly estimated taxes throughout the year.

You can elect to have 10% of your unemployment benefits withheld from your weekly check. Even if you did not select this withholding on your original claim, you can file Form W-4V with your state’s unemployment office to begin 10% tax withholding on future unemployment payments.  

You can also forgo automatic withholding and instead pay estimated quarterly taxes on your unemployment income. Use Form 1040-ES to figure and file your quarterly payments. If you choose to pay estimated taxes on your unemployment benefits, the first payment is due April 15, 2021.