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A Potential Problem You Can Easily Fix

As millions of Americans watched their jobs evaporate as a result of the COVID-19 pandemic, many were relieved to have unemployment benefits to fall back on to help them pay their bills and begin to seek new career avenues.

But those benefits won’t come without what could become certain unintended consequences – namely the looming specter of a large tax bill come 2021.

Some people will be rudely surprised at tax time next year, and to minimize the shock, the National Employment Law Project wants workers to know that the Internal Revenue Service does count unemployment benefits as taxable income. If those who aren’t withholding a portion of their benefits for federal income taxes, they’ll face a major deficit in their finances when spring filing time arrives.

The NELP says more than one-third of taxpayers aren’t aware that unemployment benefits are counted as taxable income, and just over half had no idea it was their responsibility to select whether or not taxes are withheld from any unemployment compensation they receive.

According to the Department of Labor, as unemployment ramped up during the spring, more than 31 million people were ultimately forced to file claims for federal and state unemployment insurance benefits by June.

And the situation could also be complicated by the fact that the federal government added $600 a week to supplement state benefits as part of the $2.2 trillion CARES Act stimulus package.

But there are several ways taxpayers can avoid a nasty shock.

For one, the IRS offers Form W-4V which allows people to elect to automatically set aside 10% of their unemployment compensation.

Some state’s unemployment agencies incorporate withholding on their benefit application sites or already, Michigan among them, and others ask filers about their preferred federal withholding in other ways. That’s one reason unemployment insurance claimants should pay attention to the status of their federal income tax deduction – and state income taxes as well – as they elect how they will receive their benefits.

Some states, Alabama, California, Montana, New Jersey, Virginia and Pennsylvania, don’t count unemployment benefits as taxable income at all as they add up a claimant’s state income tax due.

Some states don’t collect taxes at all, and that simplifies matters for those living in them.

It’s also possible for taxpayers to make estimated quarterly payments to avoid a rude shock and claimants filing this way can use Form 1040-ES to solve the problem.

The IRS also offers a tax withholding estimator to help out taxpayers who wish to handle tax set-aside chores themselves.

The additional income from the CARES Act supplement may also mean some taxpayers miss out on qualifying for the Earned Income Tax Credit , or EITC.

As the EITC can provide low and some middle income taxpayers with up to $6,660  – some 25 million households last year – it can be a nasty surprise to miss out come tax time.

While wages collected are considered earned income, unemployment benefits are not, so it’s entirely possible for adjusted gross income which has been pumped up by unemployment benefits to push a taxpayer’s bracket above the EITC eligibility threshold .

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