If you paid state or federal income taxes on unemployment benefits you received in 2020, you may be eligible for a refund. Here’s why, and how to get it.
Which Benefits are Taxed
Typically, unemployment insurance benefits are subject to federal income tax. You may have been unemployed, but it’s still income, and consequently still subject to income tax.
In addition, some states also expect you to pay income tax on unemployment benefits that you receive. Obviously, states without a state income tax, such as Alaska, Nevada, and Washington, don’t tax unemployment compensation either. But even some states with a state income tax don’t tax unemployment insurance benefits, such as Alabama, California, and the District of Columbia (starting in 2021).
Your city or county may tax unemployment compensation as well.
In 2020, 40 million people received unemployment compensation, and fewer than 40% of them had taxes withheld on it, according to USA Today.
If you’re one of them, it’s important to make sure you’re keeping track of the amount you’re making in unemployment compensation throughout the year so that you’ll have the money to pay the taxes at the end of the year, or quarterly through estimated taxes. On the federal level, the IRS can help you keep track of that as well.
How to Calculate Taxes on Unemployment Benefits
An easy way to pay the income tax is by having taxes withheld from your unemployment benefits. Generally, you can set up withholding when you file for unemployment, just the same way you would set up withholding from your paycheck when you start a new job. That way, you don’t ever see the money, and you don’t have to worry about coming up with the cash when tax time arrives.
(You couldn’t sign up for withholding taxes on some of the additional unemployment insurance benefits added due to COVID-19, such as the supplemental $600 and $300 Federal Pandemic Unemployment Compensation (FPUC) or $300 FEMA Lost Wages Assistance payments.)
However, 2020 was different. One of the provisions of the American Rescue Plan, enacted on March 11, 2021 to help stimulate the economy after the COVID-19-induced economic disruption, excluded federal income taxes on unemployment insurance benefits paid out in 2020. That includes all the various extended unemployment insurance packages that Congress passed to help people who’d lost their jobs due to COVID-19, such as the Pandemic Unemployment Assistance (PUA), Pandemic Emergency Unemployment Compensation (PEUC), or Extended Benefits (EB), .
What’s more, if your spouse also received unemployment insurance benefits, they were eligible for the $10,200 exclusion as well, according to the Internal Revenue Service (IRS).
There were a couple of provisos. If your adjusted gross income for 2020 was over $150,000, the unemployment insurance tax exclusion didn’t apply. And you and your spouse, if you have one, did need to pay taxes on your unemployment benefits for amounts over $10,200.
Some states, such as Arizona, Arkansas, and Connecticut, conformed with the federal unemployment insurance tax exemption, meaning you didn’t have to pay state taxes on your unemployment compensation either.
Effects of the Unemployment Insurance Exclusion
Chances are, you’ve already paid your income taxes for 2020. But what this exclusion means is, if you paid taxes on unemployment insurance benefits that you received in 2020, you can get a refund on that money, both on your federal tax return and on your state one, if your state conformed with the federal unemployment tax exclusion.
The IRS is working through the tax returns of people who filed their income taxes before Congress passed the exclusion bill, and sending tax refunds to people who are entitled to them. To get that money refunded, you may not need to do anything at all. As many as 16 million Americans might be eligible for a refund. As of early November, the IRS had issued more than 11.7 million refunds totaling $14.4 billion. The IRS will send you a notice to let you know if you’re affected.
(If you owe money to the IRS, your refund may be applied to that debt instead of being paid to you, the agency added.)
Keep in mind, you aren’t going to get $10,200 refunded. You would be refunded the income taxes you paid on $10,200.
However, if you weren’t eligible to receive additional tax benefits predicated on your 2020 income, such as the earned income tax credit, and you’re now eligible for those benefits because your 2020 taxable income is now lower due to the exclusion, you may need to file an amended federal tax return to get those additional benefits. The IRS can help you figure that out.
If you need to file an amended return for that year, you can find that form on the IRS website for federal taxes, and can typically find the state version on your state tax commission’s website. Generally, you have up to three years to file an amended return.
If your state conformed with the federal unemployment insurance compensation tax exclusion, you may need to file an amended return for your state to receive your refund. However, some states, such as Vermont and Minnesota, are following the federal government’s lead, recalculating taxes and issuing refunds without your needing to file an amended return.
Intuit, which makes TurboTax software, has a list of which states are recommending that you file an amended return to receive the state income tax refund on unemployment compensation.
However, some states that tax unemployment compensation didn’t conform with the federal tax exclusion, such as Colorado, Georgia, and Kentucky. For those states, you’re out of luck; you needed to pay state income tax on your unemployment insurance benefits, and you don’t get a refund on the state income taxes that you paid.
Moreover, if you live in one of those states, and if you filed your tax return after Congress passed the exclusion, and mistakenly excluded your unemployment compensation as income, you may need to file an amended state tax return and pay more in state taxes.
But depending on where you live, there’s some good news. Some states extended the tax exclusion to 2021 as well, such as Alabama, Arkansas, and Massachusetts. However, financial experts don’t expect the federal government to exclude income tax on unemployment compensation for 2021. Keep that in mind when filing your income taxes for 2021.
If you found this article helpful, you may find the below links useful as well!
Can You File Unemployment in Two States?
How to Transfer Unemployment to Another State
How to Settle an Unemployment Overpayment
