In early 2021, the Internal Revenue Service (IRS) announced the American Rescue Plan Act's exclusion for the 2020 tax year that waived up to $10,200 of unemployment compensation on federal income taxes. Because this news arrived in March – well into tax season last year – it left many taxpayers and tax professionals wondering if similar pandemic relief might arrive for the 2021 tax year.
Alas, there is no such tax break for unemployment compensation received in 2021.
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Consider also: Some of the Surprises in the New COVID Relief Package
Unemployment Income and Federal Income Tax
In the eyes of the IRS, jobless benefits count as taxable income, subject to the same tax rate of other income. The total amount of unemployment you received in 2021 must be included in your adjusted gross income. Most states also tax unemployment benefits as taxable income.
Unemployment income can come from various sources within the federal government or your state. How that income is handled on your tax return may vary depending on which agency paid your benefits. The IRS has a tool to help you determine whether your unemployment income is taxable and how to file your income tax return accordingly.
Unemployment Income and State Income Tax
Your unemployment compensation will be subject to your state's income tax rules, tax brackets and tax rates. If you live in one of the nine states without an income tax, your unemployment income is exempt from state income tax. A small handful of states tax only a portion of unemployment income. The majority of states tax the total amount of unemployment as taxable income.
Consider also: How Do I Get My 1099 From Unemployment to File Taxes?
Reporting Unemployment Compensation
Your state unemployment office or other agency paying your unemployment benefits will send you a Form 1099-G at the end of the tax year. The tax information you need on the 1099-G is the total unemployment income you received and how much, if any, was withheld.
During tax preparation, you will use Form 1099-G to complete Schedule 1 for federal income tax Form 1040 or 1040-SR. You will submit both documents when you file your income tax return, either by mail or tax software.
Consider also: Which Form 1040 Do You Need for 2022?
It looks like there won't be an exemption or waiver for unemployment benefits received in the 2021 tax year.
Reduce Tax-Time Surprises
When you receive unemployment compensation, you can prepare for the taxes due by signing up for tax withholding or estimated tax payments.
If you choose tax withholding, your state unemployment office or other agency will have you fill out Form W-4V, the Voluntary Withholding Request. A flat 10 percent will be withheld from your unemployment check.
If you choose quarterly estimated tax payments, you will submit a payment to the IRS based on your estimated annual tax, similar to the way self-employed taxpayers submit quarterly withholdings. You can use the IRS's Tax Withholding Estimator tool to help with the math. If you make an overpayment throughout the year, the IRS will issue a tax refund or apply it to any outstanding tax bills.
Both of these options are voluntary. They are available to you as a way to help taxpayers manage their year-end tax bills.
Speaking of surprises, if you received a notice from the IRS CP08 or CP09 stating that you may retroactively qualify for the Additional Child Tax Credit or Earned Income Credit for the 2020 tax year, this might be because the IRS adjusted your 2020 income in response to the American Rescue Plan Act (ARPA) exclusion.
When ARPA was enacted, taxpayers who already filed a 2020 tax return did not have to submit an amended return. The IRS adjusted tax information and tax returns automatically in early 2021. See the instructions that came with your notice and the updated IRS FAQs to understand how to react to this notice if you may qualify for a tax refund.
Consider also: Tax Credit vs. Tax Deduction: What's the Difference?
Unemployment Income and Tax Filing
It looks like there won't be an exemption or waiver for unemployment benefits received in the 2021 tax year. Your tax software or tax professional should walk you through the steps needed to properly report your unemployment income when submitting your 2020 tax return.
Be sure to check that nothing has changed before you file.
- Internal Revenue Service (IRS): New Exclusion of up to $10,200 of Unemployment Compensation
- IRS: 1099-G Tax Form (2021)
- IRS: Publication 525 (2021) Taxable and Nontaxable Income
- IRS: People Should Have Tax Withheld from Unemployment Now to Avoid a Tax-time Surprise
- Tax Foundation: State Taxation of Unemployment Benefits
- Tax Foundation: State Individual Income Tax Rates and Brackets for 2021
- IRS: Estimated Tax Payments
- IRS: About Form 1099-G, Certain Government Payments