Should Know: Unemployment Payments are Taxable

Shiloh Johnson
By Shiloh Johnson

Unemployment Payments are Taxable Income

For the 3rd time today you may have checked your unemployment insurance application for a status update. Or maybe you called the service line to hear the same recording again hoping to get some new information, if you even got through at all. Unfortunately, this is the truth for many of us amidst these uncertain financial conditions forced on an already volatile economy. 

If we are being honest, these payments are only a small bit of reprieve for Americans, unsure of how they will take care of their financial responsibilities in the coming months. According to Newsweekly, the national average unemployment benefit payment is $300 a week, add the $600 increase approved by the CARES Act and you might be able to keep your lights on for a little while longer.

But as all of these cash payments start to add up, you may be wondering how this will affect your tax bill next year. And you are right to be concerned because if you didn’t already know, unemployment payments are taxable income. This means that you are responsible for the tax on the payments you are set to receive.

While completing the unemployment application, you might have noticed a question asking something like “would you like federal tax deducted from your payments?” To which you may have answered no. But here is why that may be a problem:

No Free Income

As mentioned above, unemployment compensation is taxable income. The likelihood that you will exhaust all available benefits is pretty high. This could result in 6–8 months of payments being issued to you, that could wield a hefty tax bill if not taken care of ahead of time. Additionally, states are now issuing the extra $600 payment on top of the available benefit, that could result in a total payout of upwards of $20,000.

Side Hustlers Included

Being the resourceful humans that we are, we may try to pick up additional income on the side (hopefully from home) while trying to weather the storm. And in so doing, this creates another set of tax obligations. If you have never worked for yourself before, you should know that for every $1 you earn on your own (not under an employer), the IRS gets at least 10 cents. So if you’re keeping track, that could be another $20k in freelance income on top of the unemployment benefit already paid out. I get that we are not talking about millions, however, 12% tax on 40k of combined freelance and unemployment benefit payout is $4800. And after probably one of the most financially difficult years of your lives, having to fork out five grand when you are trying to play the catch-up game is no fun.

Estimated Tax Payments

Another thing to consider is that you may be required to make estimated tax payments on your unemployment benefit if you opt-out of automatically deducting the tax before issuing payment. Estimated payments, are made to the IRS every quarter (April, July, Oct, Jan) for the amount of tax associated with the income earned during the proceeding 3 months. For example, let’s say you made $2400 in Jan, Feb, and March, you would be required to pay the IRS at least $240 in tax by April 15th (not considering recent payment delays).

Excess Burden

After the 2020 tax year comes to a close, your states unemployment department will issue a form called a 1099-G. This form will be used to help you report the income you received on your tax return. If you are use to receiving a refund at tax time your benefit payments may upend that, and result in a tax bill.

What To Do Instead

Opt into having tax withheld automatically before receiving unemployment payments. If that’s not an option make quarterly estimated payments. If you have freelance income you are required to do this. Here’s a link for more info: estimated payments.

Times are crazy and its best we go into this as prepared and as informed as possible. And in the words of Nick Furry, “Until such time as the world ends, we will act as though it intends to spin on.”

Update: In a recent update from the IRS “If your modified adjusted gross income (AGI) is less than $150,000, the American Rescue Plan enacted on March 11, 2021, excludes from income up to $10,200 of unemployment compensation paid in 2020, which means you don’t have to pay tax on unemployment compensation of up to $10,200.” This was built into the plan to support those who’ve been living on unemployment income only and shouldn’t be burdened with a bill to offset a very small survival wage.

Need help managing your tax deadlines, notices & more? We’ve got you covered.  Sign up for your free trial – no credit card required.

Shiloh Johnson
By Shiloh Johnson
Shiloh Johnson is a long-time CPA and founder of ComplYant, a technology platform offering business owners and entrepreneurs a simple way to manage tax rules and requirements.

Related posts

Young businesswoman walks down the street near palm trees in LA

All things business: LA edition

The first step to starting a business can be the hardest. So take a small one. One at a time. Here's short checklist to guide you through some basic yet critical steps and help you begin. 
Wooden blocks spell out "LLC" on a table with pencils, paperclips, and notebooks nearby

Choosing a business structure: Is an LLC the best choice?

If you’re forming a business, then you need to choose a structure for your business. The structure you choose will have implications on your tax obligations, investment opportunities, filing requirements, and more. Read this article to discover if an LLC is right for you.
Digital creator holds up a handbag to her camera to create content for her social media channel

Tax filing answers: Digital creators, freelancers, and gig workers

Small business owners and those who are self-employed have a different approach to tax season than those who only have W2 income. Here are answers to a couple of questions that may get you stumped.