There’s no denying that the coronavirus turned the lives of millions of Americans upside down. Some folks saw their jobs disappear after their companies closed their doors for good. Others were furloughed and left in limbo without a paycheck, unsure when their bosses would call them back into the office.
As a result, Americans applied for unemployment insurance in record numbers in the early days of the pandemic.1 Maybe you were one of them, turning to unemployment benefits to help you weather the storm for weeks—or months—while you were on the hunt for a new job or waiting for your old job to come back.
Now with tax season on the horizon, you might be wondering whether or not you’ll have to pay taxes on those unemployment benefits you received. Don’t worry! We’ve got some answers that will help you figure it all out.
What Is Unemployment Insurance?
When you find yourself out of a job, unemployment insurance is a joint federal-state government program that might provide a safety net to break your fall. The unemployment benefits you get from unemployment insurance are designed to replace some of the income you lost while you search for a new job. It’s not going to replace all of the money you used to make, but it’s something to help you out while you’re on the hunt for a new job.
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In response to the coronavirus pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law back in March 2020 and expanded unemployment benefits in a couple ways. First, it beefed up the amount of money people received with an extra $600 benefit each week. And second, it increased the amount of time someone could receive unemployment benefits (from 26 weeks to 39 weeks, in most cases).2
Many of those benefits were about to ride off into the sunset by the end of the year . . . before Congress swooped in again with the Continued Assistance Act, which extended many of these benefits into 2021.3
Who Is Eligible to Receive Unemployment Benefits?
Each state sets its own guidelines to determine who is eligible to receive unemployment benefits. But in most states, you’ll qualify for those benefits if you become unemployed through “no fault of your own.”4
So if your job was cut in a round of layoffs or you resigned because of unsafe working conditions, you should have no problem applying for and receiving unemployment benefits. But if you just quit or you were fired with cause for “gross misconduct”—maybe because you were caught stealing office supplies (or worse)—you might be out of luck.
Some states also say you must have worked a certain amount of time at your last job or received a minimum amount of earnings from your previous employer to qualify for benefits. It all depends on where you live!
Usually, self-employed workers like independent contractors and freelancers are not eligible for unemployment benefits. But because of the coronavirus, the CARES Act opened the door for states to extend benefits to some of those workers, at least for now.5
Are Unemployment Benefits Taxable?
In a typical economic year, the answer would be “yes.” Everyone would pay federal income taxes on any unemployment benefits they get.6 But 2020 was no typical year, and in response to that, Congress passed the American Rescue Plan in March, which changes the way unemployment benefits are handled. And it’s a big change.
For 2020 tax filing purposes, unemployment benefits up to $10,200 will not be taxed.7 One more time: unemployment benefits up to $10,200 will not be taxed.
For 2020 tax filing purposes, unemployment benefits up to $10,200 will not be taxed.7
Now, there are a couple of fine print rules to know. First, if you received more than $10,200 in unemployment benefits, the excess is taxable, and you should report it as part of your income. For example, if you received $10,500 in unemployment benefits in 2020, that is $300 more than the $10,200 tax-free limit. You’ll need to claim that $300 as income and pay taxes on it.
Second, the tax break only applies if your household income was less than $150,000. If your household income exceeded that in 2020, any unemployment benefits you received will be taxed as usual, according to the tax bracket you’re in.8 Uncle Sam wants his cut! (Although it’s worth mentioning that the money from the stimulus checks will not be taxed.)
Know this, though: Your unemployment benefits are still subject to state income taxes unless you work in a state with no income tax or that doesn’t tax unemployment benefits at all.
Your unemployment benefits are still subject to state income taxes unless you work in a state with no income tax or that doesn’t tax unemployment benefits at all.
Here’s a state-by-state breakdown of states that do and don’t tax unemployment benefits:
As of March 2021, three states that typically DO tax unemployment benefits—Arkansas, Delaware, and Maryland—are making an exception and NOT taxing benefits received in 2020–2021. More states could follow suit.9
You’ll want to check your state’s unemployment office to find out more information about how your unemployment benefits will be taxed and whether or not you’re eligible for those benefits.
What if I Do Owe Taxes on Unemployment Benefits?
If you do have to claim your unemployment benefits, it’s time to look at how you can pay those taxes! Let’s take a look at the options and see which is best:
- Withhold your taxes from your unemployment benefits. When you signed up for unemployment benefits, if you chose to have 10% of each payment withheld (you can’t withhold more or less) to help cover federal income taxes, you might not have to do anything else.10 Nice!
- Pay estimated taxes. If you chose not to have taxes withheld from your benefits, you can send quarterly estimated taxes on that money over to the IRS.
- Wait until tax season. Normally, our advice is to pay taxes on income as you go rather than wait till tax season to pay all at once. But in a year that was anything but normal, we also understand that different factors might be at play, or the decision might have already been made by now. The bottom line: In this economic climate, brace for change, and stay as informed as you can.
Get Your Taxes Done Right
We're here to help shoulder that burden with you. If you’re stressing about how unemployment benefits affect your taxes—do you pay, do you not pay, how much do you pay, how do you pay?—you might want to reach out to a tax advisor for help.
Nothing takes the stress out of Tax Day like having a tax advisor in your corner who eats, sleeps and breathes all this tax stuff on a daily basis. So if you still have questions about the taxes on your unemployment benefits, get in touch with one of our tax Endorsed Local Providers (ELPs) in your area!
Would you rather file your taxes on your own? We’ve got you covered there too. Ramsey SmartTax makes filing your taxes feel like a walk in the park!