You pay taxes on windfalls like lottery wins and game show earnings, but not on stimulus checks sent out by governors and presidents. So what about when it comes to unemployment?
It can be hard to keep track of everything that American citizens are required to pay taxes on and everything we aren’t. Between federal taxes, state taxes, local exemptions, and other loopholes, it’s not always clear where unemployment fits into the bigger tax picture.
There is a lot to know about this topic, and we dive into all of it below.
Do You Have To Pay Taxes on Unemployment?
The short answer is, yes, you have to pay taxes on unemployment benefits.
We technically pay all year into unemployment. Isn’t that our money to dip back into when we’re in a rough spot? Not quite, or at least not so easily.
If you didn’t pay taxes on unemployment throughout the year, come refund season, you may be getting a smaller sum than you got in previous years.
The Impact of Covid-19 on Unemployment Benefits and Taxes
Over the past three years of the COVID-19 pandemic, more Americans have become acquainted with the ragged bottom of the social safety net than had ever before. Unemployment numbers skyrocketed higher than even during the Great Recession of 2009.
But the government quickly swooped in to help, expanding unemployment and other stimulus benefits. They rolled out stimulus checks, the monthly child tax credit, the Child Care and Development Fund, and the Pandemic Emergency Assistance Fund. They expanded access to the healthcare exchange marketplace, the Supplemental Nutrition Assistance Program, rental assistance, energy and water assistance, and more.
That was all great while the pandemic’s effects raged the hardest. However, it proved even harder on some when the government came to collect taxes on what many thought to be charity, not a loan. The government increased unemployment benefits by $600 per payment for many Americans. But when it came time for tax season, many were in for a rude awakening. All those payments counted as taxable income.
There was an exclusion of up to $10,200 in unemployment benefits as part of the American Rescue Plan. However, that only applied for the 2020 tax season. After that, struggling families found themselves struggling to pay back the IRS for the portion of taxable unemployment benefits.
Why Unemployment Benefits Are Taxable
Unemployment benefits are taxable because, in the eyes of the government, the money earned from those payments is income. You’ll see it reflected in your wages and salaries, with taxes applied accordingly.
Unemployment isn’t the same as assistance, like food stamps or a housing voucher. It’s income subsidization. Beyond that, some states also collect on these benefits.
There is one main difference between a regular income and unemployment as income when it comes to tax season. That is, you aren’t required to pay for unemployment benefits such as FICA taxes or social security out of your unemployment benefits. In other words, you don’t have to pay for that program out of the taxes taken out from benefiting from the program. That would just be redundant.
There is a way out of this headache, however. You can decide to have taxes withheld from your unemployment payments. You can select that option in whatever portal you apply for to get the disbursement of payments in your state.
The IRS strongly recommends that people have these taxes withheld. It’s easier to accept less payment to start with than live slightly better off higher payouts and then suddenly have to come up with potentially hundreds of dollars come tax time.
How Do Unemployment Taxes Work?
At the Federal Level
Each year, your salary, wages, bonuses, and even tips if you work in the service sector count toward your taxable income. When you receive social support from unemployment benefits, the government recognizes that as income.
In April of each year, tax time comes around. Being an unemployment recipient doesn’t mean that you’ve been making 100% of your earning potential all year, and now it’s time to pay your fair share. The idea is that you’ve already been paying your fair share of taxes out of your income in each check.
If you’ve ever checked out the itemized information on your pay stubs, you’ll see small percentages taken out for federal, state, and local income taxes, federal and state unemployment taxes, and Medicare and Social Security taxes.
When tax season comes around, the idea is the government simply needs to make sure you paid the proper amount in taxes. Unemployment payments simply factor into that kind of income that should be properly taxed as you’re receiving it. You will not owe anything at the end of the year if you responsibly and consistently keep having taxes withheld from those payments.
At the State Level
Every state has its policy on taking taxes out of unemployment benefits. For example, states like Alaska, Nevada, Texas, Wyoming, Florida, and California don’t require taxes on these payments; other states do.
Colorado has a flat income tax rate of 4.55% as of 2022, including unemployment. Delaware had these payments tax exempt in 2020 and 2021, but it will revert to the normal range of 2.2%-6.6%, depending on your income in 2022. As of writing, 11 states tax unemployment benefits.
Some states either fully exempt unemployment benefits or lack state income tax altogether. But if the thought of getting unemployment “for free” excites you enough to move, not so fast. Many of these states make up for it in other ways—higher sales tax, property tax, etc.
At the Local Level
It isn’t universal, but there are some cities, counties, and municipalities that will want their fair share of your unemployment taxes. You’ll have to contact your local office to determine if and what you owe.
How Do You Pay Your Unemployment Taxes?
There are three main ways to pay unemployment taxes, with valid strengths and negatives to each model.
1. Withhold State and Federal Taxes From Your Unemployment Payments Throughout the Year
This method measures up to the least headache overall. If you ask for a flat 10% taken out of each unemployment payment, you avoid the hassle of calculating what you owe come tax time. You may even get a refund.
If this option isn’t available to you in your state’s unemployment portal, you can fill out a voluntary withholding request, or W-4V, and send it to your representative agency.
2. Make Quarterly Payments
Freelancers, contract workers, gig workers, and the self-employed generally file quarterly instead of yearly taxes. This option is the most labor-intensive of the bunch, and there isn’t much of a positive. It is simply the kind of tax structure handed to the self-employed.
On April 15, June 15, September 15, and January 15, individuals who follow this model file their taxes as the rest of us do in April.
3. Pay Once per Year in Full
This option is suitable for most because it’s what most people already do—waiting to pay once a year allows you to hold off and avoid overpaying. However, you’ll have to pay during tax season rather than receive a plump tax return, which can be a hefty payment.
Also, note that if you did not pay any taxes on your unemployment payments throughout the year, you might have to pay an underpayment penalty—there’s one benefit to the quarterly model.
This model works best if you combine it with option one and have your taxes withheld throughout the year. Then, when you file, you’re likelier to get a refund than owe money.
4. Hire a CPA
There’s an entire field of professionals—CPAs, tax preparers, accountants—who know tax law and help people file taxes.
If you’re tired of the headache of figuring out what percentage of unemployment you’ll need to pay taxes for, hire a CPA. They can sort your benefits, tax filing bracket, and more to ensure you make accurate payments to the IRS.
Frequently Asked Questions
Can I Get In Trouble for Not Paying Taxes on Unemployment?
Yes, you can get in trouble, and the consequences can be worse than not paying taxes on income from private employers. With unemployment tax evasion, you’d be dodging money awarded to you by the government itself. You don’t want to be on their bad side!
Need Accounting Help? Give Us a Call
Unemployment benefits and tax law can create a complicated and grueling process. It’s not just having to pay taxes but knowing how much to pay or withhold, whether any exemptions are in place, and more.
If you need help navigating these waters, call MI Tax CPA. Whether you’re filing personal or business taxes, you can call MI Tax CPA for tax preparation assistance, tax consulting, and planning services. We answer all questions about tax debt relief and help with unfiled tax returns.
You don’t need to do it alone—call MI Tax CPA for account help.