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Are Unemployment Benefits Taxable?

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Losing a job is incredibly scary and stressful, and when it happens during a pandemic, the financial challenges can feel especially trying.

These are difficult times for many of us, as a record number of people have lost their jobs due to Covid-19. In March 2020, the federal government, under the CARES Act, expanded various unemployment programs to help alleviate the financial pressure for millions of Americans.

As of June 27, 2020, approximately 32 million people have claimed unemployment benefits according to the Department of Labor. 

If you or someone you know is receiving unemployment compensation, it’s important to understand that the benefits are likely subject to federal (and state, if applicable) income tax. 

Let’s take a look at how the IRS treats unemployment benefits because the last thing you want is a surprise tax bill when it’s time to file your return.

How are unemployment benefits taxed?

In the eyes of the IRS, unemployment compensation is considered “ordinary income,” which means that the payments are generally taxable based on your income tax rate (see 2020 tax rates here) and they need to be reported on your federal tax return (i.e. Form 1040).

But what about state taxes?

If you live in a state with an income tax, you may have to report the money you received from unemployment on your state tax return. Each state has different tax rules when it comes to unemployment benefits, so it’s best to check with your state tax agency or a tax professional directly to understand your obligations.

Before filing your taxes, you should receive a Form 1099-G in the mail from the state that paid your unemployment benefits, usually around January 31. This form will show how much unemployment compensation you received in a particular year. This information will need to be reported on your federal tax return (i.e. Form 1040). 

Good to know: The tax treatment of your unemployment benefits depends on the type of program that’s paying out the benefits. The IRS has an Interactive Tax Assistant tool that can help you figure out whether you’ll have to pay taxes on your unemployment compensation.

How do you pay taxes on unemployment benefits?

So, how does Uncle Sam expect you to pay taxes on unemployment benefits? There are three options, and they’re similar to the way you normally pay your federal taxes.

Option 1: You could ask for taxes to be taken out of your unemployment payment

This option is similar to the way taxes are withheld from a traditional paycheck (i.e., when your employer withholds taxes on your behalf).

But instead of filling out a W-4 form, you would complete Form W-4V (Voluntary Withholding Request). Once you’ve submitted the form, 10% of each unemployment payment will be withheld for federal taxes. 

If you’re expected to pay state taxes on your unemployment benefits as well, you’ll have to complete a state withholding form, too, but be aware that the withholding options (i.e. rates) are different from state to state.

Contact your state's unemployment office or tax agency to get more information on how to complete and submit a tax withholding request.

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Option 2: You could make quarterly estimated tax payments

Instead of having taxes taken directly out of your unemployment payments, you could choose to collect your unemployment benefits in full and then pay your taxes separately by sending in estimated tax payments to the IRS (and state tax agency if applicable) in four quarterly installments; estimated tax payments are typically due on April 15, June 15, September 15 and January 15 of the following year. 

Good to know: Visit the IRS to see the current estimated tax payment schedule – some payment deadlines have been extended due to Covid-19. 

Making estimated payments, however, takes a little bit of work. Every couple of months, you would need to calculate (or estimate) the taxes you owe on the unemployment compensation you received during the quarter.

Now, how do you go about figuring out the math? Well…there’s a IRS form for that, too! The IRS provides a worksheet on Form 1040-ES to help you calculate your estimated tax. 

If you’re unsure about your calculations, consider asking a professional tax preparer for help because if you underpay, you might end up owing taxes when you file your income tax return and you could get hit with a penalty.

Option 3: You could pay your taxes when you file your next income tax return

With this option, you would collect the full amount of your unemployment benefits and then pay any taxes owed when you file your income tax return. Just be aware that depending on your personal financial situation, you could end up with a big tax bill at the end of the year and an underpayment penalty, which is probably something you don’t want to add to your plate if you’ve had a tough year financially.

The bottom line

Unemployment benefits are generally taxable. It’s important to make sure you understand your tax obligations, so that there are no unwanted surprises when the next tax season rolls around.

If you have any questions about your benefits, check in with a professional tax preparer who can help assess your personal tax situation.

This article is for informational purposes only and is not a substitute for individualized professional advice. Individuals should consult their own tax advisor for matters specific to their own taxes and nothing communicated to you herein should be considered tax advice. This article was prepared by and approved by Marcus by Goldman Sachs, but does not reflect the institutional opinions of Goldman Sachs Bank USA, Goldman Sachs Group, Inc. or any of their affiliates, subsidiaries or division. Goldman Sachs Bank USA does not provide any financial, economic, legal, accounting, tax or other recommendation in this article. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice.  Information contained in this article does not constitute the provision of investment advice by Goldman Sachs Bank USA or any its affiliates. Neither Goldman Sachs Bank USA nor any of its affiliates makes any representations or warranties, express or implied, as to the accuracy or completeness of the statements or any information contained in this document and any liability therefore is expressly disclaimed.