How unemployment may create a stunning tax burden in 2020
Alistair Berg | DigitalVision | Getty Images
Many unemployed are about to find out that they could owe federal and state taxes on their unemployment income in 2020.
The news might be particularly unexpected for independent contractors and self-employed workers who are normally not eligible for government benefits but may have received pandemic unemployment benefits through the CARES law.
"People who have not had taxes withheld from these unemployment benefits will be surprised," said Nayo Carter-Gray, registered agent and founder of 1st Step Accounting in Towson, Maryland.
Failure to withhold enough tax could result in lower refunds or taxes due this spring.
Differences in State and State Treatment
Unemployment income is taxable and must be shown on your 2020 income tax return. This month, you will likely receive a Form 1099-G detailing the amount of money you paid over the year.
Federal income taxes apply to these benefits – regardless of whether they are state unemployment insurance or pandemic unemployment benefits paid under the CARES Act.
The catch is that withholding the fair amount of income tax is voluntary. You can choose to have a flat rate of 10% of your benefits withheld to cover your tax liability.
To do this, you would need to submit Form W-V4 to the government agency that manages your unemployment.
You can also make quarterly estimated tax payments to the IRS.
Uncle Sam isn't the only company looking for a part of your unemployment income. Most states will also tax these benefits.
A handful of states – Alabama, California, Montana, New Jersey, Pennsylvania, and Virginia – do not tax these payments. According to Andy Phillips, director of the Tax Institute at H&R Block, Indiana and Wisconsin offer partial unemployment income exclusion.
"Some states have withholding taxes; others impose it to ease surprises when tax time comes," said Jared Walczak, vice president of state projects at the tax foundation.
While it's too late to pay the tax bill you may owe for 2020, people who close their tax returns early can at least plan to pay the amount owed by April 15 – the due date for tax returns and liabilities owed.
"You don't have to make a payment until April 15th, but it's better to know in late January or early February that you'll have to submit the dollar amount by then," said Phillips of the Tax Institute at H&R Block.
Unemployment and tax credits
Families who received unemployment income in 2020 should also look for two key credits when filing their taxes: the Earned Income Tax Credit and the Child Tax Credit.
Both loans add up to significant dollars.
Earned Income Tax Credit is up to $ 6,600 for a low-income household and three or more qualified children.
In the meantime, the refundable portion of the child tax credit is up to $ 1,400 per qualifying child.
More from Smart Tax Planning:
Crypto is losing value. What it means for taxes
The state tax authorities are targeting professional athletes
People fled these high-tax countries in 2020
Here's the catch: while unemployment benefits are taxable, they don't count as earned income.
Under normal circumstances, getting out of unemployment would result in a reduction in both credits when you file your tax return.
The legislature resolved this problem in the Covid Aid Act at the end of the year. When you file your 2020 taxes this year, you will have the option to use your 2019 income to calculate your eligibility for credit.
"If you've transitioned from being a wage earner to filing for unemployment, you may be affected," Phillips said. "Using your 2019 income just to determine the size of your loan can be a huge benefit to taxpayers."