Unemployment Income Is Taxable

When an individual receives unemployment compensation from the Federal or State government it is reported to the individual on Form 1099-G. At the federal level, it is fully taxable as ordinary income, but not subject to Social Security (FICA), Medicare, or Self-Employment tax.

Because unemployment income is taxable, and because Federal income tax is not withheld, by default, millions of Americans could have an additional tax problem. The normal state unemployment benefit runs for 26 weeks, and the CARES Act provided 13 weeks for up to 39 weeks of benefits. In addition, the CARES Act provided $600 weekly of unemployment income through the end of July, with an extension being legislated as we speak.

Example

Let’s do a simple example of Jane, a single lady. Jane was working at aa clerical job in 2020 and earned $8,000 in gross wages through February 28th, 2020. Her withholding on that amount was $1,000. Jane was laid off on March 1, 2020, due to the pandemic and began receiving $300 weekly from her state unemployment insurance program, receiving 39 full weeks in 2020 or $11,700. Jane also received an additional $600 weekly under the CARES Act from the Federal government through the end of July, for another $12,000 in 2020 benefits. 

Jane’s total 2020 AGI will be $31,700 (8,000+11,700+12,000) and, after subtracting her roughly $12,700 personal exemption (including the new $300 charity), Jane is left with $20,000 of taxable income. Tax will be (approximately) $2,200 and Jane has only had $1,000 withheld, so she is in a world of hurt here.

Solutions

Solutions? First, Jane needs to be aware of the potential tax obligation now and to do that she will need to have her accountant estimate her 2020 tax return sometime before the last quarter of the year so she can change her withholding or make an estimated tax payment. She can either: 

  1. File a W-4V to get voluntary withholding applied immediately 
  2. Pay a quarterly estimate or 2 or 3 of say $400 each
  3. Pay the $1,200 when she files her return
  4. File her 2020 return and apply for an installment agreement

With 36 million Americans have applied for benefits, this ugly surprise will hit many clients when they file their 2020 tax returns. 

Low Income Saver’s Credit

Jane could put $2,000 in an IRA. She would qualify for a $1,000 Federal low-income savers credit, and retain the $2,000 IRA deduction, saving her another $240 of Federal tax, so that her actual tax refund would be $40, and she would have $2,000 still in the IRA! 

These are just some of the planning opportunities you can take advantage of when you are working with a tax specialist. Contact us if you have any questions or need to do a year-end review.

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