The IRS Just Made It a Lot Simpler to Get the Unemployment Tax Break. Here’s What You Need to Know

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The latest stimulus bill allows tax exemptions for up to $10,200 in unemployment benefits paid in 2020. This only applies to taxpayers whose Adjusted Gross Income (AGI) for 2020 is less than $150,000.

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  • Unemployed workers can waive up to $10,200 in unemployment benefits received in 2020 from their taxable income.
  • If you’ve already filed your 2020 tax return, the IRS will automatically begin issuing refunds beginning in May.
  • Read more about the American Rescue Plan, the latest stimulus bill recently signed into law.

Millions of Americans who received unemployment benefits last year are in for big-time tax relief thanks to the $1.9 trillion stimulus package that passed in early March. 

In addition to extending federal $300 unemployment benefits through September, the American Rescue Plan allows tax exemptions for up to $10,200 in unemployment benefits paid in 2020. This applies only to taxpayers whose Adjusted Gross Income (AGI) for 2020 is less than $150,000. 

This provision could save the average claimant hundreds of dollars when they file their taxes. After some initial confusion over how to claim the exemption, the IRS announced Wednesday that it would automatically issue refunds to taxpayers who filed their 2020 returns before the stimulus passed. Earlier this month, the agency also issued guidance on how new filers can exempt the benefits from their returns.

If you received unemployment benefits in 2020, here’s what you need to know about claiming the exemption on a new or already-filed return:

What to Do if You Have Filed Already

If you collected unemployment insurance in 2020 but you already filed your tax return, you are still eligible for the exemption under the American Rescue Plan. You do not need to take any action to claim the money you’re owed. Instead, the IRS will automatically refund the money. 

The first round of payments will begin in May and continue over the summer, according to the IRS. You’ll either receive a refund or the amount will be deducted from your taxes owed.

“There is no need for taxpayers to file an amended return unless the calculations make the taxpayer newly eligible for additional federal credits and deductions not already included on the original tax return,” the agency noted in a recent release

This includes, for example, taxpayers who claimed the Earned Income Tax Credit (EITC) but are eligible for an increased credit under the new exemption. While you’ll automatically get a refund for the exemption, you’ll need to file an amended return to get a larger credit.

What to Do if You Have Not Filed Taxes 

If you haven’t already filed your 2020 tax return, you can claim the exemption allowed by the American Rescue Plan when you file.

You can find all the information about what benefits you were paid and how much (if any) was withheld using Form 1099-G, which you should have received from your state unemployment office by mail or electronically. You may receive separate forms for state unemployment compensation and any federal benefits you received, but you should report all benefits you were paid on your return, according to the IRS. 

If you qualify, you’ll report your total benefits from Form 1099-G separately from the exclusion. Here’s how:

Generally, you report your taxes using Form 1040. But when you claim unemployment insurance, you must also complete a Schedule 1 form to report this additional income. Under the new exemption, you should report the total amount of unemployment compensation you received on line 7 of Schedule 1. Then, use the Unemployment Compensation Exclusion Worksheet to determine the exclusion amount you’re eligible for, which you’ll report on line 8 of Schedule 1. 

If you work with a tax preparer to file, they should be able to assist you in working out what to report on these forms using IRS guidance. If you file using a tax software, the IRS says these changes should now be reflected in the software you use to prepare electronically. 

Unemployment Benefits and 2020 Tax Returns

Without this new tax exemption, many people who claimed unemployment benefits in 2020 could have faced an unwelcome tax bill.

Generally, unemployment benefits are taxable income. That includes standard state unemployment benefits as well as 2020 federal benefits expansions, like PUA, PEUC, and other federal relief measures.

But millions of claimants did not have federal taxes withheld from their benefits last year, whether because they didn’t know they were taxable or because they couldn’t afford to have some amount of benefits withheld, according to analysis by the Century Foundation

To further complicate things, while state unemployment offices are supposed to offer standard 10% federal tax withholding, not all states offered withholding consistently across different CARES Act programs. 

Researchers estimate fewer than 40% of unemployment insurance payments issued in 2020 had taxes withheld.

The average unemployed worker received $14,000 in unemployment benefits in 2020, the Century Foundation estimates. Now, with $10,200 of that income tax-exempt, the average claimant will owe taxes on just $3,800 of the money they took in.

Tax Returns and Third Stimulus Payment

The bill’s mid-tax season passage may have caused a lot of confusion for unemployed taxpayers trying to determine the best time to file. 

But the good news, says Janet Holtzblatt, senior fellow at the Urban-Brookings Tax Policy Center, is that you will receive the full amount you’re owed, even if there is a delay.

For taxpayers whose stimulus eligibility was processed based on 2019 returns, “at some point — possibly later this year, but definitely when they file a tax return next year — the IRS will bump up the money and send an additional amount or what they would have received based on 2020 income.” 

In other words, you may have to reconcile your payment using a similar claim to the Recovery Rebate Credit for the previous two stimulus payments.  

Planning for 2021 Taxes if You’re Still Unemployed

The tax exemption for $10,200 in unemployment benefits currently only applies to unemployment income you collected in 2020, even though the bill also extended weekly $300 federal unemployment benefits payments through September. 

You should consider any unemployment benefits you receive in 2021 as fully taxable. If you can afford to do so, avoid a surprise bill and penalties next tax season by electing to have taxes withheld from your weekly benefits payments or by paying quarterly estimated taxes throughout the year.

You can elect to have 10% of your unemployment benefits withheld from your weekly check. Even if you did not select this withholding on your original claim, you can file Form W-4V with your state’s unemployment office to begin 10% tax withholding on future unemployment payments.  

You can also forgo automatic withholding and instead pay estimated quarterly taxes on your unemployment income. Use Form 1040-ES to figure and file your quarterly payments. If you choose to pay estimated taxes on your unemployment benefits, the first payment is due April 15, 2021.