There's no denying that Covid-19 has changed the lives of millions of Americans. Some people lost their jobs after the permanent closure of their businesses and are yet to get back on their feet. Others were fired and left speechless, not knowing when their bosses would call them back to the office.
As a result, Americans applied for record unemployment insurance at the start of the pandemic. Perhaps you were one of them, resorting to unemployment insurance to help weather the storm during weeks or months while you were out of a job or while waiting for the return of the old job.
Now, with tax season approaching, you may be wondering whether or not you will have to pay taxes on the unemployment benefits you received. Do not worry! We have a few answers that will help you figure it all out.
What is Unemployment Insurance?
Unemployment Insurance is a joint federal-state program that can provide a safety net to keep you from falling out when you lose your job. The unemployment benefits you receive from Unemployment Insurance are designed to replace some of your lost income while looking for a new job. It won't replace all the money you've earned, but it's something that will help you while you're looking for a new job.
In response to the Covi-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed in March 2020, which extended unemployment benefits in several ways. First, the amount of money received by Americans increased by an additional $600 per week. And second, the length of time a person could collect unemployment benefits increased (from 26 weeks to 39 weeks in most cases).
Many of these advantages were about to fade like the sunset at the end of 2020 before Congress stepped in again with the Continued Assistance Act, which extended many of these benefits through 2021.
Who is entitled to unemployment benefits?
Each state sets its own regulations for determining who is eligible for unemployment benefits. But in most states, you'll qualify for these benefits if you lose your job "through no fault of your own."
So if your job has been cut short due to a series of layoffs or you quit due to unsafe working conditions, you should have no problem applying for and receiving unemployment benefits. But if you simply resigned or were fired for "gross misconduct," perhaps because you were caught stealing office supplies (or worse), you may be out of luck.
Some states also stipulate that you must have worked for a certain period in your last job or received a minimum income from your former employer to qualify for this benefit. It all depends on where you live!
Self-employed persons, such as freelancers and independent contractors, are generally not entitled to unemployment benefits. But because of the Covid-19 pandemic, the CARES Act opened the door for states to extend benefits to some of these workers, at least for now.
Are unemployment benefits taxable?
In a normal business year, the answer would be "yes." Everyone would pay federal income tax on the unemployment benefits they collect. But 2020 was no ordinary year, and in response, Congress passed the U.S. bailout in March, which changed how they are administered. And that's a big change.
But the same can't be said for 2021 tax filing purposes, as there has been nothing to indicate that taxpayers should expect a similar break for the 2021 tax year.
Now you need to know some lowercase rules. Firstly, if you got more than $10,200 in unemployment benefits for 2020, the excess is taxable and must be reported as income. For example, if you collected $10,500 in unemployment benefits in 2020, that's $300 more than the tax exemption threshold of $10,200. You will have to claim that $300 of income and pay taxes on it.
Second, the tax exemption only applies if family income is less than $150,000. If your household income exceeds this limit for 2020, any unemployment benefits you receive will be taxed, as usual, depending on your tax category. Uncle Sam wants his share! (Although it's good to remember that the money from the incentive checks will not be taxed.)
However, you know this: your unemployment benefits are always subject to state income tax unless you work in a state with no income tax or in a state that does not tax unemployment benefits.
What if I owe unemployment insurance contributions?
If you have to apply for unemployment benefits, it's time to see how you can pay those taxes! Let's go through the available options and see which is the best:
Withhold your taxes from unemployment benefits: When you apply for unemployment insurance, if you elect to withhold 10% from each payment (you cannot withhold more or less) to help cover your federal income tax, you may not have to do anything else.
Pay the estimated taxes: If you choose not to withhold tax from your benefits, you can send estimated quarterly taxes on that money to the IRS.
Wait for tax season: Usually, our advice is to pay your income taxes as you go rather than waiting for tax season to pay them all at once. But in a year far from normal, we also understand that several factors may be at play or that the decision has already been made. Conclusion: In this economic climate, prepare for change and stay informed as much as possible.
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