Is unemployment taxed? Get answers to 3 key unemployment income questions

In short, yes, unemployment income is taxed.* However, paying taxes on unemployment income and understanding how getting unemployment affects your tax return, calls for a bit more explanation – especially if you want to avoid unpleasant surprises at tax time.

By far, one of the most devastating economic impacts of the coronavirus crisis is the staggering number of workers who are claiming unemployment benefits. If you’ve never received unemployment income, we understand this new territory maybe stressful as you’re looking for answers.

*Note for 2020 tax returns: A new rule may allow you to exclude up to $10,200 of unemployment benefits from your income. Find the latest details about this unemployment tax break.

Have other tax-related unemployment questions, visit our Unemployment Resource Center. 

Unemployment income – Tax calculator help

Before we jump to your questions, you may want to see how your unemployment income will affect your taxes. You can include your unemployment income in our tax calculator to get an estimate of your tax liability or potential refund.

Answering your unemployment income questions

To help you make sense of it all, we’ll answer 3 important questions:

1. Is unemployment taxable on the federal and state level?
2. How and when do you pay income tax on unemployment?
3. Does getting unemployment affect your tax return?

Plus, H&R Block Free Online allows you to include unemployment income. You can’t do that with TurboTax Free Edition.

QUESTION 1:

Is unemployment taxable? Federal and state tax considerations

First, let’s clarify what type of tax we’re talking about. Unemployment is taxed for all recipients at the federal level. How much you pay will depend on your tax bracket and how much taxable income you have.

When it comes to state taxes, it depends. If you’re in one of the states with no income tax, you won’t need to worry about paying state taxes on your unemployment income. For states with income tax, the treatment of unemployment income varies from state to state. For example, unemployment is taxed in Michigan, but in California unemployment benefits are exempt from state taxes.

Are you also wondering about the additional $600 of federal unemployment benefits from CARES Act? Yes, this unemployment income is taxable just like your state benefits.  

QUESTION 2:

Do you pay income tax on unemployment? How and when?

When you receive wage income from a job, you pay taxes as you go through wage withholdings. Information you give your employer on Form W-4 tells your employer how much to withhold from your paycheck. In other words, you’re paying your taxes little by little with each paycheck.

You have the same option to withhold taxes with unemployment income, but it’s not automatically applied. If you choose to withhold federal taxes, the percentage is set at 10%. Depending on your situation, that amount might not cover all your taxes, but at least you do pay some income tax on unemployment as you go.  

So, what are your options if you didn’t set up withholding to start?

• If you’re still drawing unemployment, you can start withholding taxes by completing Form W-4V and submitting it to your state unemployment office.
• If you need to catch up, you can pay estimated taxes. These payments can be made quarterly, giving you another way to account for your tax obligations throughout the year.

Why bother with estimated taxes? Penalties, for one. By not paying taxes via withholding or estimated payments, you risk an underpayment penalty. Plus, you’ll have a larger tax bill at tax time.

QUESTION 3:

Does getting unemployment affect your tax return?

Again, the answer here is yes, getting unemployment will affect your tax return. How it affects you depends on your situation.

Here are a few ways unemployment income can affect your taxes:

Taxes due/your refund – As mentioned above, paying taxes through withholding or estimated taxes, will reduce what you owe at tax time and reduce the chance that you may have an underpayment penalty.

How does unemployment affect your tax refund? If you haven’t paid enough in taxes, you may end up owing taxes when you file your return. If you’ve paid too much during the year, you’ll get money back as a tax refund.

Forms you receive – When you have unemployment income, your state will send you Form 1099-G at the end of January. You’ll use this form to complete your 2020 tax return.

Eligibility for tax credits – If your total income is lower as you collect unemployment income, it may affect your eligibility for certain credits or change how much credit you can receive. For example, you may now qualify for the Earned Income Credit or be able to receive more (or less) of it.

Additionally, if you’ve experienced job loss, you may be able to purchase health insurance through the Health Insurance Marketplace. Depending on your income level you may be eligible for the Premium Tax Credit.

What if you’ve repaid some of your unemployment benefits? If you’ve paid unemployment money back in the same year it was received, it can offset what you’ve received. If you repay it the next year, you’ll won’t be able to take a tax benefit unless your future year repayment is more than $3,000.

Not sure how that works? Take Roland for example: he received $2,000 in unemployment income this year but paid back $1,500 before the end of the year. When he files, he’ll only need to pay taxes on the remaining $500 of unemployment income.

Have unemployment income? You may be able to file for free

Unemployment benefits can provide a vital income source for you and your family during a stressful financial setback. When it comes to tax time, filing your return shouldn’t add to any of your worries.

That’s why we’ve made filing as easy as possible. For example, you can snap a pic of your documents, and the program will help you work through your return with step-by-step guidance.

Best of all, H&R Block Free Online allows you to include unemployment income (Form 1099-G).

Find out more about H&R Block Free Online.