COVID-19 Unemployment Benefits and Your Taxes
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The economic downturn of the coronavirus pandemic that struck back in March left millions of Americans without jobs. Currently, more than 22 million people are collecting unemployment benefits — much of which is a direct result of the country shutdown. And while the CARES Act offered some relief to those impacted by the economy closure through increased unemployment benefits, there is one big caveat to receiving those payments that many recipients may have overlooked.
The fact is unemployment compensation doesn’t come tax free. Anyone who receives it, must pay taxes on that money. That’s right. It’s taxable income – even if it doesn’t feel like you “earned” it. If you received unemployment benefits in 2020 – or any year – you must pay your share of taxes on that money. But if you find yourself sitting here, worrying that you haven’t done so yet – don’t fret. There’s still time to catch up before the end of the year. There are a few different ways to do so. Let’s walk through the basics.
Unemployment benefits are taxable
The United States has a pay-as-you-go tax system, which means you must pay income tax as you earn income during the year. And while it may feel like unemployment benefits are not considered “earned income”, they actually are. You do not have to pay Social Security and Medicare taxes on the money like you do normal wages, but unemployment benefits are taxed by the federal government and possibly by your state depending on where you reside.
When you signed up for benefits, you may not have realized taxes could be withheld from your payments. Or maybe you opted to not withhold taxes and take home the full benefit amount instead. Either way, it’s important to understand your current situation now so you aren’t surprised with a large tax bill or a significantly smaller refund when it comes time to file your return. That’s because if you haven’t paid enough tax throughout the year, not only will you have to pay the amount you owe by the filing deadline, but you’ll also be subject to an underpayment penalty.
Time is still on your side
Thankfully, if you haven’t been paying (or saving) enough tax money to cover your unemployment income, there’s still enough time left in the year to make a plan and reduce any uncertainty.
First, take some time to evaluate your income from earlier in the year before you became unemployed. Analyze the tax money you withheld. Was it enough to cover the income you earned at that time? Was it more than enough? If it calculates out to cover more than you technically earned at the time, you can use what you already paid in to cover a portion of the taxes owed on your unemployment benefits.
Use that information to create an action plan for the remainder of the year. How much money do you still have to cover the tax on? If you haven’t withheld enough to cover all of your unemployment benefits, you still have options to help minimize the impact that may have on your return next tax season.
Opt to withhold taxes from your benefits
It’s tempting to opt out of withholding tax on your unemployment benefits. But foregoing that option is an expensive choice. The tax bill racks up quick. Even if you haven’t done it yet, you can still elect to withhold your tax liability directly from your unemployment income.
Federal law allows you to have a flat 10% withheld from your benefits to cover your tax liability. Simply fill out Form W-4V, Voluntary Withholding Request, and send it to the agency paying your benefits. Before completing the form, however, check with the payor to see if they have their own withholding request form. Following their procedure will help expedite the request.
Proactively set aside 10%
If for some reason, you don’t want to have your taxes withheld directly from your benefits payments, you can always choose to save a chunk of money on your own to cover the responsibility. For example, you could consider stashing 10% of your weekly benefit into a sinking fund, which is a savings account that’s separate from your emergency savings. Sinking funds are designed to be used to save for a specific expense. In this case, it’s your tax bill. Having a separate fund allows you to know exactly how much money you’ve saved to specifically cover your tax bill and help to ensure you don’t tap it for other purchases.
Of course, you can simply save 10% of each payment in your regular savings account. But you have to be extra careful not to withdraw too much from that account for other expenses so that you don’t risk using up all the money you set aside to cover your tax liability.
Send in an estimated tax payment
If you don’t withhold taxes upfront, your other option is to submit an estimated tax payment. There are two different options for doing so. The first is to submit a payment using the IRS online payment portal. The second option is to print Form 1099-ES and mail your payment to your regional IRS processing center. Regardless of which option you choose, make sure to keep a receipt of when you sent the payment so you can report your estimated tax payment on your return.
If you have a TaxAct account, you can sign back in and the product will help you calculate your payment and complete the proper vouchers. Unfortunately, if you already filed your tax return, you can’t set up direct deposit payments. But as mentioned earlier, you can still set up a payment plan using the IRS portal. The IRS also has instructions to help you calculate your estimated payment.