With the amount of people that are unemployed this year due to the Covid-19 pandemic, you’d be surprised to hear that a large portion of those unemployed individuals do not realize that those benefits are taxed by the IRS. What makes this year different from previous years is that the federal unemployment payments of $600 a week substantially increase the benefits. So it’s important to plan ahead for federal taxes, if you haven’t already done so.
At the end of the year, you should expect to receive Form 1099-G, which will show the amount of unemployment benefits that you received. The form will also show any taxes that were withheld on those benefits. The information on Form 1099-G will be used to fill out your 2020 tax return.
There are 3 options to help you cover the taxes on the unemployment benefits:
Option 1: You can ask for a voluntary tax withholding of your benefits, which is a flat 10%. You can make this request by filling out Form W-4V and submitting it to your state’s unemployment office. It’s recommended that you check with your state’s unemployment office first, because they may allow you to file the form electronically through a benefits portal. Please note that when you fill out Form Form W-4V, the tax withholding would apply to the benefits you receive going forward, but cannot be applied retroactively.
Option 2: You can submit estimated tax payments to the IRS, which are essentially pre-tax payments that you are making on income that taxes are not withheld on. Estimated tax payments can be submitted in 2 ways.
Option 3: If you don’t want to have taxes withheld or submit estimated tax payments, the third option would be to set aside the money in anticipation of the taxes that you will end up owing on the unemployment benefits. The easiest way to do this would be to put the money into a savings or checking account and let it sit there until it comes time for you to file your tax return and pay your taxes.
Here’s an example of someone who received $20,000 of unemployment benefits this year and how much in taxes they will owe. Let’s assume that this person earned no other income other than unemployment income and files his tax return as Single with no dependents. He would take the $20,000 of unemployment income and subtract his standard deduction, which in 2020 will be $12,400. This results in income of $7,600 that will be subject to being taxed by the IRS. The tax rate for this individual based on the total income he earned would be 10%, so he can expect to owe about $760 of taxes on those benefits to the IRS.
Separately, on the state level, you may or may not be subject to taxes depending on the state that you live in. Please check with your state unemployment office to confirm if you would need to pay state taxes.