This article was last updated on March 24
Under the Biden Stimulus (ARP) package which funded another round of unemployment benefit extensions, there was a late provision added that provided a tax break on unemployment insurance (UI) benefits. This was added as a compromise to appease factions of the Democratic party who wanted more support for those receiving unemployment benefits coverage while keeping the incentive to return to work.
The amendment in the final stimulus bill will make the first $10,200 in unemployment benefits/compensation received in 2020 non-taxable (i.e. tax free). For married couples, this amount would be $20,400. This will go a long way to prevent the surprise unemployment income tax hits many jobless American households have seen or are potentially facing in 2020 when filing their tax return.
This unemployment income tax break however will apply to households with total incomes under $150,000 (Adjusted Gross Income, AGI) in 2020. For married couples, the $150,000 limit still applies as it is a household maximum and not a straight filing status doubling like many other income level based credits. Also per recent IRS guidance, this is a hard limit and if your household income is $150,000 or more, irrespective of filing status, you can’t take this tax break on any unemployment income earned in 2020.
Note that this tax break only applies for your 2020 income – used for your tax returns filed in 2021. At this stage no provisions in place for it to apply on your 2021 income (for 2022 filings). But it is highly likely Congress will extend this tax break given elevated levels of pandemic induced unemployment.
On average this tax break could reduce a tax filers liability or increase the refund received by up to $1,020 (or $2,040 for couples). Those who had more than $10,200 in unemployment income in 2020, and there are many states where jobless workers would have received more than this, will still be on the hook for unemployment related taxes above this level.
A simple example of how the tax break would work
John had $21,000 in unemployment benefits in 2020 via the PEUC and FPUC programs. He earned another $30,100 from his job before he was laid off. In this scenario, John’s total 2020 income would be below the $150,000 limit to get the tax break so the first $10,200 of unemployment income would be exempt from taxation. His taxable income (AGI) would essentially be $51,200 – $10,200 = $41,000. Based on this he would likely be able to take other low income tax credits and the standard deduction ($12,400 in 2020) which may mean John gets a pretty decent refund to boot if he paid withholding taxes on his earned income.
What if I already filed my taxes for 2020 and paid taxes on Unemployment?
The IRS have now issued guidance around this. Basically they are saying that for folks who have filed their 2020 return they do not file an amended return (as was originally assumed). The IRS will automatically make the adjustment once they update their systems to review eligibility and process this tax break. If you are eligible you will get an additional refund via direct deposit or in the mail. Tax packages like Turbo Tax and Tax act have updated their software to account for this tax break as well.
What about my form 1099-G?
The IRS receives form 1099-G (reporting unemployment benefit payments) electronically from the individual states’ unemployment agencies. If a tax return or amended tax return is filed reflecting a different amount from form 1099 G, the IRS matching engine will generate a letter to the tax holder showing the discrepancies along with an tax bill for monies due.
The IRS guidance has confirmed that this unemployment tax exclusion should be reported separately from your unemployment compensation.
Does the $10,200 lower your taxable income (AGI)?
Yes. The tax break would act like a credit and reduce your overall taxable income. See example above. It would lower your 2020 tax liability or result in a refund if you can claim the standard deduction and other refundable credits (like the expanded CTC an EITC). See the above point on what to do if you have already filed your tax return.
Should I wait to file my taxes if I can claim this credit?
No. You can claim this now if you have not filed your return. Larger tax preparation companies (like Turbo Tax) have implemented the programming to claim this credit. If you have already filed your return the IRS will review details and make an adjustment to pay back any tax credits per the above FAQ.
How does the Tax Break work for Married Couples?
For married couples filing jointly with AGI below $150k where BOTH received unemployment income, each can deduct the $10,200 for a total of $20,400 against their 2020 taxes. If you file Form 1040-NR (for non-residents, trusts and deceased individuals), you can’t exclude any unemployment compensation for your spouse.
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