The Tax Requirements of Unemployment Benefits

Unemployment benefits are taxed according to the income rate they fall under. This means you will have to pay federal taxes on the checks just as if they were actual paychecks. Depending on the year you are filing for unemployment benefits, the tax laws may vary slightly. In particular, at times when unemployment is very high, there may be a unique tax break.

Why Unemployment Is Taxed

Unemployment is considered income. All income is taxed, including earnings from savings accounts, investments or property sales. It would be unfair for your income, just because it comes from the government, to be supplied tax free. At times, your unemployment rate is as high as your income rate was previously. Without paying any taxes on this rate, you would actually be out-earning your previous salary. Unemployment is designed to help you cover basic living expenses in between jobs. It is not intended to be a source of income beyond what you previously earned or could potentially earn in a new job. 

When to Withhold Taxes

Taxes are not automatically withheld from your unemployment checks. This can be confusing for some individuals who have never had to file their taxes without a W2 before. When you work for another employer, your taxes are typically withheld in each paycheck. At the end of the year, you may expect a refund or a small payment owed, but the balance is usually negligible either way because you have paid throughout the year. With your unemployment checks, you are not paying throughout the year. Keep this in mind, because you could be stuck with a very large tax payment come April. One option to avoid this scenario is to voluntarily withhold income from your checks. To do this, fill out form W-4V. You can make contributions as you go in the amount of your choice.

American Recovery and Reinvestment Act

A record number of Americans filed for unemployment in 2008 and 2009. In response, the IRS issued a limited-time option to owe no taxes on the first $2,400 of payments through unemployment benefits. This means, if you collected unemployment benefits in 2009, you do not have to pay taxes on the first $2,400. If you are married and filing jointly, both individual can omit taxes on the first $2,400 of earnings through unemployment. This boost was designed to provide needed relief at a critical time, but it is not designed to be a permanent feature of the IRS code.

Mixed Tax Returns

One of the biggest challenges you may face come April is the fact you will have income from various sources in the year you lost your job. First, there is the employer that laid you off. Next, there is your unemployment income. Finally, and hopefully, there will be a third or fourth source of income from the new job or jobs you are able to locate. If this is your first time reporting multiple income sources, it can be intimidating. Use computer software or consult an accountant for help. Your total income from all of these sources will be counted as your income for the year.


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