And up until March 11, they all thought they needed to pay income taxes on that money.
Then the American Rescue Plan, the third recovery bill of the Covid era, passed Congress — a $1.9 trillion package that includes a tax break on those unemployment benefits. The bill exempts up to $10,200 of unemployment compensation from federal taxes, bringing the amount of unemployment the average worker must pay taxes on down to $3,800.
Many who received unemployment last year and filed their taxes before March 11 may now be wondering how to get their hands on the money they’re owed.
Let’s answer some of the most burning questions on this topic.
With so many people out of work and struggling, this tax break is a targeted way to get money back into the pockets of those who need it most. These are the people who badly need extra money to pay bills and get food on the table.
Additionally, some who collect unemployment don’t get taxes withheld throughout the year, resulting in a lump sum of tax owed in the spring that few of them can afford to pay. Expanded unemployment assistance programs made it so that workers were eligible for as many as 47 weeks of unemployment compensation in 2020. That’s a lot of weeks of failing to withhold as the balance of taxes owed continued to grow. Waiving this tax allows those who would have owed a chunk of change to try to repair their finances instead of forking money they don’t have over to the government.
From May through the summer, the IRS will be automatically issuing tax refunds to those who reported unemployment compensation on their tax returns before the American Rescue Plan created the exemption.
The IRS says it will process the refund for single taxpayers first and then move on to married couples who are filing jointly and others with more complicated tax situations.
The refunded amount will come to your mailbox as a check or into your bank account as a direct deposit if the IRS has your bank information.
No, there’s no need to file anything extra if you’ve already filed your return. Just wait for the moolah to arrive.
That being said, if the recalculation of your AGI due to the exemption will make you eligible for other federal credits or deductions that you couldn’t claim before, then you’ll want to submit an amended return.
Under the American Rescue Plan, those who received unemployment last year are exempt from federal tax on up to $10,200 of those benefits (or $20,400 for married couples filing jointly). This only applies to households reporting an adjusted gross income (AGI) below $150,000. Those who made more aren’t able to take advantage of the tax break.
Don’t make the mistake of thinking you’ll be receiving $10,200 in your mailbox. No, no, alas, you’ll be getting back the amount of federal tax you already paid on unemployment compensation, up to an unemployment compensation total of $10,200.
But the good news is that if you received anywhere close to $10,200 in unemployment, you’ll end up saving hundreds in taxes from this tax waiver.
If you owe taxes to the IRS for some reason, the agency will apply the refund you’re due to your outstanding taxes. While that doesn’t mean money in your pocket right now, it is good news for you, as it will reduce your debt.
There hasn’t yet been any word from the federal government about whether 2021 unemployment compensation will also be exempt from tax. Next year, to avoid a surprise tax bill, make sure taxes are being withheld from unemployment you get this year, so you’ll have already paid what’s required if no exemption is enacted.
Your state may be following the federal exemption example in this case… or it maybe not. Some states, like Alaska and California, never tax unemployment compensation. Others might just have exemptions to their usual rules for this tax year.
You can check whether your state will be issuing you a refund in Kiplinger’s state-by-state guide to taxes on unemployment benefits.
The most sensible thing to do with this little windfall is, of course… have a party! No, wait, you can’t have a lot of people together because of Covid. Buy yourself some caviar or some champagne … or some caviar and some champagne!
Or, come to think of it, maybe just pay the rent.
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