Millions Ambushed by Taxes on Their Unemployment Checks

Millions of taxpayers are in the process of finding out that they have to pay income taxes on their unemployment benefits. For many, it’s a lesson that will involve a reduced tax refund, or worse yet, an unexpected bill at a time when many households can’t afford it.

From March 21 through the end of 2020, more than 68 million new unemployment claims were filed, according to data from the Department of Labor. Much of that is thanks to the pandemic’s widespread economic damage, and tax preparers say each claim is potentially a headache waiting to happen. While people collecting unemployment have the option of withholding 10% of their benefits to pay income tax, it’s not a very common move, according to the IRS and tax professionals. (Some states count unemployment benefits as taxable income, others do not.)

The resulting reduction in tax refunds, or money owed to the IRS or state tax collectors, will no doubt come as an unwelcome surprise for millions of people who collected unemployment benefits last year, according to Mark Steber, chief tax information officer for Jackson Hewitt Tax Service. Indeed, only 38% of people even knew that unemployment benefits were taxable, a Jackson Hewitt survey of customers showed. 

“Unemployment is a complicated tax issue every year,” Steber said. “It catches people off guard. But what happened in 2020 is on an order of magnitude that we’ve never seen in this country.”

Most taxpayers are accustomed to getting refunds, with about 75% of those who file through Jackson Hewitt getting one, Steber said. The average tax refund in 2019 was $2,741, according to IRS statistics. This year will likely be different, although it’s too early to say by how much. 

For people that take advantage of the Earned Income Tax Credit for low-income households, the proliferation in benefits poses another problem: unemployment benefits do not count as earnings despite being taxable, and therefore do not contribute to the amount of EITC they receive. 

Another factor making taxes a nightmare this year? People may have been collecting unemployment benefits from more than one of the multiple pandemic relief programs created by the government in 2020, Steber said, meaning they may have to dig up income forms from multiple sources in order to file their taxes properly. Tax returns will get even more tangled for those who picked up side gigs to pay the bills this year. 

All this is an argument for taxpayers to file early, Steber said. Anyone who ends up owing taxes has until the April 15 deadline to pay, and it is better to know ahead of time in order to put money away to pay the bill. For those struggling to pay, the IRS also offers payment plans where taxpayers can pay outstanding taxes in installments.