You Might Need to Refile to Get Unemployment Tax Break

Now that a proposal to limit surprise tax bills on last year’s unemployment benefits has made it into the latest pandemic relief bill, the question is, how will it work?

If the latest Senate version of the American Rescue Plan is approved by the House this week, those who collected unemployment payments in 2020 won’t have to pay income taxes on the first $10,200 they received, as long their household made less than $150,000. Assuming a 10% tax rate, the forgiveness could save people as much as $1,020, lawmakers estimate.

The provision, which was added to the relief package last-minute after being introduced in February as separate legislation, covers both regular state-administered unemployment benefits and payments received as part of temporary federal pandemic relief. It’s intended to spare millions of taxpayers from unexpectedly owing federal taxes when they can ill afford it.

But how exactly will people benefit? The IRS has been accepting 2020 tax returns since Feb.12, so those who filed already may have to file amended returns, a Senate Democratic aide said. It all depends on what the IRS  says, and whether the agency is directed to automatically adjust any previously filed tax returns. 

“Unless lawmakers were to specifically instruct the IRS to automatically make the adjustment for people who have already filed, I expect it’s most likely taxpayers will need to file an amended return in order to benefit,” Erica York, an economist at the Tax Foundation, a nonprofit that studies tax policy, said in an email.  

A spokesperson for the IRS didn’t respond to a request for comment.

The measure will undoubtedly come as welcome news to millions who received an average of $14,000 in unemployment benefits last year, according to estimates from The Century Foundation, a progressive think tank. All told, about 40 million people received more than $580 billion in unemployment insurance in 2020, the group said, estimating that fewer than 40% of payments had taxes withheld. 

Amended tax returns require filling out the 1040-X form, according to York, who said it’s not entirely unprecedented to change the tax code in the middle of tax season, though it is unusual.

“It creates many difficulties for the IRS, for accountants, and for taxpayers,” she wrote. “Certainly not ideal, but the circumstances of a retroactive unemployment exclusion—avoiding or reducing surprise tax bills in a pandemic-induced economic downturn—makes more sense than other retroactive tax changes.”

The measure was first introduced by Sen. Dick Durbin, a Democrat from Illinois, and Rep. Cindy Axne, a Democrat from Iowa.  

Medora Lee contributed to this story.