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Unemployment Compensation Payments: Yes, They are Taxable!

If you are receiving unemployment benefits, it is important to know that the Internal Revenue Service (IRS) considers those benefits income and therefore are taxable.  If you don’t want to be faced with a large tax bill during tax season, you should make a plan now to pay the additional income tax.

The Long and Short of It

Any money that you receive as an unemployment benefit is considered to be income and is therefore taxable.  But these benefits are not subject to the normal payroll taxes which include the Social Security and Medicare withholdings.

You’ll need to keep in mind that while everyone owes Federal Income Tax on their UC Benefits, State Tax will vary. Check with your local State Unemployment Agency for the tax requirements in your State.

How To Pay

There are 3 Options to pay your income tax while you receive your UC Benefits.

  1. Have your State unemployment office withhold the tax – You should be given the option to elect this method when you initially apply for Unemployment. If you have already applied but did not elect this option, you can contact your local Unemployment Office to request the withholding of Federal and State (if applicable) taxes.  Once you’ve selected this option, your taxes will be taken out with each check you receive, similar to when you are receiving a paycheck.
  2. Pay quarterly estimated tax payments – This option is more time-consuming and is more difficult to navigate.  You will need to pay 4 quarterly payments each year in order to avoid paying penalties for failing to pay enough tax during the year. You will need to submit your payments to the State and Federal Governments separately, as well.
  3. Pay the tax in full when due – If you are only receiving UC Benefits for a short period of time and need more money immediately, this may be a good option.  But keep in mind that you may face a large tax bill in April and will need to save the money to pay this bill in full when it is due. 

The Impact of COVID-19

The Coronavirus Aid, Relief & Economic Securities (CARES) Act created the Federal Pandemic Unemployment Compensation (FPUC) program.  This program was created to provide an additional $600 in unemployment compensation to Americans who are out of work due to the COVID-19 Pandemic.  Not unlike the regular Unemployment Compensation (UC) Benefits, these benefits are also taxable and add to the tax liability for those receiving Unemployment Compensation.

The Bottom Line

All unemployment benefits are taxable at the Federal level and for some people at the State level.  You should contact your State Unemployment Office to ensure that your Federal and State (if any) taxes are being automatically withheld.  Doing this now can save you from an expensive tax bill later.

Posted July 2020 – Copyright 2020

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