You Could Owe Thousands In Taxes from Unemployment Insurance — What to Know

Lizzy Francis
·4 min read

According to recent reports, millions of Americans who received unemployment insurance in 2020 — some 40 million people — could actually find that they were taxed on their unemployment insurance when they file their taxes for the 2020 fiscal year.

How did this happen? Well, some people don’t know that unemployment insurance is taxable — which it is, depending on what state they live in. Others might have signed up to withhold 10% of their unemployment benefits through their state, but not had the enhanced federal benefits withheld as well. The federal enhancement helped pad the unemployment insurance system as tens of millions became unemployed through the COVID-19 stimulus packages, but some states didn’t help withhold those unemployment payments. Here’s what you need to know if you owe money — and if help is on the way.

Could You Owe Taxes On Your Unemployment Insurance?

It depends on what state you live in. If you live in one of the seven states that don’t have state income tax at all (Alaska, Florida, Nevada, South Dakota, Texas, Washington State, Wyoming) you shouldn’t see any indication that you owe the state income tax.

Montana, New Jersey, Alabama Pennsylvania, and Virginia, as well as California exempt unemployment benefits from income taxes.

Ad two states only tax a portion of unemployment benefits — Indiana and Wisconsin.

In every other state, unemployment benefits are treated as regular income. At the federal level, that’s also true. According to Experian, you could be taxed federally on your unemployment insurance anywhere from 0 to 37 percent.

That’s why many people choose to set up withholding on their unemployment checks — where they ask the state to withhold a portion (10 percent) of their unemployment insurance, which the state automatically sends to the IRS come tax time. But some people, according to CNBC, did that and still owe thousands to the IRS. Here’s why they might still be screwed.

I Asked My State to Withhold On My Insurance But Still Owe Taxes. What Next?

In fact, CNBC reports, even folks who used the tax withholding system so that they wouldn’t owe thousands in taxes they couldn’t afford to pay come the season, still owe thousands to the IRS — because some states simply withheld the money from state unemployment insurance and didn’t do the same for the enhanced federal payments, despite the withholding system being a federal law. This is a big deal. Unemployed workers from at least three states — California, Minnesota, and Hawaii — had told the outlet that they, too, had received unexpected tax bills after utilizing their state’s withholding system.

For those who weren’t expecting to receive ginormous tax bills, the development may be shocking. After all, having thousands of dollars of cash on hand is not usually something people who are unemployed are able to access, and an unexpected tax bill when people are struggling to pay bills, rent, or feed themselves and their kids could sink them. As a result, there has been some legislation at the federal level that could potentially pass and help taxpayers.

Is There Help On The Way?

In very early February, a handful of Democratic Senators re-introduced legislation that would allow the first $10,200 of federal unemployment insurance to be tax-exempt. But the difference between reintroducing legislation and it passing a filibuster-proof majority is massive — especially when taxes are due in about five weeks. There’s also been some talk to provide tax forgiveness to those surviving on unemployment through the stimulus package.

Some states have also tried to step in to stop the problem before it starts. In Maryland and Delaware, Washington Post reports, for example, lawmakers have already worked to ensure that there’s no state income tax on unemployment insurance during the pandemic.

But the problem in other states will still be felt, strongly. And as additional unemployment insurance is set to expire in just 10 days, the problem could become more acute.

You should also be aware of tools that help you pay off your taxes in installments — a sad reality given that many question the very nature of levying taxes on unemployment insurance at all. Still, barring some major action from the Senate (not impossible, of course) you might be stuck with a bill you didn’t expect, and there are tools to help you weather it if need be.

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