Unemployment benefits are treated as regular income and are subject to taxation, but they are exempt from Social Security and Medicare taxes.
You’ll typically receive Form 1099-G from your state’s unemployment office in January, which details the total amount of benefits you received in the previous year. You’ll need to include this information when filling out Schedule 1 of your 1040 form for your federal tax return.
Form 1099-G will also show any taxes that were withheld from your benefits for federal and state income taxes, which you must also report on your tax return.
While most states tax unemployment benefits, there are exceptions. California, Montana, New Jersey, Pennsylvania, and Virginia do not tax unemployment benefits. Additionally, Alabama, Indiana, and Wisconsin may partially or fully exclude unemployment benefits from taxation in certain cases.
How Unemployment Benefits Are Taxed
Unemployment benefits are considered ordinary income, akin to wages, but they are not subject to Social Security and Medicare taxes.
When you receive unemployment benefits, you should expect to receive Form 1099-G from your state unemployment office in January, detailing the total compensation you received for the previous year. This information should be reported on Schedule 1 of your 1040 form when filing your federal tax return.
Form 1099-G will also indicate any amount withheld from your benefits for federal and state income taxes, which you are required to report on your tax return.
Although most states tax unemployment benefits, there are exceptions. States like California, Montana, New Jersey, Pennsylvania, and Virginia do not tax unemployment benefits. Additionally, states like Alabama, Indiana, and Wisconsin may offer partial or full exclusions for unemployment benefits from taxation in certain situations.
How to Pay Taxes on Unemployment Benefits
When you start receiving unemployment benefits, you have the choice to have taxes deducted from your payments, similar to how taxes are withheld from your regular salary. This helps prevent any unexpected tax bills during tax season.
You can opt to have taxes withheld when you initially apply for benefits, or you can fill out IRS Form W-4V (Voluntary Withholding Request) and submit it to your state unemployment office. It’s important to note that you can only request up to 10% of each payment to be withheld for federal income taxes.
Ultimately, the decision to have taxes withheld from your unemployment benefits is up to you. Mitchell Freedman, a CPA and personal financial specialist, suggests considering your individual financial situation. If you typically receive a tax refund even after receiving benefits, you may opt not to have taxes withheld. However, if you’re concerned about owing taxes come tax season, having taxes withheld can alleviate some of the stress associated with paying your tax liability.
Other Options to Pay Taxes on Unemployment Benefits
If you prefer not to have income taxes withheld from your unemployment benefits, there are alternative options to ensure you cover your tax obligations. One approach is to pay estimated taxes quarterly, providing you with more flexibility in managing your finances. Alternatively, if you return to work later in the year, you can choose to have more taxes withheld from your paychecks.
Morris Armstrong, an enrolled agent, advises considering your financial situation when deciding on tax withholding. If you’re facing financial constraints and need all available funds for living expenses, you may opt for minimal tax withholding now and address any tax shortfall during tax season. However, it’s important to be aware that this approach may result in penalties for not paying taxes throughout the year, especially given the current higher interest rates.
Armstrong emphasizes the importance of acknowledging that unemployment benefits are taxable income and recommends having taxes withheld whenever possible. Additionally, he suggests making adjustments later on through either withholding or estimated tax payments to ensure compliance with tax obligations.