Tax preparers are concerned that many of the millions of Americans receiving unemployment benefits due to the pandemic are unaware that they might owe money to the IRS next year.
Jobless benefits are subject to federal income taxes, as well as state income taxes in most parts of the country.
But workers who are collecting benefits for the first time may not be aware of those tax implications, or they might opt against having taxes withheld from their benefit payments. People who do not have enough money withheld during the year could end up with smaller refunds or balances due to the IRS when they file their 2020 tax returns.
“It’s a bigger issue now because the volume of people who are unemployed is higher than usual,” said Cari Weston, director for tax practice and ethics at the American Institute of CPAs.
The coronavirus pandemic has led to the highest unemployment rate since the Great Depression and record numbers of workers applying for unemployment benefits. Tens of millions of Americans have filed claims for unemployment benefits since March.
Congress passed legislation in late March expanding unemployment benefits. The $2.2 trillion CARES Act directed states to extend jobless benefits to out-of-work independent contractors and others who don’t qualify for traditional unemployment insurance, and it boosted benefits so that people received an additional $600 per week on top of what they were getting from their states.
The weekly boost to benefits expired last week, and its fate is a central point of negotiations between Democrats and Republicans over the next coronavirus relief package.
Recipients of unemployment benefits have to pay federal income taxes on them, but not payroll taxes. Additionally, most states require people to pay state taxes on their unemployment benefits. Alabama, California, Montana, New Jersey, Pennsylvania and Virginia don’t tax the benefits, along with states that don’t tax any wage income.
The taxable nature of unemployment benefits contrasts with the stimulus checks Congress authorized in the CARES Act. Those direct payments are not taxable income because they are considered advance payments of a tax credit.
When people apply for unemployment benefits with their state, they have the option to have 10 percent of each payment withheld for federal income taxes. But tax professionals said some people may not know how to sign up for withholding.
Additionally, tax professionals said some recipients may choose not to have taxes withheld from their unemployment benefits because they need as much money as possible immediately.
“That is a common feeling,” said Ken Kohlhof, an enrolled agent with a tax preparation business in Nevada.
Tax preparers said that in some cases, people choose to have money withheld from their benefit payments but the amount withheld doesn’t cover all the taxes they owe, like when someone is only unemployed for part of the year.
There also are some taxpayers who may be unaware altogether that unemployment benefits are taxable.
A survey commissioned by Jackson Hewitt in June found that 37 percent of U.S. adults thought unemployment benefits were not considered taxable income. About half of the 1,000 respondents did not know that recipients had to request taxes be withheld from unemployment compensation.
A survey in May conducted on behalf of Credit Karma of 1,022 unemployed adults who are receiving benefits found that 27 percent thought their benefits were not taxable. Of those who knew they had to pay taxes on them, about half said they are having taxes withheld.
Christina Taylor, head of operations for Credit Karma Tax, raised concerns about the 27 percent.
“This can spell trouble for those who are not actively withholding a portion of their unemployment income to put toward taxes,” she said in an email to The Hill.
Preparers also note that unemployment compensation does not count as earned income for purposes of the earned income tax credit (EITC), which could result in some households not receiving a credit or receiving a smaller credit than they have gotten in the past.
House Democrats passed a coronavirus relief measure in May that would allow taxpayers to use their 2019 earned income instead of their 2020 earned income for EITC purposes, but the Senate GOP’s competing measure does not include a similar provision. Negotiators are in the process of trying to hammer out a deal with components of each measure.
Tax professionals are encouraging people receiving unemployment benefits to do a mid-year checkup of their income and taxes and then adjust as necessary.
Kathy Pickering, chief tax officer at H&R Block, said a smaller-than-expected refund or a balance due to the IRS could add an additional financial challenge for someone who lost their job.
“Do a quick check right now so you know where you are,” Pickering said. “It can put you back in control so you can manage those things a bit better.”
In a statement to The Hill, the IRS said it “continues to remind taxpayers throughout the year to do a withholding checkup whenever a taxpayer encounters a change in the personal financial situation, such as a loss of employment.”
The agency said it will provide further communications to the public “on the tax consequences of receiving unemployment benefits and on the importance of doing routine checks of your withholding.”
People have several ways that they can respond if they have not been having taxes withheld from their unemployment benefits, tax preparers said. They can request that federal income taxes start to be withheld from their unemployment compensation by filling out a form W-4V and submitting it to their local unemployment office. They could make estimated tax payments or set money aside in their bank accounts for taxes.
Significantly underpaying taxes throughout the year risks a penalty, but the IRS has provided penalty relief in the past when the agency considers the circumstances it warranted, like during the first filing season of President TrumpDonald John TrumpLincoln Project ad dubs Jared Kushner the ‘Secretary of Failure’ Pence: Chief Justice Roberts ‘has been a disappointment to conservatives’ Twitter bans Trump campaign until it deletes tweet with COVID-19 misinformation MORE’s 2017 tax-cut law.
Tax preparers said they wouldn’t be surprised if the IRS takes steps to assist people who do not have enough money withheld this year.
“They will try not to penalize taxpayers for coming up short at the end of the year,” Kohlhof said.