Unemployment benefits can help cushion the blow when you lose your job. But if you received unemployment compensation in 2022, you may be in for a surprise when you prepare your tax return. That’s because you could owe taxes on your jobless benefits.
How Are Unemployment Benefits Taxed?
Let’s back up: Is unemployment taxable? Unfortunately, the answer is yes — and that can seem like Uncle Sam kicking you when you’re already down.
If you received unemployment compensation in the past, that may come as a surprise. Back in 2021, the American Rescue Plan provided a small measure of relief for people who received benefits in 2020 at the peak of the COVID-19 crisis: The first $10,200 of unemployment compensation was shielded from taxes for households with incomes under $150,000 in 2020.
But that relief measure applied only to 2020. Expect to pay ordinary income taxes on unemployment when you file your 2022 tax return (due April 18, 2023) and in future tax years.
Still, many people are surprised to learn that they have to pay taxes on their jobless benefits. A Jackson Hewitt survey found that 39% of adults weren’t aware that unemployment is taxable.
Here’s a breakdown of how taxes on unemployment benefits work.
Federal Income Taxes
When you receive unemployment benefits, they’re taxed at the federal level as ordinary income.
That means if you got $10,000 from unemployment during a typical year, it would be taxed in the same income tax brackets as it would if you’d earned $10,000 from a job. But you wouldn’t owe payroll taxes, i.e., Social Security and Medicare taxes, on your benefits.
State Income Taxes
At the state level, it looks a little different. You won’t owe state taxes on your unemployment if you live in one of the following nine states that don’t have state income taxes:
- New Hampshire (taxes dividends and interest income, but not wages or unemployment benefits)
- South Dakota
Of the remaining 41 states, the following seven plus the District of Columbia exempt unemployment from taxes:
- New Jersey
A few others partially tax unemployment, but in most states, your unemployment is fully taxable.
How Do I Pay Taxes on My Unemployment?
There are two basic ways to pay federal taxes on your unemployment. Because the U.S. has a pay-as-you-go tax system, neither answer is “pay it all next year” — though as we’ll discuss shortly, the consequences for doing so aren’t too harsh.
- Have your state unemployment office withhold it. This is how it works when you’re employed and your employer automatically takes out a portion of your check for taxes. You can opt to have 10% of your benefits automatically withheld, but you don’t get the choice of having more or less withheld. When you first apply for benefits, you’ll have the option of filling out IRS Form W-4V for voluntary withholding. If you’re already receiving benefits, you can still submit Form W-4V to your state office to change your withholding.
- Pay unemployment taxes quarterly. The IRS says you should make quarterly estimated payments if you expect to owe at least $1,000 in taxes from all your income sources and you haven’t had at least 90% of what you’ll owe for the year withheld. Alternatively, you’re in the clear if you had 100% of the prior year’s tax bill withheld if your adjusted gross income is under $150,000, or 110% if your AGI is over $150,000.
What if I Haven’t Had Taxes Withheld?
There’s no need to panic if you haven’t had taxes withheld on your unemployment compensation.
A lot of people are in that situation. Either they haven’t had taxes withheld because they’ve needed their entire check to survive, or they just didn’t know they had to pay taxes on their benefits.
If you’re still receiving benefits and the 10% withholding wouldn’t threaten your ability to pay for your basic needs, we suggest submitting Form W4-V to your state unemployment office ASAP.
The worst-case scenario: You owe money on Tax Day and can’t afford the bill.
While the IRS may have a reputation for making grown-ups cry, owing money at tax time isn’t as terrifying as it sounds, so long as you file a tax return on time. (You can get more time to submit your return if you file for an extension, but the tax bill is still due on April 18, 2023.)
In most situations, you can automatically get approved for a payment plan that will cost you just 0.5% in interest per month, up to 25% of your overall bill. If you can afford to pay the entire bill within 120 days, you won’t incur additional fees. Otherwise, you’ll pay $31 to set up a direct deposit payment plan online or $107 to set it up by phone or email, or in person.
Of course, the IRS will encourage you to pay as much as you can afford, but you can select a monthly payment that’s as low as the total amount you owe divided by 72.
Fees aside, 0.5% per month works out to 6% per year. By comparison, the average credit card interest rate is over 17%, which makes the IRS look like a pretty generous creditor. For that reason, we’d suggest going with a payment plan when you can’t afford a tax bill, rather than charging it to a credit card.
You may also qualify for certain tax credits that will offset the amount you owe.
Just make sure you file a tax return next year, even if you can’t afford to pay. The failure to file penalty is pretty steep at 5% per month up to 25% of your tax bill.
The bottom line: You will pay taxes on your unemployment compensation. Pay them upfront either automatically or quarterly if you can. But know that if you owe taxes on your benefits next year, that doesn’t spell doomsday for your finances.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected]