Since March, an estimated 40 million Americans have filed for unemployment. The CARES Act, which passed on March 27th, was an enormous relief to our country’s workers. This was the first time that many of them feared for their financial security.
How were unemployment benefits affected by the CARES Act?
This new law did three things:
- It expanded who qualified for unemployment,
- It extended the eligibility period, and most note-worthily,
- It promised an extra $600 per week on top of the state benefits.
Most gifts from the government come with strings attached, and this one is no different. If you are receiving these funds, don’t be surprised that this money is considered taxable income, as all unemployment benefits are. In January, expect to receive a Form 1099-G (Certain Government Payments) from the state. This tax form will show the amount of unemployment compensation you received, and the amount of taxes withheld.
The problem here is that most people are not having tax withheld from their unemployment benefits. This taxable income will most likely result in a tax bill after filing their 2020 income tax returns. Many who accepted additional unemployment benefits without withholding money for taxes may be surprised when they owe more taxes than they realized.
How do you pay taxes on unemployment?
There are several ways to pay taxes on unemployment, including:
- Have taxes automatically withheld – You can file a Form W-4V (Voluntary Withholding Request) to have federal and state (if applicable) income taxes withheld automatically from your unemployment benefits—just like a paycheck.
- Make estimated tax payments – You pay quarterly income tax payments every three months, based on the total unemployment benefits that you received.
- Pay income taxes when you file your tax return – You pay any income taxes owed when you file your next income tax return.
- Have extra withheld when you return to work – You can ask your employer about increasing your withholding to set aside more funds to pay your tax bill next year.
There are advantages and disadvantages to each of these solutions. Do some planning with your tax preparer to avoid a surprise tax bill and choose the option that best works for you.