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Do You Have To Pay Taxes On Unemployment Benefits?

by Ryan Guina

It may not seem very logical, but did you know if you are out of work and receiving unemployment benefits, you have to pay taxes on the money you are receiving while out of work? Sadly, it’s true. But many unemployed have no idea they are responsible for taxes on unemployment benefits and as a result, they get socked with a large tax bill in the new year. It almost goes without saying that if you are out of work, you probably won’t have the extra cash to give to the IRS.

Paying Taxes On Unemployment Benefits

As with most forms of income, the IRS is ready to collect on the revenue you are receiving even if you are out of work. The same is true on the amount of money you receive as part of a severance package or from accumulated vacation/sick pay once you leave a job.

Unemployment Income Tax Exemption is Limited

In an effort to help the unemployed, the Obama Administration temporarily created an unemployment benefit taxation exemption in 2009 as part of the Economic Stimulus Plan. This effort was only for the 2009 tax year. Individuals are allowed to exclude up to $2,400 of compensation received from unemployment benefits. A married couple could exclude a total of $4,800 if both spouses were unemployed.

However, this help for the unemployed is set to expire for this year’s tax term. In the 2010 tax year, there is no exemption of tax allowed from unemployment benefits unless Congress passes additional legislation in the months to come.

How to Prepare for an Unemployment Income Tax Bill

The only way to avoid a hefty tax bill is to get prepared for the upcoming tax season. Many people do not realize that taxes on unemployment checks are not withheld and it is the responsibility of the recipient to account for these taxes. Last year the IRS recommended to all taxpayers to start withholding tax amounts from unemployment checks should they lose their jobs.

Much like those who are employed, those receiving unemployment could opt to have 10% of their income withheld by completing Voluntary Withholding Request, Form W-4V. The request to withhold money should take into consideration of the $2,400 tax exemption.

Form 1099-G will be sent out from organizations or governmental entities that issued unemployment benefits to recipients. The 1099-G will show the amount of benefits that should be reported for the purpose of income taxes on the taxpayer’s 1040 return.

Start Saving Now

If you have not been withholding your own funds or have not requested monies be withheld, start saving now. Contact a licensed tax preparation professional to discuss the estimate of taxes owed. Once you know about how much you’ll have to owe, you can implement a savings plan to ensure you have enough money to cover the tax bill if you don’t believe you are covered, especially if you have been out of work and receiving benefits for an extended period of time.

If you anticipate a future layoff, then it is a good idea to have taxes withheld if you begin receiving unemployment benefits. It is also good to have an unemployment plan in place if you believe you may be in danger of facing a layoff.


Published or updated September 20, 2010.
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{ 5 comments… read them below or add one }

1 Abigail

The people at the unemployment office usually tell you this and/or there’s a spot on the form to elect to have 10% taken out. Whether that will be enough depends on how much you’ve paid in.

But depending on how early in the year you end up on UE and whether you have a spouse that earns decent money, you may NOT end up owing taxes, thanks to the Earned Income Credit. (Not something you should gamble on, though, so best to pay the 10% to be safe.)

That said, just to show you how screwy tax law is, I was on Social Security disability and was able to work a little as an independent contractor. I literally made under $15,000 that year and owed money to the IRS. For Social Security taxes. Weird.

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2 Ryan

I was on unemployment benefits several years ago after I separated from the military and I elected to have the 10% income tax withheld. It was a wise decision because I didn’t end up owing taxes that year! But I might have had to if I didn’t elect to have the 10% withheld. My advice is to have the money withheld if you don’t absolutely need that additional 10% to get by while you are searching for a new job.

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3 Larry

I see you comment on taxes on unemployment benifits , but , what about tax liabilities on sickness / disability benifits ?

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4 CATHERINE

I KNOW YOU HAVE TO PAY FEDERAL TAXES ON YOUR UNEMPLOYMENT
BUT ARE YOU ALSO RESPONSIBLE FOR TAXES TO THE STATE FOR UNEMPLOYMENT LIKE NEW MEXICO

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5 Mike

For those on unemployment remember you will also have the opportunity to earn a partial benefit credit. That means you can earn up to a certain amount, perhaps you found a part-time job, without your weekly benefit being reduced.

As an example, your determination letter may say you are on Tier 2, will be paid $400.00 per week, and can earn up to $150.00 per week from a job, without any money being taken away from your $400.00 benefit. Thus, you take home $550.00 that week; $400.00 from unemployment compensation and $150.00 from your part-time job.

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