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.