More than ten percent of Americans are currently jobless due to the pandemic. If you’re fighting to get a job, you’re probably depending on your unemployment insurance benefits in the meantime. Unemployment benefits were recently expanded on a dramatic basis to help with the coronavirus relief efforts.
Unemployment benefits may be your best means of financial security at the moment. But they might also make your tax situation complicated next year. Unemployment compensation is taxable income, but it doesn’t automatically go through the tax process. You have to set aside a portion to pay to the government.
All taxable income is subject to federal income taxes. The state tax rates vary widely, though. Some states do have income tax on unemployment benefits, while others don’t consider this taxable income. If you live in Pennsylvania, Virginia, New Jersey, California, Alabama, or Montana, you won’t have to pay taxes on your unemployment compensation.
In addition, if you live in a state without income tax, you won’t have to pay taxes on your unemployment benefits. There are nine US states that don’t charge income tax.
Taxes don’t need to be legally withheld from a person’s unemployment checks. However, there are benefits to doing so. The main one is that this course of action lets you avoid massive tax bills later.
Preparing to Avoid a Tax Bill
Proper preparation is key to avoiding a tax bill without getting in trouble with the IRS. Pay attention to all the forms you fill out during your unemployment application. There is an IRS form called Form W-4V that will allow you to apply to have ten percent of your compensation withheld automatically.
With that said, not everyone will pay a 10 percent federal tax rate. If your household income is above a certain threshold, you might have to pay more.
The IRS website has a withholding calculator that allows you to estimate how much you should be paying in taxes on a quarterly basis.
If you use the calculator and discover that you have to pay more than 10 percent, the automatic withholding form won’t be sufficient. Instead, you should make manual quarterly payments throughout the year. This helps prevent you from having a tax liability in the following year.