How Unemployment Affects Your Taxes

Many people consider unemployment benefits to be “free money”. After all, if you are in a position to depend on them for your livelihood, they really should be. Unfortunately, the IRS considers unemployment benefits the same as any other source of income, albeit with a few differences. The easiest way to figure out exactly how unemployment affects your taxes is to talk to one of the top tax relief companies. Alternatively, you can read this article where we will explain exactly how unemployment and taxes work together.

How unemployment affects your taxes?

The fact of the matter is that the U.S. tax system is incredibly complex, complicated, and convoluted. It is practically impossible to fully understand how unemployment affects your taxes in every single situation. That being said, you can start understanding how unemployment benefits and taxes work together by knowing the following three things:

  • Unemployment benefits are taxable
  • You cannot deduct your job-hunting expenses
  • Unemployment income is not considered to be earned income
tax form on a laptop and a post-it note staying don'f forget to pay your taxes
You do not want to forget to pay your income taxes.

As you might expect, the simple fact that unemployment benefits get taxed by the IRS means that you can accrue penalties if you do not report them accordingly. Therefore, you will want to familiarize yourself with all the possible IRS penalties and how to avoid them even if you are unemployed. Otherwise, you may find yourself in a very awkward situation and even jeopardize your benefits.

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Now, let’s dive a bit deeper into the subject.

How are unemployment benefits taxed?

The way that unemployment benefits work is by replacing a portion of your regular wages. Therefore, the IRS considers them to be your wages, in a way. This means that all of your unemployment benefits get taxed at your normal income tax rate. Now, this also means that you are eligible for standard tax credits and deductions, even if your unemployment benefits are your sole source of income. However, there is a chance that your state might withhold some of your taxes for one reason or another. This will be clearly stated on a Form 1099-G that you receive from the state that paid your unemployment benefits.

Job-hunting expenses

It used to be that you could deduct your job-hunting expenses (travel, resume costs, etc.) when filing your tax report. However, this is no longer the case. These days, all of the costs that are associated with job hunting are no longer deductible. All you can do is rely on the popular tax deductions that are still available to you. Furthermore, you also cannot deduct any moving expenses while receiving unemployment benefits, unless you are an active member of the military who is moving under military orders.

person handing a tax form to another
You cannot deduct your job-hunting expenses anymore.

Unemployment income is not the same as earned income

One of the more important things that you need to about how unemployment affects your taxes is that your unemployment income is not considered to be the same as “earned” income. The ramifications of this are that you can’t utilize unemployment compensation to benefit from EITC (Earned Income Tax Credit), nor you can use it to influence your childcare credit. In fact, being on unemployment benefits may actually reduce the amount of credit that you have previously received. If you are relying on these credits, it may be beneficial to hire a professional tax consultant to help you figure out your exact situation. There may be times when you can make a deal with the IRS and keep the amount of credit that you previously had. However, this heavily depends on the circumstances, which is why talking to a tax professional is usually preferable.

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Paying federal and state income taxes on unemployment benefits

Taxes on unemployment benefits are paid both on the federal and state level. There are strict rules that you need to follow, and the procedure might not be as simple as we all want it to be. While there are certain situations in which you might not need to pay state taxes, it is in your best interest to learn how to do so.

Paying federal taxes

When it comes to federal taxes on your unemployment benefits, the easiest way to pay them is to simply have them withheld from your weekly payments. To do this, you will need to file a Form W-4V with your state’s unemployment office. Do note that if you do this, the state will withhold 10% of each payment. Unfortunately, there is no way to change this percentage.

number 10 on a red background
Your state can only withhold 10% of your unemployment benefits.

The second option is to mail a check alongside Form 1040-ES or make the payment through IRS Direct Pay. The downside of this option is that it requires quite a bit of work and effort on your part, as you will need to do a lot of calculations.

Lastly, you can simply wait until your tax return and see how much you owe. However, this is not the best option in most cases, as you might be facing underpayment penalties.

Paying state income taxes

The problem with paying state income taxes on unemployment benefits is that each state has its own rules. For example, some states simply don’t have a state-level income tax. Other states might not tax unemployment benefits at all. Yet other states will tax only a portion of the benefits while some will tax them in full. The only states you don’t have to worry about state income taxes are Florida, Nevada, Tennessee, Texas, Alaska, South Dakota, Wyoming, New Hampshire, and Washington. The states of New Jersey, Pennsylvania, California, and Virginia don’t tax unemployment benefits at all.

Unless you live in one of those states, you will need to pay taxes on your unemployment benefits. Figuring out the exact amount can be rather tricky, however. The best thing you can do is get in touch with a professional tax advisor or your state’s tax agency.

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The easiest way to find a good tax professional near you is to consult the Consumer Opinion Guide. We can help you choose among the top tax relief companies in your state!

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